Shohei Ohtani's Record-Breaking Contract

On December 9, Shohei Ohtani ended his free agent courtship by signing a record-breaking 10 year / $700M contract with the Los Angeles Dodgers. Ohtani’s deal not only made him the highest paid player in Major League Baseball, but it also made him the highest paid athlete in America.

Ohtani’s former teammate and future hall of famer, Mike Trout, is the second highest paid player in professional baseball; he is currently playing under a 12 year / $426M contract with the Los Angeles Angels—$274M less in total value. Although the total value is jaw dropping, Ohtani’s deferred salary is what makes this deal even more unique.

Deferred salaries in of itself are not unique to MLB. Former Arizona Diamondback’s owner, Jerry Colangelo, notoriously negotiated several deferred contracts in the early 2000’s. His approach led to a star-studded ball club and an eventual World Series win in 2001. However, when Ken Kendrick took over as the managing partner in 2004, he had to foot the bill for 18 different deferred salaries left over by Colangelo, 15 of which were no longer a part of the Diamondbacks organization—most notably Randy Johnson, Curt Schilling, and Luis Gonzalez. According to Kendrick, he was responsible for $254M in deferred salaries. This, in essence, financially restricted the Diamondbacks over the next decade because they had to continue paying former players along with their current roster.

On a larger scale, this led to MLB codifying deferred salaries into its Collective Bargaining Agreement (CBA); the CBA has largely maintained the same structure for deferred salaries since. Currently, there are no restrictions on how much money can be deferred, but each club is responsible for paying the deferred salary in an amount “equal to the present value of the total deferred compensation obligation, on or before the second July 1 following the championship season in which the deferred compensation is earned.”In other words, clubs can continue to defer as much as they want, but they will be subject to the Competitive Balance Tax (CBT)—commonly referred to as the “luxury tax.”

The luxury tax refers to an increased tax rate for each dollar that exceeds a predetermined amount set forth by the CBA. The predetermined amount is outlined in the current CBA (in effect until the end of 2026); the remaining total is as follows: $237M in 2024, $241M in 2025, and $244M in 2026. And the tax rate is is determined by using the average annual value of each player’s contract, plus any additional player benefits (e.g., moving expenses, travel allowances, etc.). Thus, if a ball club spends more than $237M in its 40-man roster payroll in 2024, they will be taxed an excess amount.

The tax rate is compounded over time for each consecutive year a club exceeds the predetermined amount. In year one, a club will have to pay a 20% tax on all overages; in year two, a club will have to pay a 30% tax on all overages; and in year three and beyond, a club will have to pay a 50% tax on all overages. If a club’s payroll goes below the luxury tax threshold for a season, then it resets, and they will go back to paying 20% if the exceed it again in the future. There are also additional surcharges if a club goes $20M over the threshold; the surcharge ranges from 12% to 60%.

Ohtani’s new contract creates a situation where the luxury tax will inevitably collide with his deferred salary. However, like Colangelo’s Diamondbacks, the Dodgers front office could not have asked for a better situation for their immediate future.

Typically, deferred salaries are spread out over a long period of time (i.e., ten years). And basic economics would tell us that the value should decrease over the length of the contract because of inflation and the decrease of the U.S. dollar over time. Since this is the case, it could look like Ohtani may have left some money on the table. This requires a deeper look.

If Ohtani’s chose to not defer any of his salary, then his contract would have an average annual value (AAV) of $70M for the next 10 years, and the Dodgers’ CBT payroll would reflect such. But any money deferred outside the term of the contract is calculated using its present-day value. Ohtani elected to defer 97% or $680M of his contact outside the term of his contract. Therefore, after adjusting for inflation, the Dodgers only have a payroll hit of roughly $53M when they start paying his annual salary of $68M in 2034. Their remaining payroll will look something similar to this: $52M in 2035, $50.5M in 2036, $49M in 2037, $48M in 2038, $47M in 2039, $46M in 2040, $44.6M in 2041, $43.5M in 2042, and $42.5M in 2043. Ohtani will still receive his $68M during each of those years, but it will not be as hard of a strain on the team’s payroll for CBT purposes; there is reportedly no interest with the deferred salary, so there is no additional compensation for the team to consider.

One major factor to also consider for Ohtani is if he chooses to move out of California by 2034. If he moves to a state with no state-income tax, then he can maintain millions more. If moves out of California to a tax-free state (i.e. Texas), then he will pay approximately 39.6% of his income in taxes (federal). If he stays in California, then he will pay approximately $53.75% in taxes (state, federal, and payroll). Obviously, Ohtani does lose the opportunity costs that comes with receiving the $68M now, but he will more than make up for it with off-the-field deals. The only real “risk” Ohtani faces with a deferred contract is the club’s ability to pay him. However, Forbes valued the Dodgers as worth $4.8B in 2023, so they are nearly a sure bet to be able to pay him.

The Dodgers, like the Diamondbacks of the early 2000s, are in a win-now mode, only their window is much larger. And since the Dodgers have been to the postseason for 11 consecutive seasons, it is likely that MLB will see its best player in the postseason for years to come.

Caleb Ortega is a 2L at South Texas College of Law. He served in the United States Marine Corps and is the Secretary of his school’s Sports & Entertainment Law Society. He can be reached on X and LinkedIn.

References:

[1] https://www.sportico.com/personalities/athletes/2023/shohei-ohtani-dodgers-contract-details-700-1234757983/

[2] https://www.eastvalleytribune.com/sports/deferred-contracts-still-limiting-d-backs-budget/article_a2bbfeec-ee4f-514c-9460-bb3725a7abf6.html

[3] https://www.mlb.com/news/shohei-ohtani-dodgers-deal-deferrals-explained#:~:text=“Article%20XVI%20–%20Deferred%20Compensation”,Uniform%20Player%27s%20Contract%20may%20provide.

[4] https://www.mlb.com/glossary/transactions/competitive-balance-tax

[5] https://www.mlb.com/news/shohei-ohtani-dodgers-deal-deferrals-explained

[6] https://www.cnbc.com/2023/12/14/why-shohei-ohtanis-700-million-contract-and-deferred-income-is-risky.html#:~:text=The%20Japanese%20superstar%20will%20receive,a%20guaranteed%208%25%20interest%20rate.

[7] https://www.voanews.com/a/7400829.html#

[8] https://smartasset.com/investing/inflation-calculator#1jDpbQlOr1

[9] https://www.forbes.com/teams/los-angeles-dodgers/?sh=1910ba8223ae

[10] https://www.usatoday.com/story/sports/mlb/columnist/gabe-lacques/2023/10/12/los-angeles-dodgers-mlb-playoffs-history/71154122007/#