How Deferrals REALLY Work with example. Because most sources are useless.

[bean5302]

Alrighty! So this has been brought up a lot of times. The Dodgers are ruining baseball, teams are mortgaging their futures, these players will stop signing their contracts when the first team declares bankruptcy, etc. Unfortunately, real source material for understanding how deferrals work is in very short supply. Most stories with headlines suggesting they'll explain just say the same things, and list a bunch of historical contracts without any actual explanation at all.

First, here's my source (Forbes cites the Athletic as it's source)
https://www.forbes.com/sites/danfreedman/2024/12/12/a-deep-dive-into-deferred-contracts-from-the-1950s-to-today/

What the article says. MLB teams have to 100% pre-fund deferred salaries within 2 years after the deferral is earned. Ohtani deferred 2024's salary so the Dodgers have to pre-fund the liability by July, 2026. MLB lets teams discount the total amount due by an assumed 5% growth rate for however long the salary is deferred. In Ohtani's case, the deferral period is 10years.

Ohtani made $2MM in direct salary in 2024 and he deferred the other $68MM for 10 years to be paid in 2034. Assuming a 5% growth rate, that means the Dodgers have to put away $41,746,101 in 2024 for it to grow and be worth $68,000,000 in 2034, but MLB gives the Dodgers a 2 year extra grace period so don't have to put that money in until 2026, which I think is a potentially major problem. This doesn't mean the Dodgers haven't already funded it or their agreement with Ohtani doesn't require the Dodgers to immediately fund. I think it's likely Ohtani did tell the Dodgers they had to immediately fund. The longer the Dodgers wait to fund, the more cash they have to spend. If the Dodgers invest the cash in the current year it equals $41,746,101 per year. If they wait a year and don't start funding to 2025 it increases to $43,833,406, and if they wait the maximum of 2 years under MLB rules, it jumps to $46,025,077.

This is kind of a WORST CASE scenario if the Dodgers push funding off 2 years with the glossary:
Year = Calendar Year
Salary = Salary paid to Ohtani directly by the Dodgers during the year he plays.
Deferred = Salary from this year which Ohtani has elected to defer into the future.
Escrow Paid = This is the future salary Ohtani elected to defer getting paid out in the future year.
Def. NPV @5% = This is the amount of cash, which if invested at 5% will grow to the deferred ($68MM) in 8** years.
LA Escrow Cash = This is the amount of cash LA will need to invest into Ohtani's escrow account under MLB pre-funding rules.
LA Cashflow = This is the amount of cash LA will have to pay directly for Ohtani's services.
Ohtani Balance = This is the amount of cash due to Ohtani in the future.
Escrow Required = This is the balance the escrow account needs to be at under the 5% MLB growth rule.
*Actual Escrow = This is the balance of the escrow account if we assume the Dodgers can't get a 5.00% return and only get 3.00%
*Shortfall = This is the extra cash the Dodgers would need to kick-in if their investments only earned 3.00% instead of 5.00% to fully fund Ohtani's escrow.
*LA Total Cash = This is the total cash flow from the Dodgers into Ohtani's salary and benefits.

*If the Dodgers DO get 5.00% on their investment, there would be no shortfall and the "LA Cashflow" would exactly match "LA Total Cash" column.
**Even though the salary is deferred 10 years, this assumes LA doesn't even start funding for 2 years under MLB rules so they only get 8 years of growth.

This is how deferrals work. This is how teams are required to fund them. This is what happens if a team isn't able to earn 5.00% or better. This is why Ohtani's contract is not reeeeallly 10 years and $700MM.

Do pay attention to the LA Total Cash column at the far end of the spreadsheet. I don't expect the Dodgers won't be able to secure a bare minimum of a 2.00% investment even under dire market conditions so 3.00% is a fair bad case scenario to model. You can see the Dodgers could be on the hook for $10MM of cash more per year than they bargained for at the end of Ohtani's playing time if their investments don't pan out well, and you can see continued cash shortfalls on the escrow after Ohtani quits playing. The risk, though, isn't as much as you might expect even in a really bad case scenario. This is also why the NFL (50% max) and NBA (25% max) restrict deferrals. They have salary HARD CAPS. Hard caps could become major issues with deferrals. That $8.8MM shortfall in 2034, after Ohtani no longer plays could hypothetically become dead cap or at least I'm sure the NFL and NBA are concerned about major salary cap manipulation.

Basically, it's the same as Ohtani getting $2MM salary + $41.7MM and investing the $41.7MM himself at 5%, except he doesn't have to pay the taxes on the $41.7MM yet. There is far more complexity to the issue from a tax perspective for the Dodgers, but I'm not sure how they technically fund it or report it. 

What if an MLB team goes bankrupt? Well, it depends on whether on the technicalities of how the deferrals are funded. Are they put into an irrevocable trust not owned by the team or are the assets held in Dodgers cash investments, etc? If a player allowed the escrow account to be co-mingled with Dodgers assets, yeah, the player could become a general creditor which would be potentially bad. I think that's improbable, though. What a mess if the Dodgers traded Ohtani to the Yankees? The Dodgers would have to potentially have to sell off hundred of millions of dollars in their investments, get killed by the taxes, and then fund the Yankee's new escrow account because the Yankees aren't going to trust the Dodgers to hold the money, know what I mean? Anyway, luckily, MLB requires certain liquidity and cash reserves for their teams so teams in dire financial circumstances (recently the Mets) or rough spots (Padres) can be forced to be sold (Mets) or cut payrolls (Padres). The risk of a true bankruptcy for an MLB team seems remote without the collapse of the entire sport.

[ashbury]

Hello Twins front office, if you are lurking, what's happening, ummm, yeah, I'm gonna need you to go ahead and, like, blink twice or something, and confirm that this is about how you see it, m'kay?  That would be great.  😀

 

(Fantastic post.)

[nicksaviking]

37 minutes ago, ashbury said:

Hello Twins front office, if you are lurking, what's happening, ummm, yeah, I'm gonna need you to go ahead and, like, blink twice or something, and confirm that this is about how you see it, m'kay?  That would be great.  😀

 

(Fantastic post.)

[ashbury]

53 minutes ago, nicksaviking said:

If you would, would you walk us through a typical day for you, Mr. St. Peter?

[Vanimal46]

This is old school Twins Daily. Content that taught me something I didn’t know before. Excellent work! Better than 99% of the front page articles here. 

[tony&rodney]

The Diamondbacks had their wrists slapped a few years back for too many deferrals. One thing to consider is that any team can defer contracts but only to that amount where the money gets set aside and is covered. How does a team worth $1 billion defer $1 billion+ in salaries? This is complex and it is easy to understand how the players like this arrangement because it is good for income. Similarly it is easy to understand how the wealthier teams like this arrangement because it reduces their CBT liability and they have the money to set aside which satisfies requests from players and may also benefit the club financially as well in the long run.

I'm not seeing the attraction for about 20 teams in MLB and it makes one wonder how that affects competition. From a distant viewpoint it looks like the CBA is largely a negotiation between the MLBPA and the  ten or so wealthiest franchises. The players get enough to agree to terms, especially the top earners, and roughly two thirds of the clubs are still viable financially via revenue distribution to still be among the club (MLB).

 

[IndianaTwin]

3 hours ago, Vanimal46 said:

This is old school Twins Daily. Content that taught me something I didn’t know before. Excellent work! Better than 99% of the front page articles here. 

 And with a headline that was clickbaity in a helpful way.  

[IndianaTwin]

My son got me a "Relax, I have a spreadsheet for that" refrigerator magnet, so yeah -- thanks for this. It's also helpful to know the rules for covering such deferrals. 

To make sure I'm understanding the columns, the cash flow of the payout to Ohtani is in the first and third columns, right? 

In March 2023, Forbes put the Dodgers' franchise value at $4.8 billion. I don't know how much a franchise grows in value, but if it's 3 percent per year for 12 years, that puts the value at about $6.8 billion when Ohtani starts to get his big checks. One wonders about the possibility of him getting into the ownership structure at that point. 

(Of course, that doesn't take taxes into account. Who knows where brackets will be then, but at the current top 37 percent federal and 12.3 percent California taxes, his current pay would have him in a marginal bracket hitting 50 percent on the portion for his home games and the road games in California.)

[old nurse]

All very nice except for one small detail. MLB handles the escrow accounts. The CBA would state where any of the profits off an escrow account goes. Teams are also required to escrow the year’s payroll . 

[tony&rodney]

18 hours ago, old nurse said:

All very nice except for one small detail. MLB handles the escrow accounts. The CBA would state where any of the profits off an escrow account goes. Teams are also required to escrow the year’s payroll . 

Curious where you find this information?

[bean5302]

19 hours ago, old nurse said:

All very nice except for one small detail. MLB handles the escrow accounts. The CBA would state where any of the profits off an escrow account goes. Teams are also required to escrow the year’s payroll . 

 

38 minutes ago, tony&rodney said:

Curious where you find this information?

@old nurse's assertion is reasonable based on the CBA's Basic Agreement page 241-242 describing player salaries and other debts which are held in an MLB Escrow account controlled by the office of the commissioner. I believe this only pertains to salary being paid in the given playing year. However, where the actual funding of deferred salaries are concerned, it appears to be left up to the player's specific contract with some restrictions.
https://www.mlbplayers.com/_files/ugd/4d23dc_d6dfc2344d2042de973e37de62484da5.pdf

Quote

page 90 - Unless the Uniform Player’s Contract provides otherwise, a Club may fund deferred compensation obligations in such manner as it elects, provided that: (a) the funding method used by the Club must be such that the amount(s) funded are exclusively for the uses and purposes of satisfying the deferred compensation obligation(s) being funded; (b) the amount(s) funded are maintained in the form of unencumbered assets comprising cash or cash equivalents and/or registered and unrestricted readily marketable securities, unless a Club obtains the Parties’ prior written authorization of an alternative form; and (c) such amount(s) funded are subject to the claims of the Club’s general creditors

What I read is teams can co-mingle the deferred comp escrow with their own assets as specified under the Uniform Player Contract (UPC), but if the club does that, the escrow account must not be shielded from general creditors as I noted above. Ohtani is almost certainly not following a UPC as I outlined.

Of course I'm probably not an agent or front office employee of the Twins or an MLB front office employee or a lawyer or financial compliance officer. Probably. LOL.

[NeverSeenATwinsPlayoffWin]

I wonder what tax loophole makes this a beneficial deal for Ohtani. From the player's perspective, it seems very disadvantageous to defer payment, unless those deferrals reduce Uncle Sam's cut of your contract.

MLB's rules allowed the Dodgers to pay more to the luxury tax last year than the Rays and Athletics spent on their entire rosters. I don't understand why teams are allowed to do this type of maneuvering to move payroll into future years when large-market teams can just spend whatever they want. 

[tony&rodney]

What seems possible if not real is that the Milwaukee Brewers or as many as 20 other teams would not be allowed to defer $1 billion + in salaries. The playing field is not level. There is what I would term a very lame defense of deferrals up on MLBTradeRumors.com. Ultimately, the wealthy teams (in terms of valuation/market size) (all of the owners are wealthy) make good use of the current rules and dictate to some extent how the lower half exist.

I don't think that a cap or floor necessarily helps. I do think combining all media monies and stadium revenues into a pot and dividing by the number of teams would work. Well, except that that will never happen.

There are other decisions that can have some effect. Change the days on IL to 15 days and not allow a player who is sent to the minor leagues  to be recalled for any reason for 15 days. Reduce the number of times a player can be shuttled back and forth. Change the number of years a player can be retained in the minor leagues to age 25 or 26. Simply ideas off the top of my head, some need further thinking and work. 

[bean5302]

36 minutes ago, NeverSeenATwinsPlayoffWin said:

I wonder what tax loophole makes this a beneficial deal for Ohtani. From the player's perspective, it seems very disadvantageous to defer payment, unless those deferrals reduce Uncle Sam's cut of your contract.

MLB's rules allowed the Dodgers to pay more to the luxury tax last year than the Rays and Athletics spent on their entire rosters. I don't understand why teams are allowed to do this type of maneuvering to move payroll into future years when large-market teams can just spend whatever they want. 

Not sure how this works for MLB, but assuming this works the same way as a non-qualified deferred compensation plan like 409A plans for executives and companies.
Ohtani's deferrals are not taxable as income. Thus, if he doesn't live in California or the United States when the deferrals start, he probably doesn't ever pay ordinary income tax to them for the deferrals.

For the Dodgers, they can claim the future payments as a deferred tax asset on the profit/loss statements in the books (P&L). Essentially, the Dodgers say they're going to have to pay those benefits in the future, and thus, they should be able to claim the tax benefits from paying that liability in the current year. So the $68MM future benefit nets the Dodgers a $27.2MM boost to their P&L, assuming the Dodgers have a 40% corporate tax bracket (68 x 40%). Of course, that assumes the Dodgers file as a C-Corp rather than an S-Corp or LLC or something like that.

You can see in the chart that the Dodgers had to fund the escrow out of pocket. The chart assumes the Dodgers move it into the future, but they don't have to do that. If the Dodgers didn't use the grace period and funded immediately (which Ohtani's contract probably required), the Dodgers' cash flow was likely the $41.7MM. It'd look like this for reference:

[old nurse]

17 hours ago, tony&rodney said:

Curious where you find this information?

 The supposition that the Dodgers are controlling the funds of an escrow account are made without the least bit of proof. 

[tony&rodney]

2 hours ago, old nurse said:

 The supposition that the Dodgers are controlling the funds of an escrow account are made without the least bit of proof. 

I was only wondering where you fund your information because I was curious.

[old nurse]

3 hours ago, tony&rodney said:

I was only wondering where you fund your information because I was curious.

Sorry I don’t keep a bibliography and detailed notes of where I read things at.. try looking up the old owners of the Mets as to why MLB would not want the owners hanging on to differed money 

[bean5302]

On 1/28/2025 at 1:33 PM, IndianaTwin said:

My son got me a "Relax, I have a spreadsheet for that" refrigerator magnet, so yeah -- thanks for this. It's also helpful to know the rules for covering such deferrals. 

To make sure I'm understanding the columns, the cash flow of the payout to Ohtani is in the first and third columns, right? 

In March 2023, Forbes put the Dodgers' franchise value at $4.8 billion. I don't know how much a franchise grows in value, but if it's 3 percent per year for 12 years, that puts the value at about $6.8 billion when Ohtani starts to get his big checks. One wonders about the possibility of him getting into the ownership structure at that point. 

(Of course, that doesn't take taxes into account. Who knows where brackets will be then, but at the current top 37 percent federal and 12.3 percent California taxes, his current pay would have him in a marginal bracket hitting 50 percent on the portion for his home games and the road games in California.)

Missed this. Yes. Cashflow payout to Ohtani is his salary and the Escrow Paid.

[Trov]

Thanks for the post, it is a bit over my head on the financing side, but the Dodgers have a lot more than Othani's deferred salary. I do have a feeling that if continue to do this eventually they will lack the funds.  This is because not every player will be cool with kicking their money down the road and want more upfront.  The fact that the money already needs to be set aside does help the Dodgers, but teams have learned not having the cash on had will start to be a problem, ala the Padres. Big market teams like the Dodgers will be able to do this, but the mid and smaller markets will not. 

[tony&rodney]

On 2/25/2025 at 8:32 AM, Trov said:

Big market teams like the Dodgers will be able to do this, but the mid and smaller markets will not. 

Small market teams are not allowed to defer contracts to the level of the Dodgers by MLB because they don't have the money to set aside.