From cba questions... second to last bullet point.
18. What is the "luxury tax?" Why does it exist? How is it determined? Who pays it?
The luxury tax is a mechanism that helps control team spending. While it is commonly referred to as a "luxury tax," the CBA simply calls it a "tax" or a "team payment." It is paid by high spending teams -- those with a team salary exceeding a predetermined tax level. These teams pay a penalty for each dollar their team salary (with a few exceptions, see below) exceeds the tax level.
The tax level is determined prior to the season, and is computed by taking 53.51% of projected BRI (see question number
12), subtracting projected benefits, and dividing by the number of teams in the league1. The tax level may be adjusted from there, based on what happened during the previous season:
- If the league didn't pay the players enough the previous season, i.e., if they had to cut the players a supplemental check to make their guarantee, then the shortfall, divided by the number of teams in the league1, is added to the tax level. For example, if the players are paid $90 million less in 2017-18 than they are guaranteed, then the 2018-19 tax level is adjusted upward by $3 million.
- If there is an overage -- i.e., if the players were paid more (pre-escrow) than their guaranteed share in the previous season -- and the system is getting close to exceeding what the league can get back through the escrow system, then the tax level (and salary cap) may be reduced in order to put on the brakes (see question number 17 for more information).
Teams pay an incremental tax rate based on their team salary as of the team's last regular season game, and whether the team is a "repeat offender," i.e., whether they were also taxpayers in at least three of the four previous seasons (not including the most recent season):
| Lower | Upper | Tax rate | Incremental maximum | Tax rate | Incremental maximum |
|---|
| Team salary above tax level | Non-repeater | Repeater | | | |
|---|
| $0 | $4,999,999 | $1.50 | $7.5 million | $2.50 | $12.5 million |
| $5,000,000 | $9,999,999 | $1.75 | $8.75 million | $2.75 | $13.75 million |
| $10,000,000 | $14,999,999 | $2.50 | $12.5 million | $3.50 | $17.5 million |
| $15,000,000 | $19,999,999 | $3.25 | $16.25 million | $4.25 | $21.25 million |
| $20,000,000 | N/A | $3.75, and increasing $.50 for
each additional $5 million | N/A | $4.75, and increasing $.50 for
each additional $5 million | N/A |
For example:
- A team with a team salary $12 million over the tax level pays a tax of $21.25 million (the incremental maximum of $7.5 million for $0 to $4,999,999, plus the incremental maximum of $8.75 million for $5 million to $9,999,999, plus $2 million times the incremental rate of $2.50 for $10 million to $14,999,999).
- A team that was a taxpayer in three of the four previous seasons, with a team salary in the current season $4 million over the tax level pays a tax of $10 million ($4 million times the repeater rate of $2.50 for $0 to $4,999,999).
When determining the amount of tax a team owes, the league uses its team salary (see question number
13) on the date of its last regular season game (i.e., if a player is traded away before the end of the season, then none of his salary is taxed), with the following adjustments:
- Cap holds and exceptions are ignored.
- Any "unlikely bonuses" (see question number 74) that were actually earned are added to the team salary.
- Any "likely bonuses" (see question number 74) that were not earned are subtracted from the team salary.
- Any trade bonuses (see question number 99) for players received in trade after the last regular season game are added to the team salary. This amount may be pro-rated -- see question number 100 for details.
- Any amounts from settlements of grievances are added to the team salary.
- For players who signed as free agents (i.e., not draft picks) under the current CBA, and make less than the two-year minimum salary, the minimum salary for a two-year veteran is used in place of their actual salary.2,3
- For minimum salary players whose salary is partially paid by the league (see question number 22) only the amount paid by the team (the two-year minimum salary) is taxed.