The luxury tax and you: A primer

Phillies fans have grown accustomed to a very generous Santa in Ruben Amaro Jr. (David M Warren/Staff file photo)

There is no edict that says the Phillies must remain under the mythical barrier of the Competitive Balance Tax, better known as the luxury tax. The team is not required to open its books to anyone, so we cannot be sure what sort of profit margins exist at 1 Citizens Bank Park Way. Needless to say, times have never been this good for the money machine. And, in turn, the Phillies' payroll has never been higher.

But $178 million remains the ceiling set publicly by Ruben Amaro Jr. "Luxury tax" has replaced "revenue sharing" as the buzz phrase in South Philadelphia, the surest sign of changing times. (In fact, under the new collective bargaining agreement, the Phillies are ineligible to ever receive any revenue sharing money should times be tough again.)

Amaro has often said this winter that his team is up against the tax threshold. That has been met with skepticism because in actual dollars, the Phillies will pay their current roster approximately $156 million in 2012. 

But that's not how the payroll is calculated for luxury tax purposes.

Last season, the Phillies fell short of paying luxury tax by less than $1 million, according to a baseball source. Two payments totaling approximately $8 million from the Houston Astros to offset salaries for Roy Oswalt and Hunter Pence ensured the Phillies could stay under the $178 million mark.

The complication lies in two factors: Major League Baseball recognizes contracts by their annual average value (AAV) — not by the dollar amount the team is actually paying that player. So, for example, Cliff Lee earned $11 million in salary last season because the Phillies back loaded the contract. But under the guise of MLB, Lee accounted for $24 million in payroll because of the AAV of his five-year, $120 million deal.

In some instances, that can benefit the Phillies. Chase Utley made $15 million in 2011 and $15 million in 2012, but he counts for only $12.14 million against the luxury tax.

Ultimately, the two figures do not differ greatly.

NAME 2012 $$ AAV $$
Cliff Lee $21.50 $24
Roy Halladay $20 $20
Ryan Howard $20 $25
Cole Hamels $15 $15
Chase Utley $15 $12.14
Jimmy Rollins $11 $11
Jonathan Papelbon $11 $12.5
Shane Victorino $9.5 $7.3
Joe Blanton $8.5 $8
Placido Polanco $6.25 $6
Carlos Ruiz $3.7 $2.95
Kyle Kendrick $3.59 $3.59
Jose Contreras $2.5 $2.75
Ty Wigginton $2 $2
Jim Thome $1.25 $1.25
Laynce Nix $1.15 $1.25
Dontrelle Willis $0.85 $0.85
Brian Schneider $0.80 $0.80
Vance Worley* $0.48 $0.48
Antonio Bastardo* $0.48 $0.48
John Mayberry* $0.48 $0.48
David Herndon* $0.48 $0.48
Michael Martinez* $0.48 $0.48
Mike Stutes* $0.48 $0.48
Hunter Pence ARB 3 ARB 3
TOTAL $156.47 $159.26

* = estimated salary at major-league minimum of $480,000

So for 2012, the AAV is $3 million more than actual payroll. But we're still well shy of the mythical $178. 

That's where Hunter Pence, who remains unsigned, factors. Pence is in his third year of arbitration and his agent Rick Thurman (who just negotiated a mega-arbitration deal for Tim Lincecum) submitted a salary request of $11.8 million. The Phillies countered at $9 million, a difference of $2.8 million. (Pence made $6.9 million in 2011.)

The Phillies typically avoid arbitration hearings at all costs. They can be messy and detrimental. Since arbitration began in 1974, the Phillies have entered eight hearings. They have won seven and lost one, that one being the most recent in 2008 with Ryan Howard.

Thurman showed a willingness to go to a hearing last winter when he took Pence up against the Astros and won. That's not to say a hearing will happen again in 2012, but that $2.8 million could be quite important to the Phillies for luxury tax purposes.

Why? Well, every payroll (as recognized by MLB) must include monies for player benefits. That number, according to a source, typically amounts to $10 or $11 million per season. That's why the Phillies were so close to the limit last season, even with the Astros subsidizing a large chunk of salary.

So if Pence makes $9 million in 2012 and $10 million in benefits is added, the Phillies hit that mythical $178 million figure. If he's at $11.8 million, they could go over.

Again, we'll stress these are rough calculations and plenty of things can change between now and the end of the season, when MLB does its accounting. But this paints a clearer picture of how the Phillies actually toe the line between paying the tax and not.

Teams that surpass the threshold of $178 million in 2012 will be taxed 20 percent for every penny over. The ceiling remains $178 million in 2013, but the penalties increase for repeat offenders. So if the Phillies go over in 2012 and 2013, they would pay a 30 percent tax in 2013. If they go over only in 2013, it's a 17.5 percent tax.

The threshold then increases to $189 million in 2014. So, logically, it would make most sense for the Phillies to be amenable to paying the luxury tax in 2013 because with the higher ceiling in 2014, they could avoid it. Once a team skips a year in paying luxury tax, they receive amnesty and return to the original rate of 17.5 percent.

Either way, the Phillies are relegated to bottom-feeding on the current market, turning to such moves as signing outfielder Juan Pierre to a minor-league deal Friday. Pierre made $8.5 million in 2011 and always has a good rep because he puts the ball in play and can run. He'll have a shot at the final bench spot out of spring training.

The Wilson Valdez trade wasn't made solely for financial purposes, but it didn't hurt saving $500,000 on the utility infielder spot when they already had a quite similar player in Michael Martinez. The Phillies never planned on replacing Valdez with such names as Jeff Keppinger and Ryan Theriot, who both signed elsewhere in the last two days.

Neither side on the Pence negotiations was willing to comment this week beyond a standard "negotiations are continuing." It's unlikely the case moves to a hearing, but it bears watching because $2.8 million means a lot to the Phillies right now.

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