How does the NBA's luxury tax work?

How does the NBA's luxury tax work?

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How does the NBA's luxury tax work?

In theory, the NBA has a salary cap which is supposed to deter teams from stacking the deck and signing every high-price free agent they want. But because the league’s salary cap is a “soft” one, organizations are easily able to circumvent that cap in order to re-sign their best players, bring in pricey outside help for those players and use exceptions to acquire other mid-tier free agents.

Without the ability to do that, some of the greatest teams in NBA history – the ’80s Los Angeles Lakers, the ’90s Chicago Bulls, the ’00s Lakers and the ’10s Golden State Warriors – would never have been able to come together, so we should be thankful the NBA is so lenient about how they regulate the salary cap.

The main deterrent team owners face when building their rosters is something that’s known as the luxury tax. In the simplest terms, the luxury tax is an incremental tax owners have to pay for their teams going over the salary cap. The higher over the salary cap they go, the higher the annual tax they have to pay is. Obviously, this affects some owners – the ones with less money, usually located in smaller markets – more than others.

Here’s how ESPN’s Larry Coon breaks it down:

“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) exceeds the tax level.”

The exact tax rates depend on a few different factors. For starters, and rather obviously, how far above the salary cap a team’s roster is:

  • For teams between $0 and $4,999,999 over the cap, the tax rate is $1.50 for every dollar over the cap.
    • The incremental maximum for this level is $7.5 million.
  • For teams between $5,000,000 and $9,999,999 over the cap, the tax rate is $1.75 for every dollar over the cap.
    • The incremental maximum for this level is $8.75 million.
  • For teams between $10,000,000 and $14,999,999 over the cap, the tax rate is $2.50 for every dollar over the cap.
    • The incremental maximum for this level is $12.5 million.
  • For teams between $15,000,000 and $19,999,999 over the cap, the tax rate is $3.25 for every dollar over the cap.
    • The incremental maximum for this level is $16.25 million.
  • And for teams $20,000,000 over the cap or above, the tax rate is $3.75 for every dollar over the cap, and increasing $0.50 for each additional $5,000,000 over $20,000,000.

So, for a simple example, let’s say a team is $18 million over the cap. Their luxury tax would then be $38.5 million. Why? Because we add the incremental maximums of $7.5 million, $8.75 million and $12.5 million to arrive at the bracket between $15.0 million and $19.99 million. That leaves us at $28.75 million. Then we multiply $3 million (the difference between the $18.0 million the team is over the tax and the $15.0 million of the relevant incremental maximum value) by $3.25, giving us $9.75 million. Add those two totals together and viola, we arrive at the $38.5 million luxury tax.

Additionally, there’s a higher tax for teams known as repeat offenders. Repeat offenders are defined as teams that have paid luxury taxes in at least three of the prior four seasons.

For repeat offenders, the luxury tax breaks down as follows:

  • For teams between $0 and $4,999,999 over the cap, the tax rate is $2.50 for every dollar over the cap.
    • The incremental maximum for this level is $12.5 million.
  • For teams between $5,000,000 and $9,999,999 over the cap, the tax rate is $2.75 for every dollar over the cap.
    • The incremental maximum for this level is $13.75 million.
  • For teams between $10,000,000 and $14,999,999 over the cap, the tax rate is $3.50 for every dollar over the cap.
    • The incremental maximum for this level is $17.5 million.
  • For teams between $15,000,000 and $19,999,999 over the cap, the tax rate is $4.25 for every dollar over the cap.
    • The incremental maximum for this level is $21.25 million.
  • And for teams $20,000,000 over the cap or above, the tax rate is $4.75 for every dollar over the cap, and increasing $0.50 for each additional $5,000,000 over $20,000,000.

Using the same example of a team $18.0 million over the tax, the luxury tax for a repeat offender would be a whopping $56.5 million. First, we get $43.75 million by adding the three incremental maximums before we arrive at the appropriate bracket. We then get $12.75 million by multiplying the missing $3.0 million by $4.25 to get to the full amount the team is over the cap. Add the two and we get our luxury tax total.

Needless to say, that’s a sizable chunk of change even for the richest owners, which goes to show just how effective the luxury tax can be as a deterrent to high-spending teams.

HOW MUCH TAX WOULD A TEAM PAY?

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