Personal services versus royalties in Sergio Garcia endorsement deal.
Sergio Garcia loses and wins in Tax Court
- Golfer Sergio Garcia signed a “head-to-toe” endorsement deal with sporting equipment maker TaylorMade in 2002.
- The endorsement deal was for personal services and royalties for use of Garcia’s image. Personal services are taxed as income in the United States and royalties are taxed at a lesser, variable rate.
- Garcia valued the personal services at 15 percent of the contract and the royalties at 85 percent of the contract.
- The IRS argued that the entire endorsement deal was for personal services and assessed a $1.7 million deficiency.
- The Tax Court found evidence that the deal hinged upon Garcia’s image and brand and adjusted the deficiency to reflect a 64/35 percent split between royalties and personal services.
Sergio Garcia’s golf career is built upon passion and craft. Popular with fans, Garcia won the 2017 Masters Tournament and the 2008 Players Championship. Garcia has accumulated $49 million in tournament winnings in his career. Feuds, angry outbursts on the greens and hurling a golf club at his caddy have marked his career, and Garcia is a golfer who holds the fans’ attention. He has spent most of his career ranked in the top ten among professional golfers.
For these reasons, sporting equipment maker TaylorMade signed Garcia to a seven-year endorsement contract in 2002. The contract was in exchange for Garcia using TaylorMade products exclusively during tournament play, including TaylorMade clubs, Adidas shoes, Maxfli gold balls and any other golf equipment he would use in a professional event. TaylorMade thought so highly of Garcia that they made him a Global Icon, a designation intended to promote their brand.
The IRS determined deficiencies of $930,248 for 2003 and $789,518 for 2004 related to the endorsement contract. The critical issue was how much of the endorsement money was for personal services performed in the United States, which would count as income and be taxed as income, and how much was royalty income, which, because Garcia was domiciled in Switzerland, would be taxed at 15 percent, the rate negotiated in the US-Swiss tax treaty. In Tax Court, both sides stipulated that 69 percent of the golfer Garcia’s personal services activities in 2003 occurred in the US. In 2004, that percentage was 68 percent.
Endorsement deal with TaylorMade
Garcia and TaylorMade wrote into the endorsement contract that 15 percent was for personal services and 85 percent was royalties for the use of the golfer’s image and Garcia’s using their golf equipment exclusively when playing in tournaments. Garcia’s argument was that the inclusion of the 15/85 split in the contract should be respected because the golfer and TaylorMade were “adverse parties” and that gave the percentage split some credibility. However, TaylorMade’s CEO stated that the allocation of personal services and royalty income was irrelevant to the company.
The IRS argued that all of the income from the endorsement deal was personal service income, hence the $ $1.7 million deficiency.
The Tax Court proceedings revolved around setting a more accurate percentage split between Garcia’s personal services income and royalty income. The Court determined that the endorsement contract was not solely for personal services and royalties for the use of Garcia’s image were a significant part of the deal, according to the Court’s decision:
“Multiple witnesses, familiar with the sports advertising industry as a whole and with the practices of TaylorMade specifically, have clearly and credibly testified that both the use of petitioner’s image rights and the personal services petitioner provided (especially his use of the TaylorMade products while playing in professional golf events) were crucial elements of petitioner’s endorsement agreement.” Sergio Garcia vs. the Commissioner of Internal Revenue, 2013
The Tax Court, in fashioning a compromise figure somewhere between Garcia’s generosity and the IRS’s absolutism, used a very recent decision about another golfer as a guide. A 2002 decision that hinged upon the same issues as the Garcia case involved Retief Goosen, one of the best golfers in the world at the time. He won the US Open in 2001, as well as several lesser tournaments. His image was in stark contrast the Garcia’s volatility, as he was known for his cool demeanor and focus under pressure. Goosen also had an endorsement contract with TaylorMade. The company characterized Goosen as a brand ambassador and not a Global Icon. At the time, the Court agreed with Goosen’s characterization that his endorsement income was 50 percent for personal services and 50 percent for royalties for use of his image.
The Court used this as a starting point to find a usable percentage split for Sergio Garcia. The challenge was that Garcia’s endorsement deal was much bigger than Goosen’s even though he was considerably less successful as a golfer. But the judge framed those discrepancies as evidence that TaylorMade’s primarily was interested in Garcia’s image and therefore the relative percentage of royalty income should be higher than 50 percent. The Court ultimately decided that a 65 percent to 35 percent split between royalties and personal services was warranted.
Sergio Garcia did not win his case outright, but he certainly reduced his tax deficiency considerably. A tax liability of 68 percent of 35 percent is a lot better that a liability of 100 percent, as the IRS argued.