Luxury Tax - The Overpayment Penalty

NBA teams are hit with a hefty charge for paying players too much

The National Basketball Association caps player salaries at a certain level, which is based on a percentage of projected league revenue. But it is a "soft" cap -- there are a wide variety of mechanisms that teams can use to go over the cap. Teams can spend above the cap without penalty -- up to a certain point. But once a team's payroll hits the luxury tax threshold, the franchise faces additional charges.

History of the Luxury Tax

Under the previous collective bargaining agreement that took effect starting with the 2005-06 season, the luxury tax threshold was set at 61 percent of basketball-related income, and the tax charge was $1 for every $1 of payroll above the threshold. If the tax threshold was set at $65 million and a given team's payroll was $75 million, that team would be charged $10 million.

For the 2010-11 season, the salary cap was just over $58 million and the tax threshold was set at $70.3 million. Seven teams exceeded that number and paid the tax; the Orlando Magic were charged $20.1 million, while the Lakers and world-champion Dallas Mavericks had tax bills of $19.9 and $18.9 million, respectively. The largest tax charge was a staggering $54 million paid by the world champion Cleveland Cavaliers after the 2015-2016 season.

Tax Burden

Every team under the luxury tax threshold gets an equal share of luxury taxes collected for a given season.

That creates a double incentive for teams not to exceed the tax number: If you have a payroll over the tax threshold, you're hit with that charge and you also miss out on the payment. Less-wealthy teams have made quite a few moves driven by the luxury tax. For example, Utah's trade of Eric Maynor to the Oklahoma City Thunder.

Utah's payroll for the 2009-10 season was higher than anticipated because Carlos Boozer didn't opt out of a contract as expected and because they chose to match Portland's contract offer to restricted free agent Paul Millsap. So the Jazz swapped Maynor -- a very promising rookie point guard at the time -- with Matt Harpring, a highly-paid veteran with serious injury problems, for the draft rights to 2002 second-round draft pick Peter Fehse.

The Current CBA

The NBA and the player's union reached an agreement for a new collective bargaining agreement in late 2016 that will run through the 2023-2024 season. The luxury tax works the same way under the current CBA, except, as the "Washington Post" notes:

  • The luxury tax “apron” -- meaning the space teams have to operate between the luxury tax line and the “hard cap” -- is only $4 million, leaving teams little wiggle room if they jump over the luxury tax threshold.
  • The $4 million number was put in place when the salary cap was in the neighborhood of $50 million -- a figure that has nearly doubled to about $94 million. It's projected to increase by millions in coming years.
  • The apron is increasing to $6 million over the luxury tax line for next season and will then increase by half of the rate of the annual salary cap increase each year after that.

    In essence, there is no real hard cap -- but as the salary cap continues to increase, teams will have to pay an ever-larger penalty for signing players above the luxury tax threshold.

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    Your Citation
    Zegers, Charlie. "Luxury Tax - The Overpayment Penalty." ThoughtCo, Jul. 23, 2017, thoughtco.com/definition-of-luxury-tax-325991. Zegers, Charlie. (2017, July 23). Luxury Tax - The Overpayment Penalty. Retrieved from https://www.thoughtco.com/definition-of-luxury-tax-325991 Zegers, Charlie. "Luxury Tax - The Overpayment Penalty." ThoughtCo. https://www.thoughtco.com/definition-of-luxury-tax-325991 (accessed November 22, 2017).