CBA 101: The Luxury Tax

Hey all. Welcome to the second in a series of posts where I'll be outlining the basic rules of the NBA Collective Bargaining Agreement.

Again, useful sources for more information on the salary cap include the CBA itself and of course Larry Coon's CBAfaq.com.

In the last post, I talked about the salary cap in the most general sense, and touched on some key ideas to understand when talking about team salaries, cap room, and exceptions.  In this post, we'll move on to other team salary thresholds, including the salary floor, the luxury tax, and the apron.

The Salary Floor

The salary cap is a limit to the amount a team can spend in terms of annual salary.  This year's salary cap is about $63 million.  The salary floor is the opposite - it is the minimum each team is expected to spend in salary.  Each year it is set at 90% of the salary cap - meaning this year it is $56.7 million.

There aren't really any penalties to not spending enough - the team simply needs to top up their salary at the end of the year to that minimum amount.  So if a team spends $50 million this year in salary, at the end of the year they cut a cheque to the NBAPA for the remaining $6.7 million.  That money is then redistributed among the players on the team proportionally to their salary.

As you can see, that's not much of a penalty.  But it does provide incentive for teams to get to the salary floor, since they in theory add assets without spending any more actual money.  I outlined a scenario where this came into play in one of my off-season review pieces.

The Luxury Tax

So, we have the salary floor and the cap.  The next threshold is the luxury tax.

With a soft cap, as outlined in the first post of this series, a team can exceed the cap by using exceptions.  This allows teams that want to spend money to increase their team salary year over year.  That can lead to rich teams spending a ridiculous amount of money to buy wins.  As evidenced by the Knicks in the past decade and more, that doesn't always work.

Nonetheless the league was concerned about parity. So the luxury tax threshold was introduced.

Once a team spends beyond the luxury tax, they are penalized financially - they pay a fine (or tax) directly to the league, in addition to the salary they pay their players.  In the original version of the luxury tax, teams were taxed $1 for every dollar they were over the tax.  In the newest CBA, those penalties are increased - it starts at $1.50 per dollar, and those penalties go up the higher your team salary is.  After the first $5 million, the tax increases to $1.75 per dollar.  After the next $5 million, it is $2.50 per dollar.  And it keeps going up.

This means teams have to pay a huge amount of tax on even a small salary if they are far over the tax, thus discouraging teams from trying to just outspend the rest of the league.  The Brooklyn Nets are a great example of this - last year they paid $90 million in tax, and lost money because of it.  Andrei Kirilenko's deal with them was only worth about $3 million to him, but because of how deep they were in the tax, it cost them $15 million.

The total payment of tax that goes to the league gets distributed as the league sees fit - but at least a chunk of it gets paid out to non-tax teams each year.  So not only do teams lose the money they are taxed when they cross the tax threshold, but they also lose the payout from the league that non-tax teams get.

It should be noted that unlike the cap, which is looked at all the time to determine if a team is over or under at the time of any transaction they want to make, luxury tax payments are determined only based on team salary at the start of the last game of the regular season.  So a team can be over the tax all year long, but if they can dump salary at the deadline, they might not have to pay any tax at all.

The Repeater Tax

In the newest CBA, they made the luxury tax even more punitive, as seen above.  But they didn't stop there.  They realized that some teams would be willing to bear the weight of paying heavy taxes if they thought it would give them a shot to win it all.  There was a concession made here - let those teams spend big money for a shot, but don't let them do it indefinitely.  They added a clause to the luxury tax called the "repeater" tax.

If a team is paying the luxury tax, the league checks to see if they have done so a lot recently as well.  If the team has paid luxury tax in at least three of the past four seasons (including the current season), then they activate the repeater tax.  The impact of this is that their tax payment to the league is increased by an additional $1 per dollar over the tax threshold.  In the Nets case, that would have been an additional $31 million in taxes if they had activated the repeater tax penalties.

The Luxury Tax Apron

And the owners were not done yet.  In the interest of further limiting teams who wanted to pay the tax, it was decided that not only should teams be punished financially, but they should actually lose the ability to add salary in certain ways.

Tax paying teams lost the Mid-Level Exception (MLE).  They are now reduced to the Tax-Payer's MLE, which offers significantly less money per year ($3.3 million versus $5.3 million) and one less year in maximum contract length (3 years versus 4). They lost the ability to use the smaller Bi-Annual Exception as well.

They also lost the ability to receive a player in a sign-and-trade transaction.  We'll get into more details of how sign-and-trades work in a future post, but essentially they allow teams without cap room to sign free agents using the traded player exception instead of an exception like the MLE, meaning they can sign players to larger salaries.

But upon reflection, this created a disastrous step from $1 under the luxury tax to $1 over it.  It was considered too sudden a penalty to apply all of these financial penalties (losing the non-tax team payout, paying luxury tax) and also apply all of these more practical penalties.  So the practical penalties (the losses of the exceptions and sign-and-trades) were pushed back $4 million above the tax line.

That point $4 million above the tax is called the tax apron.  Any team above the tax apron is limited to the smaller exceptions listed above, and cannot receive a sign-and-traded player.

The trick here is, the reverse is also true.  If a team receives a player in a sign-and-trade, or uses the full Mid-Level Exception, they cannot at any point during that season exceed the apron.  No matter what.  This is the one situation in the NBA where there is a true hard cap implemented - only for the one year, mind you.  As I noted in the final installment of my off-season review series, this was the reason behind using the tax-payer's mid-level exception instead of the full mid-level exception to sign James Johnson - the Raptors are not hardcapped for the year because of that choice, which frees up trade options later in the season.

So there you have it.  Those are the basic rules that apply to high-spending teams, and the implications of exceeding the luxury tax.  Next time, we'll get into more detail on trade rules.

As we go along with this, I'll try to answer any specific questions related to the post in the comments, but if there are any larger topics you want covered, sound off in the comments as well, and I'll dedicate a future post to covering it in-depth.