Tax Consequences When a New Employer Bears the Cost of the Employee's Terminating a Prior Employment Relationship
15 Pages Posted: 14 Jun 2007
In the past few months, several college basketball coaches have accepted jobs at different schools. Several of these coaches, who were still under contract at their former institution, had buyout provisions that allowed them to terminate their relationship for a set price. John Beilein, the former West Virginia University and new University of Michigan basketball coach, is a prominent example of this since his buyout price was so high.
Prior to Beilein's hiring, there was speculation in the media that the University of Michigan would pay West Virginia University the amount owed under Beilein's contract (reported at the time to be approximately $2.5 million). The question then arose as to the tax consequences to Beilein that such a payment would engender.
The determination of the tax consequences to an employee whose new employer makes the buyout payment owing to the employee's prior employer raises issues that can arise in numerous circumstances and so warrants consideration. While we focus on Beilein's facts in the article, that is merely for convenience; and the issue is of much wider significance. The tax treatment of buyout obligations is merely a subset of the broader question of how to tax a new employer's payment of personal obligations of the new employee that are connected to the commencement of the new employment.
There were three possible methods for the University of Michigan to address Beilien's buyout provision: (1) the University of Michigan could pay, or reimburse Beilein for, the required buyout; (2) while the University of Michigan would neither pay the required buyout amount nor specifically reimburse Beilein, the university could pay Beilein a higher salary in order to offset or mitigate his buyout expense and (3) the University of Michigan could neither pay the buyout nor reimburse Beilein, and no additional compensation would be paid to Beilein to offset his expense.
This article will examine the possible tax consequences for each of the three options.
Keywords: Taxation, Employment, Termination, Buyout, Beilein
JEL Classification: H20, H24, H25
Suggested Citation: Suggested Citation