Circumventing The Luxury Tax

The Greedy Pinstripes is going to be making some minor changes when the 25-man/Active Roster is announced later today (it's due to 5:00pm EST). While getting ready for that change I decided to do some digging to figure out some things regarding the team payroll.

You see, I wasn't 100% sure about how options and extensions affected the average annual value of a player's contract. For example, when CC Sabathia signed the extension at the end of last season, then what was the new AAV? Over at River Avenue Blues they believed that the new deal just took over, meaning you'd go by the 5 year/$122 million contract. But that didn't seem right to me, as that doesn't make the new contract an extension at all. If CC had opted out and the Yankees re-signed him to that 5 year deal, then it would make sense. What about the options for Nick Swisher and Robinson Cano? Is the option year treated as a whole different contract, or is that option year simply added onto the current contact as I believed? After all, if the buyout to those option years was figured into the AAV before, why wouldn't the option year be included into that contract when it was picked up? Well, I ended up stumbling upon information that was very interesting.

For starters, it turns out that option years are included with the rest of the contract. Therefore, Nick Swisher's AAV is not $10.25 million, it is $6 million, based on his deal now being 6 years and $36 million. This is what happened to Marco Scutaro's contract with the Boston Red Sox, which you can read about here. Also, Robinson Cano's AAV is not $14 million, it's $8.8 million, based on his deal now being 5 years and $44 million.

Something I hadn't expected to find dealt wiith Derek Jeter's contract, and average annual value. I figured all options were treated the same, meaning that the year of the option didn't count until the option was exercised, however the buyout for that option was figured into the AAV. It turns out different types of options are treated differently according to how it affects the Luxury Tax. While club and vesting options are figured in like how I originally thought, player and mutual options are treated as "guaranteed years". So we are to treat Derek Jeter's 2014 player option as a guaranteed year, therefore it's not an AAV of $17 million based on a contract of 3 years and $51 million, it's an AAV of $14 million based on a contract of 4 years and $56 million ($51m - $3m buyout + $8 million 2014 salary).

Now we get to my favorite part.

Luxury Tax rules stipulate that if an extension is signed before the current deal expires (the expiration date is Opening Day of the last year of the contract), then the years and money "spent" from the old deal are consolidated into the years and money of the new deal. Here are two of the bigger examples I ran into...

Philadelphia extended Ryan Howard before the 2010 season started, thus making it so his old deal affected the AAV of his new deal. Howard's deal before the extension was agreed to was for 3 years and $54 million (an AAV of $18 million), for the years of 2009 through 2011. Howard's new deal was worth 5 years and $125 million (an AAV of $25 million), for the years 2012-2016. Therefore, according to the Luxury Tax, his current contract is now a 6 year deal worth $153 million (The old deal made the AAV of 2010 $18m, plus the years of 2012-2016 at an AAV of $25 million each, and finally add the $10 million buyout of the club option for 2017). This ended up costing the team more towards the Luxury Tax threshold in 2010, but less towards the Luxury Tax threshold in 2011-2016. This made sense for the team as the Luxury Tax threshold was $170 million in 2010, while the team was only at $142 million on Opening Day. Therefore they had no reason to worry about the AAV of Howard's contract being a bit higher in 2010, as they wouldn't reach that $170 million mark anyway (unless they made a huge splash during the season with a signing/trade). Philly could instead look and see that the AAV for Howard's contract would be lower in each of the remaining 5 seasons, making it a bit easier for them.

The case of the Boston Red Sox and Adrian Gonzalez is the opposite of the Phillies and Ryan Howard. Boston extended Gonzalez after the 2011 season started, thus making it so his old deal did not affect the AAV of his new deal. Adrian's old deal, which he signed with the San Diego Padres, was for 4 years and $9.5 million, which is an AAV of $2.375 million. This was important to the Sox because of the Luxury Tax threshold for 2011 being $178 million, and the team already looking at an Opening Day payroll of $161 million. Boston didn't want to sign a new deal that would dramatically raise the AAV of Gonzalez's deal, because that would mean they reached the threshold and cost themselves a lot of money in luxury tax penalties. Adrian's new deal with Boston was for 7 years and $154 million, an AAV of $22 million, so you can see why the team did what they did... waiting until after Opening Day of 2011 to make the extension official. The move ended up making the AAV of Adrian's deal more for 2012 and beyond, but they would cross that bridge when they came to it, rather than taking the sure hit in 2011.

This is exciting as it shows us how the Yankees could re-sign Robinson Cano and Curtis Granderson, while keeping each player's AAV down a bit.

Robbie's current AAV is $8.8 million, which is an absolute steal for the Yankees as Fangraphs put Cano's value the last three years at $19.1 million, $26 million, and $25.2 million. However Cano is due for a contract of like 8 years worth upwards of $184 million (an AAV of $23 million), and that may be a low estimate. The AAV of Cano's deal would go from $8.8 million to $23 million. That could hurt. But if the Yankees sign Cano before Opening Day of the last year of his contract (which would be 2013, assuming the team exercises his 2013 option at the end of this season), then that old AAV would affect the new AAV. So say Robbie and the Yankees agree to an extension worth 8 years and $184 million (no options), and it's done before Opening Day of 2013 (after the option was already picked up at the end of the 2012 season). That would make the new deal worth 9 years and $192.8 million ($8.8 million for 2013, added to the $184 million for 2014-2021), which is an AAV of $21.42 million. It's not a huge difference in AAV, but every little bit is going to matter when it comes to the $189 million threshold in 2014 and 2015.

What about Curtis Granderson? Well say Granderson and the Yankees agree to an extension worth 4 years and $68 million (no options) before Opening Day of 2013 (he has an option for 2013 that would need to be excercised at the end of the 2012 season). That would make his new deal actually 5 years and $74.05 million ($6.05 million for 2013, added to the $68 million for 2014-2017), which is an AAV of $14.81 million. Only a little more than Cano's extension would save, but again... every little bit counts.

If you add up the savings by extending Cano and Granderson before Opening Day of 2013 (and after each of their options were exercised), the team could save a total of $3.77 million towards the Luxury Tax threshold. Not a lot of money, but since the team is going to be cutting it close already, that $3.77 million savings could make a big difference.