Salary Cap Basics

[Eddie Grove]

The salary cap is discussed all the time on TV by people who say crazy
things that show they do not understand it. I think the situation is
simple, but it has been presented incorrectly so many times that
casual fans cannot help but be confused.

There is a pretty complete description at
https://russellstreetreport.com/salarycap/nfl-salary-cap-faqs/
However, hopefully my take is easier to internalize.


*****


The salary cap is a rule that is meant to insure team parity. In
baseball with no cap the rich teams like the Dodgers can outspend the
poor teams like the Rays and that can produce an uncompetitive
product. The NFL does everything it can do to promote parity among
teams in different circumstances.

The rules of the cap are simple:
(1) Any salary paid in a year is a cap hit in that year
(2) New bonus money is spread evenly over the next 5 years
or the remainder of the contract, whichever is shorter
(3) An incentive that was achieved the previous year counts this year
(4) An incentive that was not achieved the previous year counts
in the following year if it happens.
(5) Non-guaranteed bonuses such as roster bonuses and workout bonuses
count as salary in the applicable year.

Notes:

(2): Roster bonus money counts as salary in the given year, except
roster bonus paid in the first year counts like a signing bonus and is
spread over up to 5 years.

(3) and (4): Suppose a player has an incentive for rushing 1000 yards.
If the previous year he had 1200 it is type (3)
and if the previous year he had 800 it is type (4).

(5): Aaron Rodgers got a $40M roster bonus in year 1, guaranteed.
Thus it is amortized over multiple years like a signing bonus. However,
because it is a roster bonus, it is considered as salary for year 1 and
is his to keep whatever comes. The difference is that if it was a
signing bonus and he retires after 1 year, the team could appeal for him
to return the money applicable to later years' cap hits.


The league allows the team to convert salary to bonus money at will,
assuming the player agrees. The only difference to the player is that
instead of receiving some money on a weekly basis he receives it in a
lump sum up front. Most players agree happily. To avoid having to ask,
more and more contracts specifically include language allowing the
team to convert salary to bonus money without even asking the player.

You hear talking heads discuss restructuring contracts to create cap
space as if it is a big deal. Most of the time, the only thing
happening is that some salary is converted to a signing bonus.
This is utterly trivial.

The other way to reduce the cap hit is for the player to agree to take
less money. Most will refuse. One example is Big Ben taking a $5M pay
cut from $19M to $14M in his last year, but this is a rare exception.

The final point is that deferred cap hits apply in the next season
when a player is cut or traded. However, if it happens after June 1
these deferred cap hits can be split over 2 years. Moreover, a team
gets a couple of exceptions allowing it to pretend the player left
after June 1, so in practice most of the big dead cap hits are split
over 2 years.

In the examples, I assume a league imposed minimum salary of $1M for simplicity.

*****


Suppose someone gets a 5 year deal for $13M a year for a total of
$65M. He has to get a minimum of $1M/year in salary.
That leaves $60M to play with.

The simplest contract is

Contract 1 Payments:
$13M salary in year 1
$13M salary in year 2
$13M salary in year 3
$13M salary in year 4
$13M salary in year 5

Contract 1 Cap Hits
$13M from salary in year 1
$13M from salary in year 2
$13M from salary in year 3
$13M from salary in year 4
$13M from salary in year 5


Now suppose the player wants money fast, and the team is happy to
oblige him. They agree to pay $60M up front.

Contract 2:
(a) $60M bonus in year 1
$1M salary in year 1
$1M salary in year 2
$1M salary in year 3
$1M salary in year 4
$1M salary in year 5

How should the league approach this? Is it fair to cost the team $61M
against the cap in year 1? They decided the fair approach was to
consider the two contracts to be similar, and so the cap hit for the
$60M bonus is spread evenly.

Further examples will get more complicated with multiple
bonuses. I'll mark each bonus with a letter, (a) here.

Contract 2 Cap Hits
$11M = $1M from salary, $12M from (a) in year 1
$11M = $1M from salary, $12M from (a) in year 2
$11M = $1M from salary, $12M from (a) in year 3
$11M = $1M from salary, $12M from (a) in year 4
$11M = $1M from salary, $12M from (a) in year 5

This is an example of the salary cap working as intended.


*****


Now suppose the team wants to finagle the cap and spend more money on
other players in the next two years. The player insists on being paid
at least $13M every year, so they can't just set the early years small
and later years high. The solution is multiple bonuses.

Contract 3:
(a) $12M bonus in year 1
$1M salary in year 1
(b) $12M bonus in year 2
$1M salary in year 2
(c) $12M bonus in year 3
$1M salary in year 3
(d) $12M bonus in year 4
$1M salary in year 4
(e) $12M bonus in year 5
$1M salary in year 5

(a) is spread over 5 years, (b) is spread over 4 years,
(c) is spread over 3 years, (d) is spread over 2 years,
and (e) counts fully in year 5.

Contract 3 Cap Hits
$3.4M = $1M salary, $2.4M (a) in year 1
$6.4M = $1M salary, $2.4M (a), $3M (b) in year 2
$10.4M = $1M salary, $2.4M (a), $3M (b), $4M (c) in year 3
$16.4M = $1M salary, $2.4M (a), $3M (b), $4M (c), $6M (d) in year 4
$28.4M = $1M salary, $2.4M (a), $3M (b), $4M (c), $6M (d), $12M (3) in year 4

We still have $65M in total cap hits, but the first two years are
very low cap hits and the last two years are much higher cap hits.

Technically, Contract 3 cannot be implemented directly as described. If
you specify a guaranteed bonus in the contract, it counts in year 1 even
if the money changes hand in later years. You start with Contract 1,
and convert $12M in salary to a signing bonus every year.


*****


However, we can still do better. For reasons I do not understand,
you can add years to a contract along with language that terminates
the contract after a certain year. So add language that the contract
self-terminates after year 5, and add fake years 6, 7, 8, and 9 at
absolutely any salary, because it will not matter. In one extension,
Tom Brady set the fake salaries to make the total extension average
out to (fake) $28.3M per year because he is just that petty.

Contract 4:
(a) $12M bonus in year 1
$1M salary in year 1
(b) $12M bonus in year 2
$1M salary in year 2
(c) $12M bonus in year 3
$1M salary in year 3
(d) $12M bonus in year 4
$1M salary in year 4
(e) $12M bonus in year 5
$1M salary in year 5
fake years
$1M salary in year 6
$1M salary in year 7
$1M salary in year 8
$1M salary in year 9

Again, this contract is achieved by converting $12M of salary
into signing bonus each offseason. Due to the fake years,
each of the bonuses can be amortized over the maximum of 5 years.

Contract 3 Cap Hits
$3.4M = $1M salary, $2.4M (a) in year 1
$5.8M = $1M salary, $2.4M (a), $2.4M (b) in year 2
$8.2M = $1M salary, $2.4M (a), $2.4M (b), $2.4M (c) in year 3
$10.6M = $1M salary, $2.4M (a), $2.4M (b), $2.4M (c), $2.4M (d) in year 4
$13.0M = $1M salary, $2.4M (a), $2.4M (b), $2.4M (c), $2.4M (d), $2.4M (e) in year 5
... fake years below ...
$9.6M = $2.4M (b), $2.4M (c), $2.4M (d), $2.4M (e) in year 6
$7.2M = $2.4M (c), $2.4M (d), $2.4M (e) in year 7
$4.8M = $2.4M (d), $2.4M (e) in year 8
$2.4M = $2.4M (e) in year 9

Checking, the total cap hits still come to $65M, maybe arithmetic is correct.

The fake years exist until they don't. When the contract
self-destructs after year 5, the cap hits for the fake years come due
immediately as would a balloon payment on a home equity line. The
reality is: $34M dead cap hit in year 6, and this is unavoidable,
except it can be split over two years if the player leaves the team
and the June 1 cap split rule comes into play.

If you want to achieve the full cap deferment of Contract 4, you have
to have the fake years in place 4 years in advance. If you began with
Contract 1, you would need to restructure the contract by adding a
fake extension before you converted any of the year 2 salary into
bonus money.


*****


If you cut a player or trade a player, you have to account for the cap
hits that were previously spread to future years. Suppose you cut or
trade a player after 3 years.

Contract 1
No deferred cap hits to worry about

Contract 2
The deferred cap hits (a) 2 * $12M = $24M

Contract 3
The deferred cap hits are (a) 2 * $2.4M, (b) 2 * $3M, (c) 2 * $4M = $18.8M

Contract 4
The deferred cap hits are (a) 2 * $2.4M, (b) 3 * $2.4M, (c) 4 * $2.4M = $21.6M

In Contracts 2 and 3, there are 2 remaining years each bonus was
spread over. With the fake years in Contract 4, there are a different
number of years applicable to each different bonus.

The accounting is straightforward. In theory, the cap hit comes due in
the coming year. If you cut a player after June 1 or use the June 1
exceptions, you are allowed to split the cap hit evenly over the next
two years and that happens for most big dead cap hits. I think the
Falcons are saying they will absorb all of Ryan's dead cap hit in one
season, but that is unusual.

The main thing to understand is that a specific deferred cap hit is
never deferred again, except perhaps for the June 1 exception above.
You can defer some other salary, but specific compensation has to be
counted within 5 years [or less depending on the length of the contract].


*****


Those are the rules for the cap. However, knowing the rules is not the
same as having a good perspective on how to apply them. That will
require another post.

[observer]

Thanks, Eddie.