NBA Free Agency Glossary: What is the luxury tax?

When the NBA enacted a salary cap in the 1980s, they added exceptions and provisions to allow teams to exceed it. While this saved the flailing league from financial ruin and permitted teams to keep marquee players, it didn’t address the gulf in financial power some teams held over others. To help balance the scales, the league would eventually add a tax penalty on high-spending teams, colloquially called the luxury tax. 

Luxury tax is a financial penalty levied on organizations that exceed the NBA’s soft salary cap. The “tax level” is set at 121.5 percent of the salary cap for each salary cap year, and is calculated based on a team’s salary commitments as of their final regular season game. The higher a team goes above the luxury tax level the higher the penalty, and if a team is beyond the luxury tax in three of the four preceding seasons, they are subject to “Repeater Tax Rates,” which are even more stringent. Teams that don’t exceed the luxury tax are redistributed the luxury tax payments from those teams that do.  

The luxury tax worked for a time, but some teams came to operate in a different financial stratosphere through mega-rich owners, lucrative local television deals, money-printing arenas, and massive corporate sponsorships. When all it took to build a championship-caliber roster costs was money, some ownership groups were more than willing, and capable, of footing the bill. To once again rebalance power in the NBA, the league enacted tax aprons to curtail the roster-building power of money. 

Luxury tax aprons 

The NBA’s newest CBA has added two tax aprons alongside the luxury tax. Instead of just costing teams money, the tax aprons will severely limit teams’ ability to add players to round out their roster. Citing the example in the CBA, the first apron in 2023-24 was set at $170 million and the second at $180 million. When a team crosses an apron threshold they are restricted in the types of transactions they can make, and, most crucially, certain roster moves can hard cap teams at an apron level. 

While the NBA is retaining its soft salary cap structure, the introduction of the tax aprons is intended to have a hardening effect. This was the hope with the luxury tax (how’d that work out?), and it remains to be seen what the long-term ramifications of the tax apron will be. The NBA is the league of unintended consequences, and chances are the tax apron will have its fair share. Now that we have an idea of what the luxury tax and apron are, let’s dive into the restrictions and penalties they present to teams. 

Luxury tax penalties 

Luxury tax penalties are purely financial, and follow an escalating penalty for each dollar spent over a tax bracket threshold. A tax bracket is calculated by dividing the current league salary by the salary cap in 2023-24 and multiplying it by $5 million. 

Example for 2024-25 tax bracket 

Formula: (2024-25 salary cap/ 2023-24 salary cap) x $5 million = tax bracket 

($140.7 million / $134 million) x $5 million → 1.05 x $5 million = $5.25 million

With the tax brackets calculated for each season, the league has five tiers of escalating luxury tax payments based on how far a team is above the luxury tax line. The first is 0 to 100 percent of the tax bracket over the luxury tax where teams must pay $1.50 in tax for every dollar they are over the tax. The next is 100 percent to 200 percent, which carries a $1.75 for every dollar penalty, followed by 200 percent to 300 percent and a $2.50 for every dollar tax, then 300 percent to 400 percent with a $3.25 for every dollar fine, and finally teams that are 400 percent of the tax bracket over the luxury tax are subject to a $0.50 increase from $3.25 for every 100 percent increase they are above the tax bracket. 

Teams that are repeat offenders, beyond the tax in three of the previous four seasons, are subject to a repeater tax penalty that is more severe. Here’s a visual example that should make it more clear. 

These are the luxury tax rates for the 2023-24 and 2024-25 seasons, but starting in 2025-26 the luxury tax will undergo some changes. While the tax bracket structure will stay the same, the penalties will change. It will favor teams just above the luxury tax, but teams that blow by it will face even more stringent financial penalties, and the repeater penalty should all but end the upper levels of spending. 

Tax apron restrictions 

Before we delve into the restrictions brought on by the NBA’s two tax aprons, we need to understand where it will be set in the future. The tax aprons are calculated using the luxury tax and the salary cap. To keep things as simple as possible, this past season, the first apron was $172.3 million and the second apron was $182.8 million. Going forward, the aprons will increase, on a percentage basis, in accordance with salary cap growth. 

The restrictions brought on by the aprons are vast, and all restrictions on teams in the first apron apply to teams in the second apron.

First apron restrictions

1. Cannot use the bi-annual exception
2. Cannot sign players using the Non-tax payer mid-level exception
3. Cannot sign a player waived during the current season who was making more than the non-taxpayer mid-level exception
4. Cannot take back more than 100% of the salary it sends out in a trade
5. Cannot use a traded player exception generated in the previous year
6. Cannot acquire a player through a sign-and-trade

Second apron restrictions 

1. Cannot use the mid-level exception.
2. Cannot aggregate multiple player salaries in a trade.
3. Cannot send cash as part of a trade.
4. Cannot acquire players using any traded player exception created by sign-and-trade.

Ramifications of the luxury tax and tax aprons

In the short term, the tax aprons, in conjunction with more draconian luxury tax penalties, should cap team spending at the highest level. Before the introduction of the tax aprons, teams still possessed significant flexibility to build their roster even as they blew past luxury tax thresholds. If you were willing to spend the money, you could build a strong team through sheer financial might.

The new CBA has clearly set out to remedy this. The tax aprons take away the tools to spend your way to a talented roster, and the increased tax penalties will make it far more painful to push financial boundaries. With spending being more painful and less likely to produce results, teams are likely to be financially prudent. It’s not a hard cap by any means, but it’s a significant step in that direction. 

To leave an idea of what the future holds, these are rough projections for the salary cap, luxury tax threshold, first apron, and second apron over the next six seasons.