As complicated as it all is, this is my go to document when I'm trying to figure things out. Written by some law student at Delaware I believe.
http://www.law.du.edu/documents/sports-and-entertainment-law-journal/issues/03/dosh-money-postseason-mlb.pdf
Calculating the Actual Club Payroll - Calculating a club’s payroll upon which a tax may
be assessed is a complicated matter that requires taking into account the possibility of
assignment of player contracts, termination of contracts, multi-year contracts, performance
bonuses and a whole host of other payments and payment issues. The attitude of some is very
similar to the attitude taken by some with individual taxes: find the loopholes and exploit them.
Clubs can use mechanisms of deferred compensation and other creative solutions to decrease not
only the strain of a player’s salary on the club’s budget, but also to bring the club’s aggregate
payroll down low enough to incur little or no luxury tax. Accordingly, there are very detailed
rules as to the calculation of a club’s payroll for luxury tax purposes and the Office of the
Commissioner of MLB completes the calculations.
As a starting point, the 1996 CBA defines “Actual Club Payroll” to be the sum of: (a)
1/28th of player benefit costs (MLB administers such things as worker’s compensation and
player pensions, so each of the 28 clubs are expected to pay their share), ( the yearly salaries of all players under a Uniform Player Contract with the club for that year, and © other sums
defined under the rules.84 The most complicated aspect of the calculation is which player
contracts, or portions of player contracts, are attributable to the current year’s Actual Club
Payroll calculation. The easiest point to start from is to include the salary, attributable to that
contract year, for each player who remains on a club’s active list for the entire season.85 While
this may sound simple, it can get far more complicated when attempting to determine the value
of a multi-year contract for any single season and when attempting to attribute deferred
compensation to any one season. For a multi-year contract, an Average Annual Value is
calculated as follows: the sum of (a) the base salary for each guaranteed year86 plus ( any
signing bonus, or portion thereof, which is attributed to a guaranteed year87 plus © any deferred
compensation attributed to a guaranteed year.88 The total sum derived from this calculation is
then divided by the number of guaranteed years to give an Average Annual Value of the contract.89 Other types of bonuses, such as performance and award bonuses, are attributable to
the year in which they are earned.90 Similarly, a contract clause which increases the base salary
in future guaranteed years for performance in a prior year is added to the Average Annual Value
for each of those years.91
As mentioned above, some player contracts include option years, which are years in a
contract that are not guaranteed, but which are exercisable at the option of either the player or
the club, depending on how the option is structured. Not surprisingly, any option year which is
exercised results in the base salary for that year being includible in the calculations for that
year’s Actual Club Payroll. However, many contracts require payment to the player of some
monies if the option is not exercised by the club, sometimes referred to as an option buyout.
These monies are deemed a signing bonus and are thus either distributed pro rata over the
guaranteed years in the contract during the Average Annual Value calculation or are attributed to
the first full year if there are no guaranteed years.92 If the player then never receives the option
buyout, there are provisions by which the club is credited or refunded the amount of the option. buyout that has already been included in the Actual Club Payroll for any previous years.93
The last complication in calculating an Actual Club Payroll relates to deferred
compensation. Put simply, deferred compensation is any amount due to a player after the last
season of his contract has been performed. This mechanism is sometimes used to defer some of
the burden of a player’s salary so that a team can afford to acquire him without taking a current
hit to its budget. Presumably because it might also be used to defer compensation to later years
in order to keep Actual Club Payroll numbers down and avoid the luxury tax, the rules are
specific as to how these monies are to be allocated in Actual Club Payroll calculations. If the
contract specifies which year(s) the deferred compensation is attributable to, then those amounts
are includible in the Actual Club Payroll for that year.94 If, however, the deferred compensation
is not attributable to any given year, the amount is prorated over the guaranteed years of the
contract.95 Included as deferred compensation is any annuity compensation arrangement, which
is an agreement by the club to purchase an annuity to pay the player after his services as a player
are over.96 The cost to the club of purchasing the annuity is includible, but not the proceeds the
player is scheduled to receive after his service as a player is over.
sorry for not removing all the citing but you get the idea