Competitive Balance Tax
Each year, clubs that exceed a predetermined payroll threshold are subject to a Competitive Balance Tax -- which is commonly referred to as a "luxury tax." Those who carry payrolls above that threshold are taxed on each dollar above the threshold, with the tax rate increasing based on the number of consecutive years a club has exceeded the threshold.
A team's Competitive Balance Tax figure is determined using the average annual value of each player's contract on the 40-man roster, plus any additional player benefits. Every team's final CBT figure is calculated at the end of each season. (Note: If a player signs a contract extension that doesn't kick in until a later season, his AAV for the purposes of the CBT doesn't change until the new deal begins.)
The following thresholds were put in place per the 2022-26 collective bargaining agreement:
2022: $230 million
2023: $233 million
2024: $237 million
2025: $241 million
2026: $244 million
A club that exceeds the Competitive Balance Tax threshold is subject to an increasing tax rate depending on how many consecutive years it has done so.
First year: 20 percent tax on all overages
Second consecutive year: 30 percent
Third consecutive year or more: 50 percent
If a club dips below the luxury tax threshold for a season, the penalty level is reset. So, a club that exceeds the threshold for two straight seasons but then drops below that level would be back at 20 percent the next time it exceeds the threshold.
There’s also a surcharge threshold for clubs that exceed the base threshold by $20 million or more.
$20 million to $40 million: 12 percent surcharge
$40 million to $60 million: 42.5 percent surcharge for first year; 45 percent for each consecutive year after that
$60 million or more: 60 percent surcharge
Clubs that are $40 million or more above the threshold shall have their highest selection in the next Rule 4 Draft moved back 10 places unless the pick falls in the top six. In that case, the team will have its second-highest selection moved back 10 places instead.