Tribune Media et al. v. Comm’r, Nos. 20940-16 & 20941-16, T.C. Memo 2021-122 | October 26, 2021 | Buch, J. |
Short Summary: In 2009, Tribune Media Co. (“Tribune”) formed Chicago Baseball Holdings, LLC (CBH) with the Ricketts family. Tribune contributed the Chicago Cubs Major League Baseball team and related assets (“Chicago Cubs”) (with a fair market value of approximately $770 million minus liabilities of approximately $35 million) and the Ricketts family contributed $150 million of cash. CBH then distributed approximately $700 million of cash to Tribune. After the transaction, the Rickett family became majority owners of CBH with Tribune holding a minority share.
To finance the large cash distribution to Tribune, CBH was funded with $425 million of senior debt from unrelated parties and approximately $250 million of debt from RAC Finance, an entity closely related to the Rickett family (“RAC”). Tribune executed two guarantees on the closing date: a senior guaranty and a sub-debt guaranty.
Tribune timely filed a 2009 Form 1120S. On its Form 1120S, Tribune reported the Chicago Cubs transaction as a disguised sale. It reported a loss of approximately $190 million and a net long-term capital gain of approximately $33 million. It also reported a net built-in gain of approximately $33 million.
CBH also timely filed a Form 1065. On its Form 1065, it reported that its partners contributed $150 million of cash and approximately $730 million of property. It also reported that it made an approximately $700 million distribution.
The IRS examined Tribune’s and CBH’s 2009 tax returns. Later, the IRS issued a notice of deficiency to Tribune, which determined an increased tax liability of approximately $180 million attributable to built-in gains under section 1374. The notice also made adjustments to items reported by CBH to Tribune—that is, it reduced Tribune’s reported capital contributions from $715 million to $20 million. It also reduced Tribune’s reported allocable share of recourse liabilities from $673,750,000 to zero and increased Tribune’s share of nonrecourse liabilities from approximately $6 million to approximately $27 million.
The IRS further issued an FPAA to Northside Entertainment Holdings, LLC (formerly RAC). Through the FPAA, the IRS determined partnership items of CBH, namely, adjustments to income, capital contributions, and disguised sale proceeds. The FPAA also set forth the IRS’ determinations regarding the nature of CBH’s liabilities. Both parties, through their authorized representatives, timely filed petitions with the Tax Court and the cases were consolidated for purposes of trial and briefing.
- Whether the $250 million from RAC Finance was bona fide debt or equity?
- Whether the $425 million of debt borrowed by CBH was bona fide debt?
- Under the factors in Dixie Dairies Corp., the RAC finance funds were equity for tax purposes. Thus, because it is equity, it cannot be allocated to Tribune as recourse debt—e., the portion of the distribution funded by the RAC Finance funds does not qualify under the debt-financed distribution exception of the disguised sales rules.
- The $425 million of debt borrowed by CBH was bona fide debt and under Tribune’s guarantee, it may offset a portion of the distribution/disguised sale as non-taxable.
Key Points of Law:
- A disguised sale occurs when a partner transfers property into a partnership and that partner receives cash or property in return in such a way to render the transaction a sale. Section 707(a)(2)(B) provides that “if: (i) there is a direct or indirect transfer of money or other property by a partner to a partnership; (ii) there is a related direct or indirect transfer of money or other property by the partnership to such partner (or another partner); and (iii) the transfers described in clauses (i) and (ii), when viewed together, are properly characterized as a sale or exchange of property, such transfers shall be treated . . . [as between the partner acting other than in his capacity as a member of such partnership and the partnership].”
- The result of section 707(a)(2)(B) is to revoke the nonrecognition treatment for transactions between a partner and a partnership and to treat the transaction as a taxable sale of property between unrelated parties.
- The regulations promulgated under section 707(a)(2)(B) attempt to clarify when a transfer between a partnership and its partner more closely reflects a sale rather than a contribution and distribution. The regulations state that whether a transaction is treated as a disguised sale depends on whether based on all of the facts and circumstances, the transfer of money or other consideration would not have been made but for the transfer of property and in cases in which the transfers are not made simultaneously, the subsequent transfer is not dependent on the entrepreneurial risks of partnership operations. Reg. § 1.707-3(b)(1).
- There are exceptions to the disguised sale rules, including the debt-financed distribution rule. This rule permits a partner to receive a debt-financed distribution of property from a partnership as part of a disguised sale tax free up to the amount of debt allocated to that partner. Reg. § 1.707-5(b)(1). To invoke the debt-financed distribution rule, the partner must “retain substantive liability for repayment” of the debt, meaning it must be allocated the partnership liability.
- Under the debt-financed distribution rule, a partner’s allocable share of a partnership liability is its share of the liability under normal rules for allocation of partnership liabilities, multiplied by the percentage of the liability used to fund the distribution. Reg. § 1.707-5(b)(2). The allocation of partnership liabilities among partners depends on whether the liability is a recourse liability or a nonrecourse liability. Treas. Reg. § 1.707-5(a)(2).
- A recourse liability is a liability for which “any partner or related person bears the economic risk of loss. Reg. § 1.752-1(a)(1). A nonrecourse liability is one for which “no partner or related person bears the economic risk of loss.” Treas. Reg. § 1.752-1(a)(2).
- In determining whether an advance is debt or equity, the Tax Court considers 13 factors outlined in Dixie Dairies Corp.: the names given to the certificates evidencing the indebtedness; presence or absence of a fixed maturity date; source of payments; right to enforce payments; participation in management as a result of the advances; status of the advances in relation to regular corporate creditors; intent of the parties; identity of interest between creditor and stockholder; “thinness” of capital structure in relation to debt; ability of corporation to obtain credit from outside sources; use to which advances were put; failure of debtor to repay; and risk involved in making advances. Dixie Dairies Corp. v. Comm’r, 74 T.C. 476 (1980).
- Section 752 and its regulations govern the allocation of partnership liabilities. Under section 752(a), when a partner’s share of a partnership liability increases, the amount of that increase is treated as a cash contribution or increased investment in the partnership by that partner. Conversely, under section 752(b), a decrease in a partner’s share of liabilities is treated as a distribution of cash. The partner receiving an increase or decrease of partnership liabilities also decreases their basis in their partnership interest, reflecting their changing investment in the partnership.
- Which partner is allocated a liability depends on whether the partners are general or limited partners and whether the liability is recourse or nonrecourse. In a general partnership, the general partner is allocated liabilities. The Tax Court has held that although not a general partner, a partner’s “guarantee of an otherwise nonrecourse debt places each guaranteeing partner in an economic position indistinguishable from that of a general partner with liability under a recourse note—except that the guaranteeing partner’s liability is limited to the amount guaranteed.” Abramson v. Comm’r, 86 T.C. 360, 374 (1986).
- A partner bears the risk of economic loss for a partnership liability if the partner would be obligated to make payment to the creditor if the partnership were constructively liquidated. Reg. § 1.752-2(a) and (b)(1). In a constructive liquidation, all of the following events are deemed to occur simultaneously: (1) all of the partnership’s liabilities become payable in full; (2) all of the partnership’s assets (except property contributed to secure a partnership liability), including cash, become worthless; (3) the partnership disposes of all of its property in a fully taxable transaction for no consideration; (4) all items of income, gain, loss, or deduction are allocated among the partners as of the date of the constructive liquidation; and (5) the partnership liquidates. Treas. Reg. § 1.752-2(b)(1). A partner’s obligation to make a payment on the debt is based on the facts and circumstances and includes any statutory or contractual obligations. Treas. Reg. § 1.752-2(b)(3).
- Reg. § 1.752-2(j)(1) provides that the obligation of a partner may be disregarded if “facts and circumstances indicate that a principal purpose of the arrangement between the parties is to eliminate the partner’s economic risk of loss with respect to that obligation or create the appearance of the partner or related person bearing the economic risk of loss when, in fact, the substance of the arrangement is otherwise.”
- The doctrine of substance over form embodies the concept that the economics of a transaction, not just the formal paper steps, should determine its tax treatment. The doctrine arose in Gregory v. Helvering where the Supreme Court considered a transaction that complied with the text of the Code, but not its intended purpose. The Tax Court uses the doctrine of substance over form to “determine the true nature of a transaction and appropriately recat it for Federal income tax purposes.” However, the court uses these principles “only when warranted and generally respect the form of a transaction.” The doctrine of substance over form is applied to prevent taxpayers from mislabeling transactions to achieve a desired tax consequence. See Benenson v. Comm’r, 910 F.3d 690, 699 (2d Cir. 2018).
Insight: Tribune shows that the IRS will, in certain cases, attempt to attack taxpayer transactions with anti-abuse regulations and substance-over-form arguments. Taxpayers who enter into transactions should involve tax counsel early on to ensure that the desired tax effects of a given transaction are respected for federal income tax purposes.
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