The Tax Court recently issued its opinion in Tribune Media Co. v. Commissioner, addressing the extent to which a leveraged distribution from a partnership should be characterized as a payment in a disguised sale under Section 707. The court found that subordinate debt used to fund a debt-financed distribution from CBH partnership to Tribune Media was equity—rather than debt—for tax purposes and did not offset Tribune’s recognized gains from the disguised sale. However, the court held that a guarantee by Tribune Media of the senior debt was bona fide, so the portion of the distribution attributable to the senior debt was a nontaxable debt-financed distribution.
The facts of the case revolve around a transaction in 2009, when Tribune Media effectively sold 95% of the Chicago Cubs to the Ricketts family through a leveraged partnership. Tribune Media and the Ricketts family formed CBH partnership, with Tribune transferring the Cubs to CBH and the Ricketts family transferring $150M cash to CBH. On the same day, CBH distributed about $704M to Tribune Media. The distribution was funded by two tranches of debt: senior debt ($425 million) and subordinated debt ($248.75 million). The senior debt was a loan CBH obtained from several third-party banks, while the subordinated debt was a loan from an entity owned by the Ricketts family. Tribune guaranteed both the senior debt and the subordinated debt—in the form of guaranties of collection of principal and interest (rather than guaranties of payment).
The IRS challenged the debt-financed distribution, asserting that the subordinated debt was not bona fide debt for tax purposes and that Tribune’s guarantees of the debt were not bona fide guarantees (and thus should not be viewed as recourse to Tribune Media under the partnership liability allocation rules).
The Tax Court analyzed whether the subordinated debt was debt or equity for tax purposes and walked through the 13 factors from Dixie Dairies Corp. v. Commissioner, 74 T.C. 476 (1980):
- 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
The Tax Court found that the subordinated debt was equity, as most of the factors signaled equity, and some of the factors weighed significantly toward equity:
- There was not a fixed maturity date
- The Ricketts did not have a meaningful right to enforce repayment
- The intent of the parties was to treat the subordinate debt as equity
- The identity of the interest between creditor and stockholder, and
- The use of the advance to fund an acquisition of capital assets rather than to meet the operating needs of the business
The Tax Court subsequently analyzed Tribune’s guarantee of the senior debt to determine if it was bona fide. The IRS argued the debt was not, because it was unlikely that Tribune would be called on to pay. Nevertheless, the court explained that even though the creditors were required to exhaust other legal remedies before looking to Tribune, the ultimate obligation to pay was still Tribune’s. The court also distinguished Tribune’s collection guarantee from the indemnity provided by WISCO in Canal Corp. v. Commissioner, 135 T.C. 199 (2010).
Though the analysis of the debt and guarantee were the main questions in the case, the IRS and Tribune also disagreed about a $2.5 million deduction Tribune had taken for legal fees arising from a renewed bidding process with another party in the middle of negotiations with the Ricketts family. The Tax Court sided with the IRS, finding the $2.5 million should be capitalized because they were parts of the costs of the transaction to close the sale of the Cubs.
Tribune Media’s partial victory stemmed from its collection guaranty being respected as giving rise to a recourse obligation under the Section 752 regulations. However, whether the obligation of a partner and/or a related person (e.g., a guarantee) with respect to a partnership liability may be viewed as recourse under the Section 752 regulations is a question of fact and each obligation needs to be analyzed on a situation-by-situation basis for its treatment under the Section 752 regulations.
Practice Leader, Tax Technical, Washington National Tax Office
Grace Kim has more than 20 years of experience in the area of partnership taxation, which includes IRS, law firm and accounting firm positions. Her diversified experience includes working on a broad range of structuring and operational issues in a variety of industries and areas.
Washington DC, Washington DC
- Real estate and construction
- Private equity
- Strategic federal tax
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