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Cubs ‘Disguised Sale’ Leads to Tax Court Loss for Tribune Media

Michael McCann and Robert Raiola
·6 min read

The U.S. Tax Court recently resolved a multiyear and multifaceted dispute between Tribune Media and the Internal Revenue Service over a tax return filed more than a decade ago.

At the center of the dispute was the Chicago Cubs. The ruling will influence how future sales of teams are structured and the nature of tax advice certified public accountants will share.

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In 2009, Tribune sold the Cubs to the Ricketts Family for $845 million. Under tax law, the deal was structured as a “disguised sale,” meaning a transfer of property between partners that functions as a sale. The Tribune had created a new entity, Chicago Baseball Holdings (CBH), for which the Ricketts family contributed $150 million and funded $249 million in debt while the Tribune contributed the Cubs and guaranteed collection of the debt. If the Tribune was ultimately responsible for the debt, the amount would not be taxable.

In a more than 26,000-word opinion issued on Oct. 26, Judge Ronald Buch concluded the debt was, in fact, equity and thus taxable.

The Tribune had owned the Cubs since 1981, when it bought both the club and Wrigley Field from the Wrigley Family for $21.7 million. Like many traditional media companies in the 2000s, the Tribune struggled with adverse revenue impacts from the print-to-online transformation of news distribution. After a leveraged buyout and restructuring in 2007, the Tribune, Judge Buch wrote, “was $12.8 billion in debt.”

To address its financial turmoil, the Tribune focused on keeping core assets while parting ways with others. The Cubs were deemed disposable.

“Although the Cubs are a legacy team in MLB,” Judge Buch explained, “the team itself was not a significant source of cashflow.” The Tribune wanted the sale to include as much debt as possible.

From a tax standpoint, the Tribune’s reasoning made sense. Had it sold the Cubs for cash, the Tribune would have paid taxes on a massive gain from the appreciation of the Cubs’ value in 1981 to their value ($770 million) in 2007. So-called disguised sales are lawful under tax law. The Tribune-IRS dispute centered on whether using debt to finance the sale rendered the debt’s dollar amount taxable.

In 2007, the Tribune solicited offers for the Cubs and related assets—Wrigley Field, a stake in Comcast SportsNet Chicago and the club’s Dominican baseball operations. The Tribune also conditioned the sale on an arrangement, wherein the media company would sell 95% of the Cubs, with the buyer gaining an option to buy the remaining 5% after a dozen years. MLB cleared 10 bidding groups, including the eventual winner, the Ricketts family.

The 2008 financial crisis, which caused the Tribune to lose advertising revenue and become unable to service its debts, complicated the sale. Faced with mounting debt and uncertain cashflow, the Tribune filed for chapter 11 bankruptcy. A federal bankruptcy judge authorized the Cubs sale as well as a reorganization plan for the Tribune.

The Cubs deal would finally close in October 2009 with CBH making a cash distribution of $705 million to the Tribune. CBH initially had a board of five members, four of whom were appointed by the Ricketts family with the Tribune appointing the fifth.

The transaction also required the approval of MLB, specifically at least 75% of the 30 ownership groups. Approval was partly contingent on the deal satisfying MLB’s internal debt service rule. The rule caps the amount of debt a team can carry, in order to ensure it can make payroll and meet other obligations. One feature of this rule, Judge Buch explained, is that “related-party debt that is not secured by team assets is not treated as debt.” MLB approved the deal and “viewed the continuity of ownership resulting from Tribune’s retention of a 5% interest as a positive factor.”

The Ricketts family partially funded CBH through subordinated debt (“sub debt”), which is debt ranked behind senior debt for purposes of repayment. Marlene Ricketts and an associated commercial entity contributed $251 million to a separate entity that held the corresponding promissory note and would be run by her son, Thomas Ricketts. Several banks also infused CBH with $425 million in total. The banking debt was classified as senior debt. On the closing date, CBH used secured notes to sell $250 million of the senior debt to third parties.

Although the sub debt was labeled “debt,” the IRS considered it equity for income tax purposes. This meant the Tribune’s gain attributable to the sub debt was taxable. The IRS reasoned that the debt structure functioned as an outright purchase-and-sale, with the Ricketts family, through a lawful but complex arrangement, using debt to pay the Tribune.

Judge Buch agreed. He described the sub debt as having “the superficial appearance of bona fide debt” but more closely resembling equity. There were several key reasons for this conclusion.

First, MLB considered the sub debt equity for purposes of approving the sale. While MLB is not the decider on what counts as debt or equity under federal tax law, its analysis was influential to both the Tribune and Ricketts family.

Second, while the sub debt had a fixed maturity of 15 years for repayment—just like a loan—the date could have been extended indefinitely. That flexible arrangement suggested the debt resembled equity.

Third, the Ricketts family marketed opportunities to invest as equity investments. As described by Judge Buch, this marketing hailed such “privileges” as “priority parking, box seats, private use of Wrigley Field” and other insider benefits “typically afforded to team owners.”

Fourth, to enforce her payment rights in a legal proceeding, Marlene Ricketts would potentially have had to sue Thomas Ricketts, who was the decision-maker for both the equity holder and the debt lender. Although family members can—and have—used legal proceedings to enforce debts against relatives, here, the judge stressed, “the interrelatedness of the lender and borrower is clear [and] favors equity.”

Fifth, proceeds from the sub debt were unambiguously used to generate the $704 million distribution to the Tribune, a sequence that “resulted in a change of ownership.” A new group taking over the Cubs, Judge Buch underscored, “was not an everyday operating transaction; it was a significant change in the ownership of assets.”

Sixth, the Ricketts family simultaneously held the sub debt and controlled CBH’s equity. This meant that if CBH defaulted, “the Ricketts family (as sub debt holders) would have to enforce their rights by causing the liquidation of CBH, the company they owned. This is beyond unlikely.”

While the Tribune lost on the taxability of the sub debt, it convinced Judge Buch that the senior debt was bona fide. As a result, the portion of the $705 million debt attributable to senior debt can be treated as nontaxable and may offset gains.

The amount the Tribune will owe the IRS and accompanying penalties will be clarified in future proceedings.

One piece of data is clear: The Ricketts made a wise move in buying the Cubs. Not only did the Cubs celebrate their first World Series victory in 108 years in 2016, but the team is now worth $4.14 billion. The Cubs are the fourth most valuable franchise in the big leagues, behind the New York Yankees ($6.75 billion), Boston Red Sox ($4.8 billion) and Los Angeles Dodgers ($4.62 billion).

Going forward, expect the Cubs case to serve as a warning to tax attorneys and CPAs when they advise sports clients on the use of disguised sales. Minimization of tax exposure is key to team transfers, particularly with franchise values having jumped in recent years.

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