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November 3, 2021

Tax Court respects non-taxable debt-financed distribution but holds that portion of financing was equity

The Tax Court (court) held (Tribune Media Co., et al. v. Commissioner, T.C. Memo. 2021-122, Dkt. Nos. 20940-16, 20941-16, Oct. 26, 2021) that the senior debt portion of the financing for Tribune Media's sale of the Chicago Cubs was bona fide and a nontaxable debt-financed distribution. The court also held that the subordinated debt (the sub debt) portion of the financing was equity for tax purposes, thus the distribution of its proceeds increased the amount of gain it was required to recognize on the distribution of cash.


Tribune Media Co. (Tribune) bought the Chicago Cubs baseball team in 1981. Tribune converted from a C corporation to an S corporation in 2007. In August 2009, Tribune agreed to form a partnership with the Ricketts family, operating through Ricketts Acquisition LLC (RAC), to own and operate the Chicago Cubs in a transaction that would result in a leveraged partnership with 95% owned by the Ricketts family, 5% owned by Tribune and a debt-financed distribution to Tribune. In October 2009, Tribune and RAC formed Chicago Baseball Holdings, LLC (CBH), with Tribune and RAC as partners. On CBH's formation, Tribune contributed the Chicago Cubs, worth about $735 million, to CBH, and RAC contributed $150 million in cash. On the closing date, CBH made a special distribution to Tribune of about $705 million, funded by CBH "debt."

The leveraged financing consisted of two tranches of debt — the senior debt and the sub debt. The senior debt was $425 million in bank loans. The parties stipulated that the senior debt was bona fide debt for US federal income tax purposes but disagreed on whether the senior debt was recourse or nonrecourse to Tribune.

The sub debt principal was approximately $249 million and had a stated term of 15 years. Thomas Ricketts's mother, Marlene Ricketts, funded the sub debt through MMR Financing, LLC. MMR Financing and RAC created the separate entity RAC Education Trust Finance, LLC (RAC Finance) to fund the sub debt and to hold the corresponding promissory note. Under a subordination agreement, the sub debt principal could not be repaid until the senior debt was paid in full (apparently including unilateral extensions by the creditors). The parties disagreed as to whether the sub debt was debt or equity for federal income tax purposes.

Tribune executed guaranties of collection on the senior debt and the sub debt. Specifically, the guaranties could only be enforced if (1) CBH failed to make a payment and the debt was accelerated; (2) the lenders exhausted all creditor remedies against CBH; and (3) the lenders had not collected all of the principal and interest guaranteed by Tribune. For the sub debt guarantee to be triggered, however, the senior debt had to be paid in full. Tribune did not report the guaranties in its financial statements because it considered the possibility of them being called "remote."

Tax reporting

On its 2009 tax return, Tribune reported the Chicago Cubs transaction as a disguised sale subject to the debt-financed distribution exception to disguised sale gain. CBH reported that its partners contributed $150 million of cash and over $730 million of property during the 2009 tax year. It also reported that it made about a $705 million cash distribution.

On RAC's Schedule K-1, CBH reported that RAC owned a 95% interest in profits and losses and a 93.72% interest in capital. RAC was allocated nonrecourse liabilities of over $116 million and no recourse liabilities. On Tribune's Schedule K-1, CBH reported a 5% profits and losses interest and a 6.27% capital interest. Tribune's allocation of nonrecourse liabilities was about $6 million and recourse liabilities were about $674 million. The Schedules K-1 show that, in 2009, RAC contributed about $165 million of capital and Tribune contributed about $716 million.

IRS assertions

In concluding that the debt-financed distribution exception did not apply, the IRS asserted that (1) the sub debt funded by the Ricketts was not bona fide debt, and (2) Tribune's guaranty of the senior debt should be disregarded because the likelihood that it would have to satisfy the guaranty was remote.


The court said the Chicago Cubs transaction occurred within 10 years of when Tribune converted from a C corporation to an S corporation in 2007, so it could be taxed on net built-in gain at the corporate level.

In its analysis, the court addressed whether (1) the sub debt is bona fide debt or equity for federal income tax purposes, and (2) the senior debt guaranty is sufficient to render the senior debt recourse as to Tribune.

Sub debt is equity

The court first addressed whether the approximately $249 million of sub debt that CBH borrowed from RAC Finance was bona fide debt. Tribune argued that the sub debt was bona fide debt and thus a partnership liability of CBH. The IRS argued that the sub debt was additional equity invested by the Ricketts family.

The court found that the sub debt was equity. "Because the sub debt is equity, it cannot be allocated to Tribune as recourse debt. The portion of the special distribution funded by the sub debt thus does not qualify under the debt-financed distribution exception of the disguised sale rules," the court said.

In making its determination whether the advance was debt or equity, the court said it considered the 13 factors outlined in Dixie Dairies Corp. v. Commissioner, 74 T.C. 476 (1980). The court said that many of the factors, including intent of the parties, right to enforce payment, risk, identity of the interest and use of the advance, weighed significantly toward equity. Specifically, the following facts favored a finding of equity:

  • There was no fixed maturity date
  • RAC Finance had no meaningful right to enforce interest payments as they came due
  • While the parties wanted the sub debt to have the appearance of debt for tax purposes, they intended the sub debt to function economically as equity
  • The lender and borrower of the sub debt had an overlapping relationship
  • The sub debt terms would not have been attractive to third-party investors
  • The sub debt proceeds were used to fund the special distribution, which was an integral part of a transaction that resulted in a change of ownership
  • The risk borne by the Ricketts family was that of an equity holder, not a debt holder

In its analysis of the facts and factors, the court seemed heavily influenced by the subordination agreement. In particular, the court interpreted the subordination agreement to mean that the sub debt did not have a fixed maturity date and the holder did not have a true right to enforce repayment because the sub debt could not be repaid before the senior debt, whose maturity date could apparently be extended unilaterally by the senior note holder. Moreover, the court placed significant emphasis on the fact that the debt was marketed but not sold to third parties, as well as the language used in marketing the debt. Finally, the court pointed to the difference in the capital percentage and profits percentage as an indication that the sub debt was intended to be treated as equity.

Senior debt is allocable to Tribune

The court next addressed whether CBH's senior debt, which was bona fide debt, should be allocated to Tribune. This would allow Tribune to exclude a significant portion of the special distribution from sales consideration.

In making its determination, the court said that, to allocate a liability to a partner, it must consider the "worst-case scenario." The relevant question was which partner would have to pay the debt if the partnership were unable to do so. If the partner would be obligated to pay the liability in this worst-case scenario, the liability was recourse and allocated to the partner who bore the economic risk of loss for the debt, the court said.

A partner bears the risk of economic loss for a partnership liability if the partner would be obligated to pay the creditor if the partnership were constructively liquidated. Applying this test, the court found that Tribune bore the risk of economic loss for the senior debt because, under Tribune's guaranty, "[n]o other party was liable for the debt, no partnership assets secured the loans, and if the debt were due in full in the world of a constructive liquidation, the senior debt creditors would seek repayment from Tribune and no other party."


The court's decision is significant in concluding that a properly structured guaranty of collection can be respected for purposes of excepting debt-financed distributions from disguised sale treatment.

The more recent regulatory changes under IRC Section 752 regarding bottom-dollar payment obligations are not implicated in this decision as (1) those regulations were not effective at the time of the transaction, and (2) the guarantee at issue was not structured as a bottom-dollar payment obligation. In 2016, the IRS and Treasury issued temporary regulations under IRC Section 707 providing that a partner's share of a liability for purposes of the disguised sale rules is determined by reference to the partner's share of partnership profits, regardless of whether the liability constitutes recourse debt. In 2018, those temporary regulations were withdrawn and the rules applicable to disguised sales and debt-financed distributions of the proceeds of recourse debt were reinstated with retroactive effect.

The court's determination that the sub debt constituted equity for federal income tax purposes was surprising given the IRS's concession that the obligor "had sufficient cashflow to timely service its debts, including interest payments on the sub debt" as of the issue date. The court instead focused on various features of the debt (such as the payment waterfall and subordinated claims in bankruptcy) as support for its finding that the parties did not intend to create a debtor/creditor relationship. This rationale, however, seems to ignore the relatively low likelihood that, based on financial projections as of the issue date, the issuer would ever fail to make interest payments or that creditors would not be entitled to full reimbursement of their investment. The court's determination that the subordinated debt lacked a fixed maturity date due to the senior holders' apparent unilateral right to extend the maturity date indefinitely is noteworthy. It is much more common to allow for the maturity date of senior debt (and, in particular, third-party debt) to be extended only by mutual agreement of the parties.

Although the Tax Court acknowledged that subordination alone does not result in equity characterization, its decision in Tribune Media will likely prompt issuers of subordinated debt to look more closely at the terms and conditions of those agreements (even in an unrelated party setting). We note, however, that the court may have been influenced by the circumstances under which the sub debt arose in making its determination.


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International Tax and Transaction Services – Capital Markets
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