In this particular instance, however, the pain doesn't fall on the right party.
New York Times business reporter Floyd Norris writes today that "Tribune Company, the publisher of The Chicago Tribune and The Los Angeles Times, among other publications, ... seems likely to have to pay hundreds of millions of dollars in taxes that it would never have owed had it not tried to be so clever."
The shenanigans began with the 2007 takeover of the Tribune Company by real estate billionaire Samuel Zell, a man with essentially zero experience in the media business.
(Aside: Back at the dawn of time, when I worked -- briefly -- as a journalist, most newspapers were owned by people who actually gave a damn about journalism. Sigh.)
The initial $8.2 billion transaction was complicated enough (the Chicago Tribune ran a lengthy piece in January, by Michael Oneal and Steve Mills, unfurling the whole long sad tale), and things got more complicated still, and quickly.
To be fair -- not that I really want to be -- not everything was Zell's direct fault: the 2008 financial collapse effectively prevented Zell from selling off assets that would have buoyed his plans. Advertising was already weakening under the digital onslaught, and it was about to get much worse.
The Tribune Company slid into bankruptcy about a year after Zell's acquisition, emerging in 2012 a shadow of its former self, with thousands fewer employees than in its heyday (many of whom had given up contributions to a retirement pension in exchange for agreeing to a now-worthless Employee Stock Ownership Plan). And the future does not look bright, thanks to the huge tax bill that the company now faces.
The key shenanigan in the whole deal -- which is now coming back to haunt the Tribune in a very very big way -- revolved around taxes. Or more to the point, how not to pay them.
Those of you who have read more than a few of my posts know that I am a big believer in taxes and regulation, that I am firmly in the Justice Oliver Wendell Holmes Jr. camp ("Taxes are the price we pay for a civilized society.").
This is what happens when you structure a deal entirely to avoid paying taxes. As Oneal and Mills wrote,
Taxes were a special problem for anyone hoping to take control of Tribune Co. by using a lot of borrowed money. Federal income taxes reduced the company's cash flow each year by hundreds of millions of dollars, limiting the amount available to pay interest. And while the company boasted many prize assets like the Chicago Cubs that could be unloaded to pare down the acquisition debt, selling them piece by piece would trigger huge capital gains taxes because Tribune Co. had owned most of the assets for so long.
The Zell team's brainstorm was to take the company private and convert it into what's known as an S-Corp ESOP, a Subchapter S corporation owned by an employee stock ownership plan. Because an ESOP is officially a retirement vehicle, the structure immediately eliminates corporate income tax.
So far, so good, right?
Floyd Norris quotes tax analyst Robert Willens: "In conception, it was brilliant... It would have been probably the greatest tax avoidance structure ever devised, had they earned income."
The catch is that, as Norris notes, a company that converts "to S status may still be subject to capital gains taxes if it sells assets within 10 years after the conversion. If that happens, it owes taxes on the gain in value that accrued before the company converted."
The Tribune did sell some assets, and Zell apparently had another "clever way" to handle that potential tax problem.
The Internal Revenue Service is now questioning many Tribune Co asset sales, but especially the sale of Long Island, NY-based Newsday and that of the Chicago Cubs. Norris notes drily that the IRS concluded that Zell's gimmick was "so outrageous that it added a 20 percent 'accuracy related penalty' to the $190 million tax that should have been paid when Tribune sold ... Newsday to Cablevision in 2008. Under the law, that penalty is reserved for transactions that show 'negligence or disregard of rules or regulations,' or are 'lacking economic substance.'"
Fortune senior editor-at-large Allan Sloan wrote a few days ago,
I used to consider Zell and his tax avoidance schemes sort of amusing. But the amusement -- and congeniality -- are both long gone.
I'm sure that after litigation or the threat of it, Tribune will ultimately settle [for] considerably less than the $600 million likely total of the claims, penalties and interest. However, my bet is that Tribune will ultimately fork over more than $100 million to pay for the tax games Zell played with Newsday (one of my former employers) and the Cubs.
That's just what the company, struggling to survive in a hostile landscape for media companies, needed in its new life -- a big, fat tax bill from the past. Thanks a lot, Sam.
I believe in taxes. I don't believe in totally simplistic one-size-fits-all flat taxes. But I want a system that rewards companies and employees, not $1,000-an-hour lawyers who can figure out ways to avoid paying taxes. If Zell had been a little less clever, or a lot more ethical, ... well, a person can dream, can't she?
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