Tribune Media Says Tax Court Partially Right on Cubs Transaction

TRIBUNE MEDIA COMPANY,
formerly known as TRIBUNE COMPANY & AFFILIATES,
Petitioner-Appellee-Cross-Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellant-Cross-Appellee

CHICAGO BASEBALL HOLDINGS, LLC, et al.,
Petitioners-Appellees-Cross-Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellant-Cross-Appellee

IN THE UNITED STATES COURT OF APPEALS
FOR THE SEVENTH CIRCUIT

On Appeal from the United States
Tax Court, Nos. 20940-16 & 20941-16

PETITIONERS' OPENING AND RESPONSE BRIEF

Nicole A. Saharsky
Minh Nguyen-Dang
MAYER BROWN LLP
1999 K Street NW
Washington, DC 20006
(202) 263-3052

Phillip M. Goldberg
FOLEY & LARDNER LLP
321 N. Clark Street, Suite 3000
Chicago, IL 60654
(312) 832-4549

Joel V. Williamson
Timothy S. Bishop
Thomas L. Kittle-Kamp
Anthony D. Pastore
MAYER BROWN LLP
71 S. Wacker Drive
Chicago, IL 60606
(312) 701-7229
jwilliamson@mayerbrown.com

Corporate Disclosure Statement

1. The full names of the parties:

2. The names of all law firms whose partners or associates have appeared for the parties in the case or are expected to appear for the parties in this Court:

3. If a party is a corporation, (i) identify all its parent corporations, if any; and (ii) list any publicly held company that owns 10% or more of that party's stock:

4. Provide information required by FRAP 26.1(b) — Organizational Victims in Criminal Cases:

5. Provide Debtor information required by FRAP 26.1(c) 1 & 2:

Joel V. Williamson
Dated: August 8, 2023

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Table of Contents

Corporate Disclosure Statement

Table of Contents

Table of Authorities

Statement Regarding Oral Argument

Glossary

Introduction

Jurisdictional Statement

Issues Presented

Statement of the Case

1. Debt-Financed Distribution Ruling

2. Debt Versus Equity Ruling

Summary of Argument

Argument

I. Tribune and CBH Correctly Reported the Debt-Financed Distribution

1. The Constructive-Liquidation Test Provides the Governing Rule Here

2. Tribune Bore the Economic Risk of Loss for the Loans Under the Constructive-Liquidation Test

1. The Text of the Rule Provides No Basis to Disregard Tribune's Guarantees

2. Nothing Else Supports the Government's Interpretation of the Specific Anti-Abuse Rule

3. Tribune Bore a Meaningful Risk of Loss on Its Guarantees

1. The General Anti-Abuse Rule Is Invalid

2. The General Anti-Abuse Rule Applies to the Cubs Transaction as a Whole, Not to Each Guarantee

3. The Transaction Had a Substantial Business Purpose Under Any Standard

II. The Subordinated Debt Was Debt, Not Equity

1. Whether an Investment Is Debt or Equity Depends on the Parties' Intent

2.The Parties Intended for CBH to Repay the Subordinated Debt Regardless of CBH's Success

3. Interested Third Parties All Understood the Subordinated Debt to Be Debt

1. The Parties Treated the Subordinated Debt as Debt

2. CBH's Obligations and Performance Favored Debt

3. The Lender's Rights Favored Debt

4. The Risks of the Subordinated Debt Favored Debt

Conclusion

Certificate of Compliance

Circuit Rule 30(d) Certification

Certificate of Service

Table of Authorities

Cases

Am. Boat Co. v. United States, 583 F.3d 471 (7th Cir. 2009)

ASA Investerings P'ship v. Comm'r, 201 F.3d 505 (D.C. Cir. 2000)

Bartholomew v. United States, 740 F.2d 526 (7th Cir. 1984)

Baxter v. Comm'r, 910 F.3d 150 (4th Cir. 2018)

Belgard v. Manchac Techs., LLC, 92 So. 3d 660 (La. Ct. App. 2012)

Benenson v. Comm'r, 910 F.3d 690 (2d Cir. 2018)

Black & Decker Corp. v. United States, 436 F.3d 431 (4th Cir. 2006)

Bowen v. Georgetown Univ. Hosp., 488 U.S. 204 (1988)

Busch v. Comm'r, 728 F.2d 945 (7th Cir. 1984)

Canal Corp. v. Comm'r, 135 T.C. 199 (2010)

Central Com. Co. v. Comm'r, 337 F.2d 387 (7th Cir. 1964)

Chemtech Royalty Assocs., L.P. v. United States, 766 F.3d 453 (5th Cir. 2014)

Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984)

Coltec Indus., Inc. v. United States, 454 F.3d 1340 (Fed. Cir. 2006)

Comm'r v. Tufts, 461 U.S. 300 (1983)

Director, OWCP v. Newport News Shipbuilding & Dry Dock Co., 514 U.S. 122 (1995)

Dixie Dairies Corp. v. Comm'r, 74 T.C. 476 (1980)

Esmark, Inc. v. Comm'r, 90 T.C. 171 (1988)

Exelon Corp. v. Comm'r, 906 F.3d 513 (7th Cir. 2018)

Feldman v. Comm'r, 779 F.3d 448 (7th Cir. 2015)

Frank Lyon Co. v. United States, 435 U.S. 561 (1978)

Friedrich v. Comm'r, 925 F.2d 180 (7th Cir. 1991)

Garcia v. Sessions, 873 F.3d 553 (7th Cir. 2017)

Gokey Props., Inc. v. Comm'r, 34 T.C. 829 (1960)

Green Bay Structural Steel, Inc. v. Comm'r, 53 T.C. 451 (1969)

Gregory v. Helvering, 293 U.S. 465 (1935)

Guidry v. Sheet Metal Workers Nat'l Pension Fund, 493 U.S. 365 (1990)

Ill. Tool Works v. Comm'r, 116 T.C.M. (CCH) 124 (2018)

Inland Mortg. Cap. Corp. v. Chivas Retail Partners, LLC, 740 F.3d 1146 (7th Cir. 2014)

Jade Trading, LLC v. United States, 80 Fed. Cl. 11 (2007)

JP Morgan Chase & Co. v. Comm'r, 458 F.3d 564 (7th Cir. 2006)

Kearney Partners Fund, LLC v. United States, 803 F.3d 1280 (11th Cir. 2015)

Keys v. Barnhart, 347 F.3d 990 (7th Cir. 2003)

Kikalos v. Comm'r, 434 F.3d 977 (7th Cir. 2006)

Kisor v. Wilkie, 139 S. Ct. 2400 (2019)

Knetsch v. United States, 364 U.S. 361 (1960)

Kraft Foods Co. v. Comm'r, 232 F.2d 118 (2d Cir. 1956)

In re Larson, 862 F.2d 112 (7th Cir. 1988)

Estate of Mixon v. United States, 464 F.2d 394 (5th Cir. 1972)

Monon R.R. v. Comm'r, 55 T.C. 345 (1970)

N. Ind. Pub. Serv. Co. v. Comm'r, 115 F.3d 506 (7th Cir. 1997)

Nestlé Holdings, Inc. v. Comm'r, 70 T.C.M. (CCH) 682 (1995)

Nev. Partners Fund, LLC v. United States, 720 F.3d 594 (5th Cir. 2013)

PepsiCo P.R., Inc. v. Comm'r, 104 T.C.M. (CCH) 322 (2012)

Pittman v. Comm'r, 100 F.3d 1308 (7th Cir. 1996)

Pritired 1, LLC v. United States, 816 F. Supp. 2d 693 (S.D. Iowa 2011)

Ragsdale v. Wolverine World Wide, Inc., 535 U.S. 81 (2002)

Raphan v. United States, 3 Cl. Ct. 457 (1983)

Roth Steel Tube Co. v. Comm'r, 800 F.2d 625 (6th Cir. 1986)

Saviano v. Comm'r, 765 F.2d 643 (7th Cir. 1985)

Scherr v. Marriot Int'l, Inc., 703 F.3d 1069 (7th Cir. 2013)

Sierra Club v. FERC, 38 F.4th 220 (D.C. Cir. 2022)

Slappey Drive Indus. Park v. United States, 561 F.2d 572 (5th Cir. 1977)

Steinman v. Hicks, 352 F.3d 1101 (7th Cir. 2003)

TIFD III-E, Inc. v. United States, 459 F.3d 220 (2d Cir. 2006)

Tyler v. Tomlinson, 414 F.2d 844 (5th Cir. 1969)

UPS v. Comm'r, 254 F.3d 1014 (11th Cir. 2001)

VHC, Inc. v. Comm'r, 968 F.3d 839 (7th Cir. 2020)

W. Va. Univ. Hosps., Inc. v. Casey, 499 U.S. 83 (1991)

William Penn P'ship v. Saliba, 13 A.3d 749 (Del. 2011)

Ziglar v. Abbasi, 582 U.S. 120 (2017)

Statutes, Regulations, and Rules

5 U.S.C. § 706(2)(C) (2009)

Internal Revenue Code of 1986, 26 U.S.C. § 1 et seq.:

Deficit Reduction Act of 1984, Pub L. No. 98-369, § 79(b), 98 Sat. 494, 597

Treasury Regulations:

53 Fed. Reg. 53,140 (Dec. 30, 1988)

Del. Code Ann. tit. 6, § 18-301(d) (2009)

Del. Code Ann. tit. 6, § 18-303(a) (2009)

Other Authorities

3B Am. Jur. 2d Legal Forms (2023)

Deloitte, Life Sciences Industry Accounting Guide (2023)

Michael G. Frankel & Charles H. Coffin, New Section 752 Regulations Clarify Treatment of Partnership Liabilities, 6 J. Partnership Tax'n 179 (1989)

Penny Gusner, Average Cost of Life Insurance in June 2023, Forbes (Jun. 8, 2023)

H.R. Rep. No. 83-1337 (1954)

H.R. Rep. No. 98-432 (1984)

H.R. Rep. No. 98-861 (1984)

Dan Huckabay, How Much Does an Appeal Bond Cost?, Court Surety Bond Agency (2021)

Joint Comm. on Tax'n, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984 (1985)

Kenny Kang et al., S&P, Standard & Poor's U.S. Recovery Rating Performance — A Five-Year Study (2013)

William McKee, William Nelson & Robert Whitmire, Federal Taxation of Partnerships & Partners (2019)

Rev. Proc. 93-27, 1993-2 C.B. 343

Arthur Willis, Philip Postlewaite & Jennifer Alexander, Partnership Taxation (2023)

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Statement Regarding Oral Argument

Petitioners respectfully suggest that oral argument would be helpful to the Court because this appeal and cross-appeal involve complex tax issues and a voluminous record.

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Glossary

CBH

Chicago Baseball Holdings, LLC

Chicago Cubs or Cubs

The Chicago Cubs baseball team and related assets

Cubs transaction

The transaction that closed on October 27, 2009, in which Tribune transferred the Cubs to CBH, CBH took out the senior and subordinated debts, Tribune guaranteed the collection of the loans, and Tribune received a distribution from CBH

GAAP

Generally Accepted Accounting Principles

IRS

Internal Revenue Service

MLB

Major League Baseball

RAC

Ricketts Acquisition LLC, now known as Northside Entertainment Holdings, LLC

RAC Finance

RAC Education Trust Finance, LLC

S&P

Standard & Poor's

Senior debt

The $425 million in senior loans that CBH borrowed from third-party lenders

Senior-debt guarantee

Tribune's guarantee of collection for the senior debt

Subchapter K

Subtitle A, chapter 1, subchapter K of the Internal Revenue Code, 26 U.S.C. § 701 et seq.

Subordinated debt

The $248.75 million in subordinated debt that CBH borrowed from RAC Finance

Subordinated-debt guarantee

Tribune's guarantee of collection for the subordinated debt

Tribune

Tribune Co., now known as Tribune Media Co.

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Introduction

This case involves Tribune Media Company's transfer of the Chicago Cubs baseball team to a partnership it formed with the Ricketts family. Tribune used a well-established and thoroughly regulated type of partnership transaction, and it followed an on-point tax regulation to the letter. It paid $149 million in tax on the transaction. But the government wants more tax, so it cast aside its own regulation and asserted sweeping authority to invalidate Tribune's tax treatment under two anti-abuse rules. The Tax Court correctly rejected that approach.

In the transaction at issue, Tribune formed a partnership with Ricketts Acquisition LLC (RAC). The partnership was called Chicago Baseball Holdings, LLC (CBH). Tribune contributed the Cubs and related assets, and RAC contributed money. The partnership took out two loans, and Tribune guaranteed their collection. The partnership then used the loan proceeds to pay Tribune. Under longstanding tax regulations, the money paid to Tribune was a “debt-financed distribution,” rather than proceeds from a sale, because Tribune's guarantees made it liable for the loans. Importantly, the regulations allowed Tribune only to defer the tax and pay it over a period of years, not to avoid paying tax entirely.

The government seeks to disregard Tribune's guarantees because in its view, the likelihood Tribune would ever have to pay on the guarantees was remote. If the government can disregard the guarantees, the government can treat all of the money the partnership paid Tribune as proceeds from a sale and tax it in the year of the transaction.

The Tax Court correctly held that no basis exists for disregarding Tribune's guarantees. The Treasury Department's own regulation sets out the test for determining whether Tribune ultimately was liable for the partnership's loans because of the guarantees. That test, called the constructive-liquidation test, asks whether Tribune would have to repay the loans in the worst-case scenario where all liabilities come due and the partnership has no ability to pay. The test does not consider the likelihood of that scenario occurring. The Tax Court applied that test and held that Tribune would have to pay in that scenario, so the government cannot disregard the guarantees, and the money paid to Tribune is a debt-financed distribution.

On appeal, the government casts aside its own constructive-liquidation test and argues it can use two anti-abuse rules to disregard the guarantees. But the Treasury Department chose the constructive-liquidation test for this precise situation, and it cannot simply abandon that test when the taxpayer wins under it. Further, by their terms, the anti-abuse rules apply only in narrow circumstances not present here. And even if the government were correct on the law, the government would lose on the facts, because the Tax Court found that the guarantees had real economic value. The Court therefore should affirm on the government's appeal.

The issue on cross-appeal is whether part of the money that the partnership borrowed should be considered equity, rather than debt, for tax purposes. The partnership took out two types of loans — the senior debt (loans from various banks that would be repaid first) and the subordinated debt (loans from a separate company that would be repaid after the senior debt). Everyone agreed that the senior debt qualifies as debt for tax purposes. But the Tax Court treated the subordinated debt as equity. If the subordinated debt is equity, then the portion of the distribution to Tribune funded by that debt does not qualify as a debt-financed distribution.

The key question is whether the parties intended for the investment to be equity, with repayment depending on the success of the venture, or debt, where the funds would be repaid no matter what. Here, the parties' intent is clear: They called the subordinated debt “debt”; issued it as debt; and treated it as debt. The debt instrument required the loan to be paid back regardless of the partnership's success. If the partnership did not repay the loan, the debtholder would have the same right to repayment as the partnership's other unsecured creditors, ahead of the equity holders. All interested third parties treated the subordinated debt as debt. The lenders of the senior debt entered into binding contracts on that basis. Major League Baseball (MLB) and Standard & Poor's (S&P) both considered the subordinated debt to be debt when they analyzed the Cubs transaction to understand its effect on Tribune's and the partnership's financial positions.

The Tax Court reached the wrong result because it failed to focus on the ultimate question: the parties' intent. It mechanically applied a thirteen-factor test instead of evaluating what the factors show about the parties' intent. It also relied on standard features of subordinated debt to show equity, even though subordinated debt is a common form of financing that is widely understood to be debt. And it completely disregarded the evidence of how the interested third parties treated the subordinated debt. This Court therefore should reverse on the cross-appeal.

Jurisdictional Statement

Tax Court's Jurisdiction

Tribune and CBH (through its tax matters partner RAC), brought these consolidated cases in the Tax Court to contest the Commissioner's determinations of their federal tax liability. SA.38. The Tax Court had jurisdiction over Tribune's petition under 26 U.S.C. §§ 6213, 6214, and 7442, and over CBH's petition under 26 U.S.C. § 6226(a) and (f ).¹

Appellate Jurisdiction

On October 19, 2022, the Tax Court entered a decision in the consolidated cases that resolved all claims. SA.128-33. On January 13, 2023, the Commissioner timely filed notices of appeal. See 26 U.S.C. § 7483. On February 3, 2023, Tribune and CBH each timely filed notices of appeal. See id. This Court has jurisdiction under 26 U.S.C. § 7482(a)(1).

Issues Presented

1. Whether CBH's distribution to Tribune was primarily a debt-financed distribution under 26 C.F.R. § 1.707-5(b) because Tribune retained ultimate liability for CBH's loans under 26 C.F.R. § 1.752-2(b)(1) due to its guarantees, and there is no basis to disregard the guarantees under the specific anti-abuse rule in 26 C.F.R. § 1.752-2(j) or the general anti-abuse rule in 26 C.F.R. § 1.701-2.

2. Whether the subordinated debt should be treated as debt rather than equity for tax purposes.

Statement of the Case

Tribune's transfer of the Chicago Cubs was a straightforward partnership transaction that followed the relevant tax regulations to the letter.

A. Tribune's Transfer of the Cubs

Tribune is a media company that originally owned the Chicago Tribune newspaper. SA.7. In 1981, it bought the Chicago Cubs baseball team, Wrigley Field, and other related assets. SA.7.

In 2007, Tribune decided to divest the Cubs. SA.8-9. It wanted to refocus on its core media business, and it thought new ownership would better help the Cubs succeed. SA.8-9; see B.5-7, B.523-24. Divesting the Cubs also would generate cash and help reduce Tribune's debt load. SA.8-9.

Tribune decided to form a partnership to own the Cubs. SA.9. That structure would allow Tribune to remain a minority owner of the Cubs, preserve media relationships it had developed, obtain proceeds to pay down its other debts, and reduce its immediate tax liability. A.399; B.7-8.

Tribune chose as its partner the Ricketts family, a family with significant financial resources and an “enduring love of Cubs baseball.” SA.8. The Ricketts family, led by Thomas Ricketts, acted through RAC. SA.17.

Tribune and RAC agreed to form a partnership called CBH. SA.14. RAC agreed that it would own 95% and Tribune would own 5%. SA.11.

B. Partnership Taxation Rules Applicable to the Transfer

Tribune and RAC relied on settled rules of partnership taxation to structure their transaction.

First, a partner's transfer of property to a partnership generally is not taxable. See, e.g., 26 U.S.C. § 721(a)(1); SA.45. Congress made that choice to encourage the free flow of capital between partners and their partnerships. H.R. Rep. No. 83-1337, at 64 (1954).

Second, partners and partnerships (like any taxpayer) can borrow money, and when they do so, the loan proceeds are not taxable. SA.44-45. That is because the money received is offset by the obligation to repay the loan, and there is no net increase in wealth. SA.91-92; see Comm'r v. Tufts, 461 U.S. 300, 307 (1983).

Thus, if a partner contributes property to a partnership and the partnership takes out a loan on that property, neither step is taxable. SA.46. The question is what happens if the partnership then distributes the loan proceeds to that partner.

The Internal Revenue Code and tax regulations answer that question. If the partner simply receives a distribution of money in return for the property, the transaction can be considered a sale (called a “disguised sale”). 26 U.S.C. § 707(a)(2)(B); 26 C.F.R. § 1.707-3(b); see SA.45. In the year of the sale, the partner must recognize as income the difference between the amount of the distribution and its basis in the contributed property. 26 U.S.C. §§ 61(a)(3), 1001(a), (c).

But if the partner takes on ultimate liability for the loan (for example, by guaranteeing the loan), then the money the partner receives is a “debt-financed distribution.” SA.46-47 (citing 26 C.F.R. § 1.707-5(b)(1)). It is not immediately taxable because the partner effectively has borrowed the money using the partnership as a conduit. H.R. Rep. No. 98-861, at 862 (1984) (Conf. Rep.).

To show that a distribution is a debt-financed distribution, the partner must show that it retained liability for repayment of the loan. 26 C.F.R. § 1.707-5(a)(2); SA.47. A regulation provides that a partner retains liability on a loan if it bears the “economic risk of loss” for the loan. 26 C.F.R. § 1.752-2(a). The regulation then sets out the test for determining whether a partner bears the economic risk of loss for the loan, called the constructive-liquidation test. Id. § 1.752-2(b)(1). That test asks whether the partner would be obligated to repay the loan if the partnership were liquidated and all of its assets were treated as worthless. Id. If the answer is yes, then the partner bears the economic risk of loss, and the distribution is a debt-financed distribution. See id. § 1.707-5(b).

The fact that a debt-financed distribution is not immediately taxed does not mean tax is never paid. If the fair market value of the contributed property exceeds the contributing partner's tax basis in the property, then there is built-in gain on the property and the partner must account for some of the gain in its income each year. 26 U.S.C. §§ 704(c), 723; see 26 C.F.R. § 1.704-3; William McKee, William Nelson & Robert Whitmire, Federal Taxation of Partnerships & Partners § 11.04 (2019) (McKee). That continues until the property is sold, the partner sells its stake in the partnership, or the partner stops being liable for the loan. If any of those happens, the partner must include the remaining gain as income that year. See 26 U.S.C. §§ 731, 741; 26 C.F.R. § 1.704-3. Thus, the built-in gain on the property eventually is treated as income to the partner.

C. Details of the Cubs Transaction

Tribune and RAC structured the Cubs transaction so that the payment to Tribune would be primarily a debt-financed distribution.

First, Tribune contributed the Cubs, Wrigley Field, and other related assets to CBH, and RAC contributed $150 million. SA.14. Second, CBH raised $674 million in debt — $425 million in senior debt from third-party banks and $249 million in subordinated debt from RAC Education Trust Finance, LLC (RAC Finance), a company 90% owned by Marlene Ricketts, Thomas Ricketts's mother. SA.17-19. Third, Tribune guaranteed the collection of the senior and subordinated debts, agreeing that it would repay both debts (principal and interest) if the lenders could not collect payment from CBH. SA.30. Fourth, CBH distributed $714 million to Tribune, using the $674 million of debt and $40 million of the capital. SA.33. Thus, the payment to Tribune was a debt-financed distribution to the extent of the amount of Tribune's guarantees, and the rest was proceeds from a sale.

During the negotiations for the Cubs transaction, Tribune filed for Chapter 11 bankruptcy. SA.12. As a result, the bankruptcy court had to approve the transaction. It did so after carefully reviewing the transaction, including the proposed debt structure. SA.12-13; see B.13-35. The bankruptcy did not affect Tribune's payment obligations under the guarantees: The bankruptcy court gave administrative expense priority to obligations related to the transaction (including the guarantees), meaning that they would be paid if they came due during the bankruptcy, SA.12-13, and it ordered that the guarantees would continue in full force after the bankruptcy, B.65. At all relevant times, Tribune's cash exceeded its guarantee obligations. SA.12, SA.104.

D. Tax Reporting of the Cubs Transaction

Tribune and CBH reported the Cubs transaction as primarily a debt-financed distribution. Specifically, Tribune reported $674 million of the $714 million distribution as debt-financed distribution because that was the amount of loans it had guaranteed. A.1097. Tribune reported the remaining $40 million as sale proceeds, because that amount had no corresponding loan guarantees. A.1097.

Tribune paid some tax right away and some over time. When Tribune transferred the Cubs to CBH, the Cubs had a fair market value of $735 million and Tribune's basis in the Cubs was $146 million, SA.14, SA.34, so Tribune had unrealized gain of $589 million. On its 2009 tax return, Tribune reported $33.8 million of that gain as income from a sale (the $40 million in sale proceeds minus its share of CBH's basis in the Cubs). A.1071. Then, each year from 2009 to 2018, Tribune reported income to account for part of the remaining gain. B.437-39; see 26 C.F.R. § 1.704-3(d); McKee § 11.04[3][d].² In 2019, Tribune sold its 5% interest in CBH to RAC and re-ported the remainder of the gain as income. B.437-39.

The result is that Tribune paid a significant amount of tax on the Cubs transaction — $149 million in federal and state income tax over the life of the partnership. B.438-39. The government does not dispute that. Pet'rs T.C. Opening Br. 128-29 (proposed finding 482); Gov't T.C. Answering Br. 74 (no objection). Instead, it seeks more tax by arguing that Tribune should have treated the entire distribution as sale proceeds in 2009. SA.37.

E. IRS's Objection to That Tax Treatment

The IRS sent Tribune a notice of deficiency and CBH a notice of partnership tax adjustment. SA.2. It contended that none of the distribution to Tribune was a debt-financed distribution because (in its view) Tribune was not liable for CBH's loans despite the guarantees. SA.42. It also argued that the subordinated debt should be treated as equity for tax purposes. SA.42.

The IRS had three theories for disregarding Tribune's guarantees. First, it argued that Tribune did not bear the economic risk of loss under the constructive-liquidation test because it was unlikely that Tribune would have to pay on the guarantees because creditors would have to exhaust legal remedies against CBH first. SA.95-97.

Second, the government relied on a specific anti-abuse rule contained in the constructive-liquidation regulation. SA.98. The rule states that a partner's obligation may be disregarded if the parties entered into an arrangement with “a principal purpose” of either “eliminat[ing] the partner's economic risk of loss with respect to that obligation” or “creat[ing] the appearance of the partner . . . bearing the economic risk of loss when, in fact, the substance of the arrangement is otherwise.” 26 C.F.R. § 1.752-2(j)(1). The government asserted that it could disregard Tribune's guarantees under this rule because the chances of Tribune paying on them was too “remote.” SA.99-100.

Third, the government relied on the general partnership anti-abuse rule. SA.106. It provides in relevant part that “each partnership transaction or series of related transactions . . . must be entered into for a substantial business purpose.” 26 C.F.R. § 1.701-2(a). The government contended that Tribune's guarantees lacked a substantial non-tax purpose because Tribune provided the guarantees only to obtain tax benefits. SA.108.

F. Tax Court's Decision

Tribune and CBH brought these consolidated cases in the Tax Court to challenge the IRS's notices. A.173, A.215. The Tax Court held a 10-day trial and issued a 127-page opinion substantially allowing Tribune's tax treatment.

1. Debt-Financed Distribution Ruling

The Tax Court held that Tribune correctly characterized the bulk of the distribution it received from the Cubs transaction as a debt-financed distribution because Tribune had guaranteed collection of CBH's loans. SA.118.³

The Tax Court recognized that whether Tribune's distribution was a debt-financed distribution depended on whether Tribune “b[ore] the risk of economic loss” for CBH's loans through its guarantees, SA.94, which is determined using the constructive-liquidation test, SA.94-95. That test asks whether “the partner would be obligated to make payment to the creditor” in the worst-case scenario, where “all of the partnership's liabilities become payable in full” and “all of the partnership's assets,” “including cash,” become worthless. SA.94.

The Tax Court determined, based on the record evidence, that “Tribune would be required to pay” in those circumstances. SA.94-98. It explained that if CBH were liquidated, the lenders would turn to Tribune (and no one else) for payment. SA.95-96. It rejected the government's argument that Tribune's guarantees did not count because lenders had to exhaust remedies against CBH before seeking payment from Tribune. SA.95-97.

The Tax Court determined that neither anti-abuse rule provides a basis for disregarding Tribune's guarantees. SA.98-114. Under the specific anti-abuse rule, the government had argued that Tribune did not bear the risk of loss because the chances that Tribune would have to pay were too remote. SA.99-100. The Tax Court explained that the “probability” that Tribune would have to pay is “irrelevant” because the constructive-liquidation test already assumes the worst-case scenario. SA.101. The anti-abuse rule asks a separate question — whether the parties purposefully arranged to eliminate the partner's economic risk of loss. SA.101. Here, the Court found, “[i]t is clear that if CBH could not pay its senior debt, Tribune would have to do so.” SA.101. The specific anti-abuse rule thus “does not apply.” SA.101.

Under the general anti-abuse rule, the government had argued that Tribune's guarantees should be disregarded because they lacked a substantial business purpose. SA.107. The government argued that the guarantees themselves, rather than the overall partnership transaction, had to have a substantial business purpose. SA.107. The Tax Court rejected that interpretation, explaining that the regulation applies only when the overall transaction lacks a substantial business purpose, not when any component of that transaction lacks such a purpose. SA.105-10. The Tax Court then found that, in any event, both the overall transaction and the guarantees had substantial business purposes: Tribune and RAC formed CBH for the business purpose of owning and operating the Cubs, SA.110, and Tribune made the guarantees for the business purpose of ensuring that CBH's loans would be paid in the event of a default, SA.110-12. The Tax Court thus found the general anti-abuse rule inapplicable as well. SA.113.⁴

2. Debt Versus Equity Ruling

The Tax Court separately held that the subordinated debt was equity for tax purposes. SA.90. It recognized that debt must be repaid regardless of the partnership's success or failure, whereas equity is repaid only if the partnership is successful. SA.57. It used the thirteen factors set out in Dixie Dairies Corp. v. Commissioner, 74 T.C. 476 (1980), to determine whether an investment is debt or equity. SA.58-90.

The Tax Court reviewed each of the thirteen factors and concluded that most favored equity. It acknowledged that the subordinated debt was labelled “debt”; that the terms of the debt instrument required repayment regardless of CBH's success; and that CBH “made consistent payments according to the terms of the sub debt.” SA.59, SA.75. But it deemed the subordinated debt equity based on a handful of other facts. SA.90. It placed particular weight on the fact that the debtholder, RAC Finance, was related to RAC, and that (in its view) RAC Finance would not take enforcement measures if CBH did not pay. SA.72, SA.80, SA.90. It also relied on RAC's 95% ownership share in CBH, which aligned with RAC's share of equity contributions in CBH if the subordinated debt was considered equity — even though ownership shares and equity contributions do not have to align. SA.77-78. And it relied on common features of subordinated debt, such as the fact that the debtholder could not collect on the debt until the senior debt was repaid. SA.68. Based on those facts, the Tax Court deemed the subordinated debt equity. SA.90.

Summary of Argument

I. The Tax Court correctly held that CBH's distribution to Tribune was primarily a debt-financed distribution, rather than sale proceeds.

A. As the Tax Court explained, the payment to Tribune in the Cubs transaction qualified as a debt-financed distribution if Tribune bore the “economic risk of loss” for the loans. 26 C.F.R. § 1.752-2(a). A longstanding tax regulation explains how to make that determination: Apply the constructive-liquidation test, which asks whether Tribune would be obligated to pay the loans if CBH were liquidated, all of its assets were worthless, and all of its debts came due. Id. § 1.752-2(b). The Tax Court found that in that worst-case situation, Tribune (and no one else) would have to repay CBH's loans, so Tribune bore the economic risk of loss for the loans.

In the Tax Court, the government argued that it won under the constructive-liquidation test because the possibility of payment on the guarantees was remote. The Tax Court correctly rejected that argument, explaining that the constructive-liquidation test necessarily assumes a remote (worst-case) scenario. On appeal, the government no longer disputes that Tribune wins under the constructive-liquidation test. Instead, it argues that it can override that result through two anti-abuse rules. But its arguments are really nothing more than attempts to relitigate the constructive-liquidation test.

B. The government first argues that Tribune's guarantees should be disregarded under the specific anti-abuse rule in the constructive-liquidation regulation. That rule assumes that a constructive liquidation has occurred and that a particular partner bears the economic risk of loss, then asks whether the partner's obligation to pay nonetheless should be disregarded because the parties entered an abusive arrangement that actually eliminated the partner's risk. As the Tax Court recognized, that is not the situation here, because if CBH were constructively liquidated, Tribune would have to repay the loans, and nothing suggests that Tribune and CBH entered into an arrangement designed to eliminate Tribune's economic risk of loss.

The government argues that it can disregard Tribune's guarantees under the specific anti-abuse rule because the chances that Tribune would have to pay were remote and so the guarantees were not meaningful. That is wrong for two reasons.

First, the anti-abuse rule does not say anything about whether the risk of loss is remote. It instead asks whether the parties have entered into an “arrangement” with “a principal purpose” of either “eliminat[ing]” the partner's risk of loss or “creat[ing] the appearance” that the partner bore the risk of loss when in fact it did not. 26 C.F.R. § 1.752-2(j)(1). As the Tax Court found, there is absolutely no evidence of that here.

Second, the government's view of the anti-abuse rule would make the constructive-liquidation test superfluous. The constructive-liquidation test says that a partner bears the economic risk of loss when the partner would have to pay in the worst-case scenario of a constructive liquidation. Under the government's view of the anti-abuse rule, a partner bears the economic risk of loss only if the government believes there is a sufficient possibility that the worst-case scenario actually will occur and that the partner actually will have to pay in that scenario. If the government's view were correct, the constructive-liquidation test would be irrelevant, because even if the taxpayer satisfied it, the government could simply use the anti-abuse rule to say that the partner does not bear the economic risk of loss because the chances of payment are too remote. Nothing in the regulation's text or history supports the government's view that it can use the anti-abuse rule to circumvent the constructive-liquidation test.

Even if the government's interpretation of the specific anti-abuse rule were correct, it would lose on the facts, because the Tax Court found that Tribune bore a meaningful risk of loss on its guarantees. The government's expert agreed that there was a meaningful risk of CBH defaulting on its debts and valued Tribune's guarantees at up to $24 million. The value of the senior-debt guarantee, in particular, was comparable to real-world premiums on appeal bonds and life-insurance policies. The Tax Court's findings on this point are reviewed for clear error, which the government has not shown.

C. The government separately contends that it can disregard Tribune's guarantees under the general anti-abuse rule applicable to all partnership transactions, 26 C.F.R. § 1.701-2. That rule requires the relevant transaction or series of transactions to have a substantial business purpose. As the Tax Court recognized, it does not apply here.

At the outset, the general anti-abuse rule is invalid because Congress did not give the Treasury Department the authority to disregard any partnership transaction that it believes lacks a sufficient business purpose. Instead, Congress set out detailed rules for partnership transactions, and if a transaction follows those rules, it is allowed. When Congress wanted Treasury to inquire into the purpose of a transaction, it said so directly — and it did not do that for partnership transactions. The government's claim that it can nullify transactions even when the taxpayer followed all of the rules Congress provided is an incredibly broad assertion of governmental power that this Court should reject.

Even if the government had the authority to promulgate the general anti-abuse rule, it cannot rely on the rule here because the specific anti-abuse rule already addresses this type of transaction. If Tribune's guarantees are valid under the specific anti-abuse rule, the government cannot invalidate them under the general anti-abuse rule.

Further, the government's interpretation of the general anti-abuse rule is incorrect. That rule requires a substantial business purpose for the entire transaction at issue (here, the Cubs transaction), not every component of the transaction (such as the guarantees) in isolation. That is clear from the text of the regulation, which asks whether the “transaction or series of related transactions” had a substantial business purpose, 26 C.F.R. § 1.701-2(a)(1)(i), as well as from the examples provided in the regulation. As the Tax Court explained, the government's position makes no sense, because the government could focus on any “level of minutiae” (SA.109) to invalidate a transaction that is otherwise allowed under the tax laws.

In any event, the Tax Court correctly found that both the overall Cubs transaction and the guarantees had valid business purposes. The government concedes that the overall Cubs transaction had substantial business purposes, including forming CBH to own and operate the Cubs. And the Tax Court found that the guarantees had the business purpose of ensuring repayment for CBH's loans and had real economic value. Again, the government has not come close to showing clear error.

II. The Tax Court erred in concluding that the subordinated debt should be treated as equity, rather than debt, for tax purposes.

A. The fundamental question is whether the parties to the transaction intended to create a debt investment (meaning that the debt would be repaid no matter what) or an equity investment (meaning repayment would be contingent on the success of the partnership).

Here, the parties' intent is clear. The debt instrument required CBH to repay the subordinated debt (with interest) regardless of its success. If CBH did not pay, the debtholder could enforce payment, ahead of any equity holders. CBH made all payments on the subordinated debt according to its terms. When RAC bought out Tribune's share of CBH, the parties subtracted both the senior debt and the subordinated debt from CBH's enterprise value, showing that the parties understood both to be debt that reduced CBH's value.

Importantly, the senior debtholders treated the subordinated debt as debt. They limited the amount of the subordinated debt allowed and required the senior debt to be repaid first. Those steps would have been unnecessary if the subordinated debt actually was equity. Other interested third parties also treated the subordinated debt as debt, including MLB (which carefully evaluated the proposed debt structure to ensure CBH's financial stability), S&P (which rated CBH's and Tribune's creditworthiness), and the bankruptcy court (which evaluated the transaction to ensure it made sense for Tribune's creditors). This confirms that the parties intended to create debt.

B. The Tax Court missed the bigger picture. It mechanically reviewed thirteen factors and counted up which favored equity or debt, instead of analyzing those factors as indicators of the parties' intent. And in analyzing the particular factors, it made multiple legal errors.

For example, it viewed standard features of subordinated debt (like the fact that the debtholder can enforce payment only after a senior debt is repaid) as creating equity, even though subordinated debt is understood to be debt. Subordination simply provides the order in which debts will be paid. The fact that the lenders agreed that one debt would be paid first does not mean that the subordinated debtholder agreed to give up its rights against the borrower.

The Tax Court also noted that RAC viewed the debt as part of its investment in the Cubs. But a debt “investment” is still debt. Relatedly, the Tax Court observed that RAC's share of equity contributions would match its 95% ownership interest in CBH if the debt were considered equity. But a partner can contribute debt, equity, or services to obtain its ownership interest; that interest does not need to align with its equity contribution. Finally, the Tax Court took the view that the debt was not intended to be repaid because RAC (which controlled CBH) and RAC Finance (the subordinated debtholder) were controlled by members of the Ricketts family. But it is black-letter law that related parties can create genuine debt, and everyone here understood that the debt would have to be repaid.

C. The Tax Court's rote application of the factors missed the forest for the trees. CBH intended to repay the subordinated debt regardless of its success, as everyone involved in this transaction understood. The Tax Court ignored important evidence (such as the evidence of third-party conduct) and strained to analyze factors that had no application to this case. That approach, if affirmed, would introduce significant uncertainty to companies' financial planning and would increase the costs associated with subordinated debt in particular.

Argument

I. Tribune and CBH Correctly Reported the Debt-Financed Distribution

The primary question is whether Tribune retained liability for CBH's loans because of the guarantees, and thus could treat the distribution from CBH as a debt-financed distribution to the extent of those guarantees. The Tax Court correctly answered that question yes.

Standard of Review

The Court reviews the Tax Court's legal determinations (such as its interpretation of the applicable regulations) de novo, and its factual determinations (such as its finding that the guarantees had economic value) for clear error. See Kikalos v. Comm'r, 434 F.3d 977, 981 (7th Cir. 2006).

A. Tribune Was Liable for Repaying CBH's Loans Because of Its Guarantees

1. The Constructive-Liquidation Test Provides the Governing Rule Here

a. The rules for when a partnership distribution should be treated as sale proceeds rather than a debt-financed distribution are well settled.

Congress decided that when a partner contributes property to a partnership, that transfer is not immediately taxable, because the partner does not recognize any gain at that point. 26 U.S.C. § 721(a). It also recognized that when a partnership (like a person) takes out a loan, that also is not a taxable event so long as the loan must be repaid. Tufts, 461 U.S. at 307. Thus, if a partner contributes property to a partnership and the partnership takes out a loan on that property, neither step is taxable.

If the partner then receives a distribution from the partnership, Congress recognized that sometimes the distribution should be treated as sale proceeds and sometimes it should be treated as a debt-financed distribution.

26 U.S.C. § 707(a)(2)(B). In particular, it recognized that if the partner is responsible for repaying the loan (including because of a guarantee), then the distribution to the partner is a debt-financed distribution. H.R. Rep. No. 98-861, at 862. The theory is that, in a debt-financed distribution, the partner “has simply borrowed through the partnership.” Joint Comm. on Tax'n, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, at 232 (1985); see SA.46-47.

Congress directed the Treasury Department to promulgate regulations to provide guidance on when a distribution should be treated as sale proceeds rather than as a debt-financed distribution. 26 U.S.C. § 707(a)(2); see SA.54.

The first relevant regulation, Treasury Regulation 1.707-5, explains that loan proceeds paid to a partner qualify as a debt-financed distribution to the extent that the partner retains responsibility for the loan (in the words of the regulation, to the extent the loan is “allocable” to the partner). 26 C.F.R. § 1.707-5(b)(1). The regulation then states that whether and to what extent a loan is allocable to the partner is determined using Treasury Regulation 1.752-1. Id. § 1.707-5(b)(2) (pointing to 26 C.F.R. § 1.707-5(a)(2), which in turns points to 26 C.F.R. § 1.752-1).

The second relevant regulation, Treasury Regulation 1.752-1, states that how a loan is allocated for partnership tax purposes depends on whether it is “recourse” or “nonrecourse.” 26 C.F.R. § 1.752-1(a). A “recourse” loan is one for which a partner bears the “economic risk of loss”; it is allocated to that partner under the rules set out in Treasury Regulation 1.752-2. Id. § 1.752-1(a)(1). A “nonrecourse” loan is one for which no partner bears the economic risk of loss; it is allocated to the partners under the rules set out in Treasury Regulation 1.752-3. Id. § 1.752-1(a)(2).

The third relevant regulation, Treasury Regulation 1.752-2, is the key regulation in this case. It provides the test for determining whether a partner bears the “economic risk of loss” for a loan. SA.55-56. Here, if Tribune bore the economic risk of loss for the loans, its distribution from CBH was a debt-financed distribution to the extent of the loans. SA.55-56.

b. Treasury Regulation 1.752-2 starts by repeating the basic principle that a loan is a recourse liability allocated to a partner if the partner “bears the economic risk of loss” for the loan. 26 C.F.R. § 1.752-2(a). It then provides a test for determining whether a partner bears the economic risk of loss for a loan — the constructive-liquidation test. That test states:

Except as otherwise provided in this section, a partner bears the economic risk of loss for a partnership liability to the extent that, if the partnership [is] constructively liquidated, the partner . . . would be obligated to make a payment . . . because that liability becomes due and payable.

Id. § 1.752-2(b).

The regulation then describes how the constructive-liquidation test works. It assumes the worst-case scenario, where all debts are due and the partnership has no ability to pay and asks whether the partner would have to pay. Specifically, the test assumes that the following all “occur simultaneously”: (1) “[a]ll of the partnership's liabilities become payable in full”; (2) “all of the partnership's assets, including cash, have a value of zero” (with an exception not relevant here); (3) the partnership “disposes of all of its property in a fully taxable transaction for no consideration” (with an exception not relevant here); (4) all of the partnership's income, gains, losses, and deductions “are allocated among [its] partners”; and (5) “[t]he partnership liquidates.” 26 C.F.R. § 1.752-2(b)(1). If the partner is obligated to pay in that situation, then the partner bears the “economic risk of loss” for the debt. Id.; see SA.94.

The regulation explains which partner obligations count in determining whether a partner would pay in a constructive liquidation. “All statutory and contractual obligations,” including “guarantees, indemnifications, [and] reimbursement agreements,” are taken into account. 26 C.F.R. § 1.752-2(b)(3). Partners are assumed to “actually perform” all of their payment obligations, “irrespective of their actual net worth.” Id. § 1.752-2(b)(6); see SA.95. The regulation then specifies limited instances in which obligations can be “disregarded,” including (as explained below) the situations set out in the anti-abuse rule relied upon by the government. E.g., 26 C.F.R. § 1.752-2(j)(1).

By its terms, the constructive-liquidation test sets out an exceptionally unlikely, verging on impossible, scenario. It assumes that everything goes wrong all at once, in the worst possible way — even the partnership's cash is worthless — and asks whether a partner would have to satisfy the partnership's debt. 26 C.F.R. § 1.752-2(b)(1). For this reason, tax practitioners refer to the test as the “atom bomb” test. E.g., Michael G. Frankel & Charles H. Coffin, New Section 752 Regulations Clarify Treatment of Partnership Liabilities, 6 J. Partnership Tax'n 179, 194 (1989).

The constructive-liquidation test has provided the governing rule for determining whether a partner bears an economic risk of loss for over three decades. See 53 Fed. Reg. 53,140 (Dec. 30, 1988). The Treasury Department had good reason for choosing this test. Ordinarily, a partnership pays its debts itself, by covering the debts from its cash flows or assets. McKee § 8.02[2]. The only time a lender would seek payment from a partner is when the partnership is in severe distress. Id. But whether and to what extent a partner would have to pay could change depending on the type or degree of distress, so attempting to determine the partner's allocation of liabilities in anything less than the worst-case scenario would produce “an artificial and potentially skewed” result. Id. Using the worst-case scenario provides a clear and administrable test that avoids the need for litigation about the likelihood of financial distress or the likelihood of payment.

2. Tribune Bore the Economic Risk of Loss for the Loans Under the Constructive-Liquidation Test

The Tax Court applied the constructive-liquidation test and concluded that Tribune bore the economic risk of loss for CBH's debt because it had guaranteed the collection of that debt. SA.96-98. Although the Tax Court only addressed the senior debt (because it deemed the subordinated debt equity), its holding applies equally to the subordinated debt because Tribune's guarantees had the same terms for both loans. See SA.31.

a. The Tax Court correctly explained that, under the regulations, “[a] partner bears the economic risk of loss for a partnership liability if the partner would be obligated to make payment to the creditor if the partnership were constructively liquidated.” SA.94 (citing 26 C.F.R. § 1.752-2(a), (b)(1)). The Tax Court then determined that “Tribune would be required to pay” in that “worst-case scenario” because “[u]nder the terms of Tribune's guaranty of the senior debt, Tribune is obligated to pay when CBH fails to make a payment and the debt is accelerated, the creditors have exhausted their remedies, and the creditors have failed to collect the full amount of the debt.” SA.96.

That holding is correct. Neither Tribune nor RAC was liable for paying CBH's loans under CBH's limited liability company agreement, B.95, or under state law, Del. Code Ann. tit. 6, § 18-303(a). But Tribune separately guaranteed the loans, promising to repay the principal and interest on the loans if the lenders could not collect from CBH, and agreeing not to assign the guarantees to offload its liability without the lenders' consent. A.960, A.968-69, A.976, A.984. Thus, in the worst-case scenario, if CBH could not pay the lenders because its assets were worthless, Tribune (and only Tribune) would have the obligation to pay. SA.98. Tribune therefore bore the economic risk of loss for CBH's loans under the constructive-liquidation test. SA.91.

b. In the Tax Court, the government agreed that the constructive-liquidation test is the correct way to determine whether the loans should be allocated to Tribune. SA.54; see Gov't T.C. Opening Br. 141-43. It argued that it could prevail under that test because the guarantees were unlikely to be called. SA.94. The Tax Court rejected that argument because the constructive-liquidation test already assumes the worst-case scenario. SA.95-98. On appeal, the government does not renew its argument that it wins under the constructive-liquidation test.

Instead, the government disparages the constructive-liquidation test, calling it “divorced from reality,” “artificial,” and “irrelevant.” Opening Br. 45, 47, 50. But this is the test the government itself devised for determining the economic risk of loss, after Congress specifically directed it to promulgate regulations on that issue. The government cannot run away from the regulation just because it does not like the result in a particular case.

The government's position is especially odd in light of the background that prompted Congress's action. In Raphan v. United States, 3 Cl. Ct. 457 (1983), rev'd, 759 F.2d 879 (Fed. Cir. 1985), a partnership took on a construction loan and the partners guaranteed that loan, but the Court of Claims held that the loan would not be allocated to the partners despite their guarantees. Id. at 465-66. Congress disagreed with Raphan because, in its view, a partner that guarantees a partnership loan “share[s] the economic risk of loss” for that loan. H.R. Rep. No. 98-861, at 868-69; see 26 U.S.C. § 752 note (“Section 752 of the Internal Revenue Code . . . (and the regulations prescribed thereunder) shall be applied without regard to the result reached in the case of Raphan vs the United States.”).

Congress then instructed the Treasury Department to promulgate a regulation that would account for “guarantees, assumptions, indemnity agreements, and similar arrangements” in determining whether a partner is allocated a loan. Deficit Reduction Act of 1984, Pub L. No. 98-369, § 79(b), 98 Stat. 494, 597. In response, Treasury wrote the regulation at issue here — a regulation that specifically states that “guarantees” must be taken into account in determining the economic risk of loss. 26 C.F.R. § 1.752-2(b)(3). So the government cannot credibly claim that the regulation it wrote to address this exact situation is “irrelevant.”

The constructive-liquidation test has been on the books for more than thirty years, and taxpayers have relied on it. Although the government has revised the regulation, it has retained the constructive-liquidation test. See 26 C.F.R. § 1.752-2(b)(1) (2023). The government cannot disclaim its own on-point regulation in litigation simply because it does not like the result. See Bowen v. Georgetown Univ. Hosp., 488 U.S. 204, 213 (1988); Bartholomew v. United States, 740 F.2d 526, 531 (7th Cir. 1984).

B. The Specific Anti-Abuse Rule Is Inapplicable

On appeal, the government's approach is to try to use the specific anti-abuse rule set out in the constructive-liquidation regulation, 26 C.F.R. § 1.752-2(j)(1), to override the constructive-liquidation test. It argues (Br. 40, 44-61) that it can disregard Tribune's guarantees under the antiabuse rule because the possibility that Tribune would have to pay is “remote” and so Tribune's risk of loss was not “meaningful.” The government is wrong on both the law and the facts.

1. The Text of the Rule Provides No Basis to Disregard Tribune's Guarantees

a. The specific anti-abuse rule is part of the constructive-liquidation regulation. The regulation first sets out the constructive-liquidation test as the method for determining whether a partner has an “economic risk of loss,” 26 C.F.R. § 1.752-2(b)(1); then explains how to perform that test (assume the worst-case scenario), id.; then provides specific rules for applying that test, including rules about which obligations should be considered or disregarded, e.g., id. § 1.752-2(b)(3)-(6).

One of those specific rules is the anti-abuse rule, which states:

An obligation of a partner or related person to make a payment may be disregarded . . . for purposes of this section 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 . . . bearing the economic risk of loss when, in fact, the substance of the arrangement is otherwise.

26 C.F.R. § 1.752-2(j)(1).

The anti-abuse rule is an exception to the general rule that every payment obligation counts under the constructive-liquidation test. See 26 C.F.R. § 1.752-2(b)(3). The rule assumes that a partner bears the “economic risk of loss” for a loan in the worst-case scenario set out in the constructive-liquidation test, but then asks whether the parties intentionally arranged the transaction to eliminate that risk. In particular, it asks whether the parties entered into an “arrangement” with “a principal purpose” of either (1) “eliminat[ing] the partner's economic risk of loss” or (2) “creat[ing] the appearance of the partner” bearing the economic risk of loss “when, in fact, the substance of the arrangement is otherwise.” Id. § 1.752-2(j)(1).

In both scenarios, the partner does not in fact bear the economic risk of loss, because the parties contrived a way to either “eliminate” the risk (such as by shifting the risk to another person) or to “create an appearance” of risk when the “the substance of the arrangement is otherwise” (such as by restricting the partner's assets so it could not actually pay). 26 C.F.R. § 1.752-2(j)(1). Neither scenario occurs simply because the risk of loss is unlikely to materialize; rather, the obligation must be wholly illusory. SA.101.

b. In this case, the government relies (Br. 56) only on the second situation specified in the rule — parties that entered into an “arrangement” with a “principal purpose” of “creat[ing] the appearance of the partner” bearing the economic risk of loss “when, in fact” it did not. 26 C.F.R. § 1.752-2(j)(1). It argues (Br. 40, 49-57) that it can disregard Tribune's guarantees because Tribune did not bear a “meaningful” realworld risk of loss, as there was only a “remote” chance that the guarantee would be called. There are two fundamental problems with that argument.

First, the government's view ignores the text of the rule. The rule asks whether the obligation to pay has been eliminated because of an intentional arrangement by the parties, not whether the chance of payment is meaningful or remote. 26 C.F.R. § 1.752-2(j)(1). The rule clearly specifies the two circumstances in which the partner's obligation may be disregarded. It never uses the words “meaningful” or “remote” or otherwise refers to the likelihood of payment. Nor does it provide a standard for determining whether a risk is “meaningful” or “remote.” The government's view thus has no support in the rule's text.

The Tax Court recognized that. It explained that the anti-abuse rule requires that the parties “create an illusion of the partner's economic risk of loss without actually subjecting the partner to real financial risk.” SA.98. That is not the situation here, the Tax Court explained, because Tribune had actual financial risk. SA.101. The government provided no evidence of a purposeful arrangement to render Tribune's guarantees illusory. SA.101. Its only argument is that it was unlikely Tribune would have to pay because the parties took measures to ensure that CBH would be able to repay the loans, such as by requiring CBH to have a six-month cash reserve. SA.99; see Gov't T.C. Opening Br. 205. As the Tax Court explained, these are “common lender protections,” and “[t]he existence of oversight and protections to prevent a doomsday scenario does not render” Tribune's guarantees “illusory.” SA.101.

The government also argued that if CBH could not pay the loans, Ricketts family members would repay the loans rather than Tribune. SA.99-100. The Tax Court rejected that argument as well, explaining that “the Ricketts family was not a partner in CBH,” and “no transaction documents obligated RAC to pay the senior debt” if CBH could not. SA.99-100. More generally, the Tax Court explained, the government's argument that Tribune's risk was “remote” acknowledged the “possibility” that Tribune would have to pay, which effectively “conced[ed]” that the risk had not been eliminated. SA.101.

Second, the government's argument ignores the broader structure of the regulation and makes the constructive-liquidation test superfluous. The anti-abuse rule assumes that there has been a constructive liquidation and the partner would have to pay, then asks whether some separate arrangement between the parties actually eliminated the partner's risk. Because the constructive liquidation already has occurred, the “probability” of that situation occurring simply is “irrelevant.” SA.101.

The government wants to use the anti-abuse rule to relitigate whether a constructive liquidation is likely. But that is not how the regulation works. Instead, paragraph (b) starts with the premise that there has been a constructive liquidation and the partner bears the economic risk of loss, 26 C.F.R. § 1.752-2(b), then paragraph (j) asks whether a separate arrangement between the parties eliminates that economic risk of loss, id. § 1.752-2(j)(1). Paragraph (j) builds on paragraph (b); it does not displace it. Thus, as the Tax Court recognized, the anti-abuse rule is not a freestanding rule that allows the government to revisit whether a partner bears an “economic risk of loss.” SA.99-101.

The government's view would make the constructive-liquidation test in paragraph (b) superfluous. See Scherr v. Marriot Int'l, Inc., 703 F.3d 1069, 1077 (7th Cir. 2013) (rule against superfluity). The constructive-liquidation test states that a partner bears the economic risk of loss when the partner would have to pay during a constructive liquidation. 26 C.F.R. § 1.752-2(b). But under the government's view of the anti-abuse rule (Br. 45-47), a partner bears the economic risk of loss only if the government believes a constructive liquidation is sufficiently likely and that the partner would pay in those circumstances. If the government were correct, there would be no reason to ask whether the partner would have to pay under the constructive-liquidation test, because the government could deem that risk too remote under the anti-abuse rule. That would be an incredibly odd result, especially because the government chose the constructive-liquidation test as the test for determining economic risk of loss and defined it as a worst-case-scenario test.

c. The government makes two textual arguments, neither of which is correct.

First, the government notes (Br. 45-46) that the paragraph that sets out the constructive-liquidation test states that the test applies “except as otherwise provided” in the regulation. 26 C.F.R. § 1.752-2(b)(1). In the government's view, the specific anti-abuse rule “otherwise provide[s]” a different rule for determining who bears the economic risk of loss.

That is incorrect. When the regulation wants to displace the constructive-liquidation test, it says so directly. For example, paragraph (d)(2) states that the “general rule contained in paragraph (b)(1)” — i.e., the constructive-liquidation test — “does not apply” when a partner that owns a small share in the partnership guarantees certain kinds of nonrecourse financing. Id.

§ 1.752-2(d)(2).⁵ By its terms, the anti-abuse rule does not revisit whether a partner bears an economic risk of loss. Instead, as explained, it assumes there is such a risk under the constructive-liquidation test, and then asks a separate question about whether the parties adopted an arrangement to actually eliminate that risk. Id. § 1.752-2(j)(1). That question does not depend on whether the risk of paying is remote; it depends on whether the parties entered into an abusive arrangement so that there is in fact no risk. The “otherwise provided” language thus does not aid the government here.

Second, the government argues (Br. 46-47) that because the anti-abuse rule refers to “facts and circumstances,” it can ignore the “hypothetical facts” of the constructive-liquidation test and decide for itself whether to disregard Tribune's guarantees. But the regulation refers to “facts and circumstances” to answer a particular question — whether an obligation that would otherwise satisfy the constructive-liquidation test should be disregarded because the parties purposefully arranged to eliminate the economic risk of loss or to create the appearance of that risk where none in fact existed. 26 C.F.R. § 1.752-2(j)(1).⁶ The Tax Court found no evidence of that here. SA.99-101. The “facts and circumstances” language is not a license for the government to reanalyze whether the partner bears an economic risk of loss based on the likelihood of the partnership's default and the partner's payment.

2. Nothing Else Supports the Government's Interpretation of the Specific Anti-Abuse Rule

a. The anti-abuse rule contains an example that confirms that “economic risk of loss” for the purposes of that rule means the same thing as under the constructive-liquidation test. See 26 C.F.R. § 1.752-2(j)(4). The example addresses which partner, A or B, should be allocated a loan when the partnership agreement allocates all losses over an initial amount to A and requires A to restore any deficit in its capital account, but A's parent arbitrarily limits A's capital to just the initial amount, and B has provided a guarantee of collection for the loan. Id.

Ordinarily, under the constructive-liquidation test, A would be allocated the loan because of its obligations to cover all losses and replenish its capital account. But because A's capital is artificially capped, A does not have the assets to repay the loan and so its obligations are illusory. See 26 C.F.R. § 1.752-2(j)(4). The example accordingly applies the specific anti-abuse rule to disregard A's obligations and allocates the loan “entirely to B.” Id.

At no point does the example consider whether there is a “meaningful” risk of the partnership defaulting or of B having to pay — even though, according to the government, that is the purpose of the specific anti-abuse rule. Instead, the example assumes a constructive liquidation where the partnership has no ability to pay and the partner bears the economic risk of loss.

The Treasury Department provided this example to show how it intended for the specific anti-abuse rule to apply. The example proves that the rule does not work the way the government now claims. The Tax Court recognized its relevance. SA.99. Tellingly, the government omits this example from its statutory appendix, even though it reproduces the rest of paragraph (j) in its entirety. See Opening Br. 86-87.

b. The only decision to apply the specific anti-abuse rule, Canal Corp. v. Commissioner, 135 T.C. 199 (2010), confirms that the government's view is incorrect. There, a partnership took out a loan and paid the proceeds to a partner. Id. at 204-05. The partner gave an indemnity for the loan, so that if the guarantor paid, the partner would have to indemnify the guarantor. Id. But the partner was a corporate shell that had no assets to pay the indemnity, plus the parties agreed that if the partner ever had to pay, it would receive an equivalent partnership share in return. Id. at 213. Under those circumstances (which parallel the example provided in the regulation), the Tax Court found that the partner “had no economic risk of loss” and disregarded the indemnity under the specific anti-abuse rule. Id. at 212-17.

As the Tax Court explained, this case is very different. SA.101-05. Among other things, Tribune always had sufficient assets to pay the guarantees, and if it had done so, “it would simply be out that amount.” SA.105. Nothing eliminated Tribune's risk of loss. Notably, the government no longer disputes (Br. 56) that Canal Corp. is factually distinguishable from this case.

Instead, the government argues (Br. 55) that Canal Corp. supports the view that it can reassess the likelihood of a partnership default under the anti-abuse rule. It relies on the Tax Court's statement that it “[found] that the indemnity agreement should be disregarded because it created no more than a remote possibility that [the partner] would actually be liable for payment.” 135 T.C. at 216. But the Tax Court assumed a constructive liquidation; it did not reassess whether the partnership was likely to default. See id. at 212. And although the Tax Court made an offhand statement about the “remote possibility” that the partner would have to pay, it applied the anti-abuse rule only because it concluded the partner “had no economic risk of loss.” Id. at 217 (emphasis added); see, e.g., id. at 213 (indemnity was “a guise to cloak [the partner] with an obligation for which it bore no actual economic risk of loss”). The parties “used the indemnity to create the appearance that [the partner providing the indemnity] bore the economic risk of loss for [the partnership] debt when in substance the risk was borne by [the other partner].” Id. at 217. Application of the anti-abuse rule thus did not depend on the chances of default and payment being merely remote.

c. The government cites (Br. 51-52) two snippets of legislative history, neither of which supports its view. The first is a committee report stating that the statute on disguised sales, 26 U.S.C. § 707(a)(2)(B), was intended to ensure that a partnership transaction whose “underlying economic substance” is a sale should be taxed “in a manner consistent” with that substance (i.e., as a sale). H.R. Rep. No. 98-432, at 1218 (1984). The second is a conference report explaining that a debt-financed distribution should not be treated as a sale “to the extent the contributing partner, in substance, retains liability for repayment of the borrowed amounts.” H.R. Rep. No. 98-861, at 862. The government argues (Br. 52) that “economic substance” and “in substance” show that Congress did not intend for the specific anti-abuse rule to be limited to the facts of a constructive liquidation.

Neither of these snippets is talking about the anti-abuse rule in the regulation. Instead, they refer to the statute Congress enacted that generally provides that when a partner contributes property and receives a distribution from the partnership, sometimes the distribution is treated as a sale and sometimes it is not. H.R. Rep. No. 98-432, at 1218; H.R. Rep. No. 98-861, at 862.

The first snippet says that a transaction that is in substance a sale should be treated as a sale. But it does not say how to decide that question  — it does not say anything about allocating loans, debt-financed distributions, or the specific anti-abuse rule. See H.R. Rep. No. 98-432, at 1218.

The government takes the second snippet out of context. The report states that when a partner contributes property to a partnership and the partnership borrows money and distributes the proceeds to the partner, “there will be no disguised sale” “to the extent the contributing partner, in substance, retains liability for repayment of the borrowed amounts (i.e., to the extent the other partners have no direct or indirect risk of loss with respect to such amounts).” H.R. Rep. No. 98-861, at 862. The full quotation makes clear that “in substance” means “other partners” having “no . . . risk of loss,” id.; it does not refer to a low likelihood of loss.

More generally, the legislative history that actually is relevant to the anti-abuse rule supports Tribune's view. As previously explained, Congress wanted to ensure that a partner that has provided a “guarantee[ ]” for a loan is allocated that liability because the partner “share[s] the economic risk of loss” for the loan. H.R. Rep. No. 98-861, at 868-69. It directed Treasury to promulgate a regulation to that effect, id., and Treasury promulgated Treasury Regulation 1.752-2. See pp. 33-34, supra. Nothing in the legislative history states that the likelihood of the guarantee being called matters to that determination.

d. The government argues (Br. 47-48) that its interpretation of the specific anti-abuse rule incorporates the common-law doctrines of substance over form and economic substance. Below, the government argued that the doctrines applied directly, and the Tax Court rejected those arguments. SA.56, SA.119. The doctrines are no more relevant when the government tries to sneak them in through the back door.

When tax regulations intend to incorporate these common-law doctrines, they say so expressly. E.g., 26 C.F.R. § 1.701-2(a)(2). The anti-abuse rule does not do that. See id. § 1.752-2(j). So even if the government's reading of the specific anti-abuse rule were supported by the doctrines, that would not be a reason to believe it is correct.

In any event, neither doctrine helps the government. The substance-over-form doctrine allows the IRS to disregard the form of a transaction if the substance does not match that form. Frank Lyon Co. v. United States, 435 U.S. 561, 573 (1978). The economic-substance doctrine (also known as the shamtransaction doctrine) allows the IRS to disregard a transaction entirely if it does not meaningfully change the taxpayer's economic position. Feldman v. Comm'r, 779 F.3d 448, 455 (7th Cir. 2015); see Exelon Corp. v. Comm'r, 906 F.3d 513, 524 (7th Cir. 2018) (distinguishing the doctrines).

As the Tax Court explained, the substance-over-form doctrine does not apply here because the substance of the Cubs transaction matched the form of a debt-financed distribution. Specifically, Tribune transferred property (the Cubs) to CBH; CBH borrowed money that it distributed to Tribune; and Tribune guaranteed those loans. SA.118-19; see 26 C.F.R. § 1.707-5(b). It is well established that when the transaction's substance matches its form, the government cannot “recharacterize” the transaction as a different form (such as a sale) just to increase the tax liability. SA.118-19 (citing Esmark, Inc. v. Comm'r, 90 T.C. 171, 200 (1988), aff'd, 886 F.2d 1318 (7th Cir. 1989); Benenson v. Comm'r, 910 F.3d 690, 699 (2d Cir. 2018)). The government did not appeal the Tax Court's ruling on this point.

The economic-substance doctrine also does not help the government. The Tax Court found, as a factual matter, that the guarantees “had economic value”; “had a real-world effect on Tribune's credit rating”; and had a substantial business purpose. SA.111, SA.113. The government has not established that these findings are clearly erroneous. See pp. 70-73, infra. The government therefore cannot credibly claim that this was a sham transaction.

The government cites (Br. 48) two cases involving the economic-substance doctrine, but neither is like this one. Both involved the same partnership structure, which was designed as a tax shelter. Kearney Partners Fund, LLC v. United States, 803 F.3d 1280, 1283 (11th Cir. 2015) (per curiam); Nev. Partners Fund, LLC v. United States, 720 F.3d 594, 603 (5th Cir. 2013), vacated on other grounds, 571 U.S. 1119 (2014). As part of that structure, the taxpayers gave guarantees on loans that had no risk of default. E.g., 803 F.3d at 1292. The courts disregarded those guarantees because they lacked economic substance: The guarantees' sole purpose was to create tax benefits up to their nominal amounts, even though the lenders faced no risk. Id.; 720 F.3d at 603. Here, no one disputes that Tribune's guarantees could have been called; the parties only dispute the likelihood of that happening — an issue not addressed by the economic-substance doctrine.

Finally, the government broadly contends (Br. 53-54) that courts ignore “de minimis risks or effects.” But the anti-abuse rule does not say anything about the degree of risk. 26 C.F.R. § 1.752-2(j)(1); see p. 37, supra. None of the decisions the government cites involved the allocation of liabilities under Treasury Regulation 1.752-2; they simply involve case-specific applications of the substance-over-form or economic-substance doctrines.⁷

In sum, there is no support for the government's reading of the specific anti-abuse rule. If the government believes that its current litigating position is how the rule should work, then it should revise the regulation to provide sufficient notice to taxpayers, rather than trying to rewrite the regulation on the fly in litigation. See Kisor v. Wilkie, 139 S. Ct. 2400, 2414-18 (2019).

3. Tribune Bore a Meaningful Risk of Loss on Its Guarantees

Even if the government's interpretation of the specific anti-abuse rule were correct, Tribune would prevail because its risk of loss on the guarantees was meaningful. The Tax Court reviewed all the record evidence and concluded that Tribune's guarantees “had economic value,” so the risk to Tribune was meaningful. SA.113.⁸ The Tax Court's findings are reviewed for clear error, with the record viewed “in the light which is most favorable to the finding[s].” Pittman v. Comm'r, 100 F.3d 1308, 1313 (7th Cir. 1996) (internal quotation marks omitted). The government has not shown clear error.

a. The record evidence established that despite the Cubs' overall financial health, there was a meaningful risk that Tribune would have to pay out on the guarantees.

At the time of the Cubs transaction, the Cubs had high payroll expenses, but one of the worst records in the league. B.543. Wrigley Field needed renovation and lacked facilities to attract the best players, premium ticketholders, and corporate sponsors. B. 547-48. MLB's collective-bargaining agreement was set to expire in 2011, so there was a serious risk of a player strike (as had happened eight times before). B.515-16. Further, the United States was in the middle of a recession, and sports teams were not immune — in March 2009, the Texas Rangers had defaulted on its debt and entered bankruptcy. A.1769. As the Tax Court found, there was a “genuine concern” that CBH's cashflows could “decrease[ ] significantly.” SA.100.

The experts agreed that there was a material risk of CBH defaulting on its loans. In July 2009, S&P, an independent credit-ratings agency, gave CBH a credit rating of BB. A.823. That rating, which is junk (below investment grade), reflected a real risk of default. A.1324. Tribune's expert, Professor Anil Shivdasani, estimated that the risk that CBH would default within four years of the closing date was 5.13%. A.1332. The government's expert, Professor Douglas Skinner, estimated a risk of approximately 4%. B.457. In comparison, the four-year default rate for issuers of AAA securities is 0.18%. B.567-69. CBH's risk of default thus was between 22 and 29 times higher — a real risk by any measure.

In light of that risk, the experts agreed that Tribune's guarantees had significant economic value. Between 2012 and 2016, S&P rated Tribune's creditworthiness, and it consistently recognized that the guarantees posed a risk to Tribune. E.g., A.1013. S&P specifically identified the guarantees as presenting a “financial risk” or a “significant financial risk” to Tribune, and it added up to $100 million of CBH's debt to Tribune's balance sheet to account for them. A.1053. The Tax Court accordingly concluded that “the guarantees had a real-world effect on Tribune's credit rating” and had “genuine consequences outside of its tax benefits.” SA.113.

Both parties' experts estimated that the guarantees were worth tens of millions of dollars. Tribune's expert, Professor Shivdasani, estimated the value of the guarantees at up to $13 million, with the senior-debt guarantee worth up to $2 million. A.1318. The government's expert, Professor Skinner, initially valued the guarantees as worth up to $19 million, with the senior-debt guarantee worth up to $1 million, A.1498, A.1502, but then revised his estimate upward at trial, to up to $24 million, B.577-78.

b. The government makes four arguments in response, none of which is correct.

First, the government notes (Br. 57-58) that CBH was not expected to default on the loans. That is beside the point — a guarantor rarely (if ever) provides a guarantee expecting to pay. The government points (id.) to measures Tribune, CBH, and MLB put in place to reduce the risk of CBH's default, such as MLB's debt-service rule. But those measures did not eliminate the risk of default. SA.114. Indeed, the government's own expert estimated a small but significant risk of CBH defaulting. B.457.

The government downplays the risk of default. It argues (Br. 24-26, 50 n.12, 57-58) that the operating support agreement between MLB and a Ricketts family entity (RAC Education Trust OSA, LLC) could be used to avoid default. As the Tax Court explained, that is wrong: The agreement provided a $35 million safety net for the Cubs to use to pay its operating costs in case of a major financial shock, but it expressly stated that it could not be used to pay CBH's loans. SA.16, SA.100. The government claims (Br. 50 n.12) that the safety net could “indirectly benefit” the senior debtholders. But because of the way CBH was required to segregate its funds, CBH could default on its loans even while drawing on the safety net to fund its operations. B.555-57. The government insists (Br. 50 n.12) that MLB could require the Ricketts family entity to make “unlimited equity infusions” under the safety net, but that is incorrect — the safety net was capped at $35 million. A.892.

Second, the government relies (Br. 31-32, 55) on an internal Tribune assessment of the guarantees that described the risk of payment as “remote” for accounting purposes. But in accounting, “remote” is a term of art. Under General Accepted Accounting Principles (GAAP), Tribune had to determine whether the likelihood that it would have to pay the guarantees was “probable,” “reasonably possible,” or “remote,” and then provide a value for the guarantees in its financial statements if that likelihood was “probable.” B.444-45. Accountants generally consider an event “probable” under GAAP if there is a 75% or greater chance that it will occur, and “remote” if there is a 10% or less chance. E.g., Deloitte, Life Sciences Industry Accounting Guide 13 (2023), https://bit.ly/3rO2cBe.

Tribune determined that the likelihood it would have to pay the guarantees was “remote” for accounting purposes, so it did not include a value for the guarantees on its balance sheet. A.1000. But, as the Tax Court explained, that did not mean that the guarantees lacked economic value, because “GAAP value does not equate to the economic value.” SA.112 (internal quotation marks omitted); see JP Morgan Chase & Co. v. Comm'r, 458 F.3d 564, 569 (7th Cir. 2006) (tax and accounting standards are different). And consistent with GAAP, Tribune disclosed its exposure from the guarantees in its financial statements. SA.112.

Third, the government notes (Br. 59, 72) that in its 2009 analysis, S&P estimated that the senior debtholders could expect “full recovery” in the event CBH defaulted. Again, the government misuses a term of art: S&P defines “full recovery” to mean a 90% to 100% recovery. A.827. S&P has a higher rating for when it expects a 100% recovery. A.1382. So S&P actually was estimating that the senior debtholders were likely to lose up to $42.5 million if CBH defaulted. And, as S&P's witness confirmed at trial, that was just an estimate; the loss could be even higher. B.593; see Kenny Kang et al., S&P, Standard & Poor's U.S. Recovery Rating Performance — A Five-Year Study 3 tbl.1 (2013) (average actual recovery is only 82%). That easily qualifies as a meaningful risk of loss.

Fourth, the government argues (Br. 59) that the Court should focus only on the experts' valuations of the senior-debt guarantee, because the Tax Court treated the subordinated debt as equity for tax purposes. But the tax treatment of the subordinated debt does not affect the risk associated with that guarantee. If CBH had defaulted on the subordinated debt, Tribune would not have been able to resist enforcement of its guarantee on the ground that the Tax Court called that debt equity for tax purposes. B.559-62. The Tax Court understood this; it included the value of the subordinated-debt guarantee in its analysis of the economic value of the guarantees. See SA.112.

Even if limited to the senior-debt guarantee, there was a meaningful risk of loss. The government's expert valued the senior-debt guarantee at up to $1.1 million and Tribune's expert valued it at up to $2 million. A.1335, A.1502. The government notes (Br. 59) that the maximum value of the senior-debt guarantee was 0.43% of the value of the senior debt, which it asserts is too low to matter. But it provides no authority for that assertion. Other guarantees can cost that much or less. For example, an unsecured appeal bond can cost as little as 0.3% of the judgment it secures, Dan Huckabay, How Much Does an Appeal Bond Cost?, Court Surety Bond Agency (2021), https://bit.ly/47fhFdX; and a life-insurance policy can cost less than 0.3% of the coverage amount, Penny Gusner, Average Cost of Life Insurance in June 2023, Forbes (Jun. 8, 2023), https://bit.ly/3Dt7yV9; see B.441-42 (providing examples of guarantees from General Motors and Merrill Lynch valued at less than 0.4% of the potential liabilities). Yet no one would say that those are not meaningful guarantees.

Relatedly, the government argues (Br. 54-55, 57) that the senior-debt guarantee should be disregarded because Tribune's risk of loss was minimal compared to the tax benefits. But it identifies no standard for making that determination. And the government is wrong to say (id. at 60) that the senior-debt guarantee “shelter[ed] $425 million from tax,” because it is undisputed that Tribune paid tax on the transaction; the guarantees simply meant that the tax was deferred. See pp. 11-12, supra.

The bottom line is that the record amply supports the Tax Court's determination that the guarantees had economic value, which shows that the risk of loss was meaningful.

C. The General Anti-Abuse Rule Is Inapplicable

The government separately contends (Br. 61-73) that it can disregard Tribune's guarantees under the general anti-abuse rule, 26 C.F.R. § 1.701-2(a). In its view (Br. 61-68), that rule allows it to disregard or recast any part of a partnership transaction that it believes lacks a “substantial business purpose,” even if the transaction follows all relevant statutes and regulations to the letter. The government is wrong for several reasons.

1. The General Anti-Abuse Rule Is Invalid

Subchapter K of the Internal Revenue Code, 26 U.S.C. § 701 et seq., governs partnership taxation. Treasury has relied on its general grant of rulemaking authority, 26 U.S.C. § 7805, to promulgate a broad anti-abuse rule for all partnership transactions. It provides:

Subchapter K is intended to permit taxpayers to conduct joint business . . . activities through a flexible economic arrangement without incurring an entity-level tax. Implicit in the intent of subchapter K are the following requirements —

(1) The partnership must be bona fide and each partnership transaction or series of related transactions (individually or collectively, the transaction) must be entered into for a substantial business purpose. . . .

26 C.F.R. § 1.701-2(a). It then states that the IRS has the power to disregard, recast, reallocate, or otherwise adjust any partnership transaction that is not “consistent with the intent of subchapter K as set forth in paragraph (a)” — even if the transaction complies with “the literal words of a particular statutory or regulatory provision.” Id. § 1.701-2(b).

a. In this rule, Treasury claims that it can invalidate any partnership transaction that it believes lacks a “substantial business purpose” because that would be inconsistent with “the intent of subchapter K.” 26 C.F.R. § 1.701-2(a). It claims that it can invalidate a transaction even if the transaction follows “the literal words” of a statute or rule, based simply on its own views about the “intent” of subchapter K. Id. § 1.701-2(b). That is an extraordinarily broad assertion of authority, and the text of subchapter K does not support it.

Congress's intent is shown through the words in the statutes it enacts. W. Va. Univ. Hosps., Inc. v. Casey, 499 U.S. 83, 98 (1991). Nothing in subchapter K states that every partnership transaction must have a “substantial business purpose.” And nothing gives Treasury the authority to make its own independent determinations about Congress's “intent” under subchapter K.

Instead, in subchapter K, Congress provided a comprehensive, detailed, and “largely mechanical” set of rules for taxing partnerships. McKee § 1.05[5][a][i]. When Congress wanted Treasury to promulgate a rule to prevent tax planning or to further a particular purpose of a tax statute, it said so expressly. For example, in many places throughout the Internal Revenue Code, Congress specifically instructed Treasury to issue regulations to prevent a statutory provision from being used solely for tax planning purposes. See, e.g., 26 U.S.C. §§ 269B(b), 1274A(e)(2). In other places, Congress authorized Treasury to “prescribe such regulations as may be necessary to carry out the purposes” of certain statutory provisions. E.g., id. § 6230(k).

Subchapter K includes no such language. That “withholding of agency authority is as significant as the granting of it.” Director, OWCP v. Newport News Shipbuilding & Dry Dock Co., 514 U.S. 122, 136 (1995). The Treasury Department therefore lacks the authority to require all partnership transactions to have substantial business purposes or otherwise conform to its beliefs about subchapter K's intent. See Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837, 844 (1984); see also 5 U.S.C. § 706(2)(C).

Congress should not be assumed to have given the Treasury Department the authority to prohibit tax planning. Congress enacted subchapter K against the backdrop of the well-settled rule that a taxpayer's “motive” to reduce tax “will not alter the result or make unlawful what the statute allows.” Gregory v. Helvering, 293 U.S. 465, 468-69 (1935); see, e.g., Am. Boat Co. v. United States, 583 F.3d 471, 485 (7th Cir. 2009)(“[I]t is axiomatic that taxpayers lawfully may arrange their affairs to keep taxes as low as possible.” (internal quotation marks omitted)). If Congress intended for application of subchapter K to depend on whether the taxpayer's motive was to minimize tax, it would have said so. But “no language anywhere in Subchapter K” says that, McKee § 1.05[5][a][i], and Congress's “silence” on that point is “telling,” Ziglar v. Abbasi, 582 U.S. 120, 143-44 (2017).

Significantly, the general anti-abuse rule purports to give the IRS the power to nullify the application of federal statutes. It specifically authorizes the Commissioner to disregard a partnership transaction “even though the transaction may fall within the literal words of a particular statutory or regulatory provision” if the Commissioner decides, “based on the particular facts and circumstances,” that the transaction would “achieve tax results that are inconsistent with the intent of subchapter K.” 26 C.F.R. § 1.701-2(b). But it is black-letter law that “an agency cannot by regulation contradict a statute.” Keys v. Barnhart, 347 F.3d 990, 993 (7th Cir. 2003); see Ragsdale v. Wolverine World Wide, Inc., 535 U.S. 81, 86 (2002). Congress gets to decide the intent of subchapter K, not the IRS.

The general anti-abuse rule has been widely condemned from the beginning. One leading treatise concludes that the rule is invalid and urges courts to find the same. McKee § 1.05[5][a][i]-[ii]. Another calls the rule “[p]articularly disturbing” because of its view that the Treasury Department can overrule Congress. Arthur Willis, Philip Postlewaite & Jennifer Alexander, Partnership Taxation § 1.05[1] (2023).

Although a handful of courts have applied the general anti-abuse rule, none has addressed its validity. See, e.g., Pritired 1, LLC v. United States, 816 F. Supp. 2d 693, 742 (S.D. Iowa 2011). On at least one occasion, the government withdrew its reliance on the rule when the taxpayer attempted to challenge its validity. McKee § 1.05[1][c] (citing Jade Trading, LLC v. United States, 80 Fed. Cl. 11 (2007)). So the general antiswabuse rule has existed as a sort of Schrodinger's rule: Awake when needed to bully taxpayers; asleep before a court can strike it down. The Court should put the rule to bed for good.

b. Even if the Treasury Department had the authority to promulgate the general anti-abuse rule, it cannot apply it in this case because the specific anti-abuse rule already addresses the situation here.

All agree that Treasury Regulation 1.752-2 is the on-point regulation for determining whether Tribune's guarantees made it liable for CBH's loans (and thus allow Tribune to treat the distribution as a debt-financed distribution). That regulation contains a specific anti-abuse rule that explains when a partner's economic risk of loss can be disregarded when the parties arranged to eliminate it in one of two specified ways. 26 C.F.R. § 1.752-2(j). Treasury promulgated that regulation in response to specific direction from Congress to provide rules for when a partner is liable for a partnership's debts. H.R. Rep. No. 98-861, at 869.

The specific anti-abuse rule defines exactly what is considered abusive for the specific situation here. If the government loses under the specific anti-abuse rule, then the transaction is not abusive. The government should not be allowed to make an end-run around that result using the general anti-abuse rule, based on its own view of the “intent” of subchapter K.

The government's argument violates the “elementary tenet” that “a specific [provision] will not be controlled or nullified by a general one.” Guidry v. Sheet Metal Workers Nat'l Pension Fund, 493 U.S. 365, 375 (1990); see, e.g., Central Com. Co. v. Comm'r, 337 F.2d 387, 389 (7th Cir. 1964)(applying the “cardinal principle” that “the more specific controls over the general” to tax provisions). Application of the general anti-abuse rule here would “render [the specific anti-abuse rule] meaningless.” Garcia v. Sessions, 873 F.3d 553, 557 (7th Cir. 2017)(internal quotation marks omitted).

In the Tax Court, the government argued that there is no conflict between the rules because the general rule says that the IRS can use it to overturn the results of other regulations. Gov't T.C. Answering Br. 158; see 26 C.F.R. § 1.701-2(b). But that simply acknowledges the conflict; it does not resolve it. The government never explains why it can find a transaction to be abusive under the general anti-abuse rule when it is not abusive under the specific rule the government promulgated to address the transaction here.

2. The General Anti-Abuse Rule Applies to the Cubs Transaction as a Whole, Not to Each Guarantee

The government argues (Br. 61-73) that under the general anti-abuse rule, it can invalidate a transaction when any component of that transaction (here, the guarantees) lacks a substantial business purpose, even if the transaction as a whole (here, the overall Cubs transaction) has such a purpose. The Tax Court correctly rejected that interpretation. SA.106-10.

a. The plain text of the rule makes clear that the relevant unit of analysis here is the overall Cubs transaction. The rule states:

The partnership must be bona fide and each partnership transaction or series of related transactions (individually or collectively, the transaction) must be entered into for a substantial business purpose.

26 C.F.R. § 1.701-2(a)(1). The rule explains that “the transaction” at issue could be either one “transaction” or a “series of related transactions.” Id. So if a “series of related transactions” is at issue, then a court does not also consider each individual “transaction,” because the regulation “collectively” defines “the transaction” that must have a substantial business purpose to be the “series of related transactions.” Id.⁹

Here, “the transaction” for purposes of the rule is the “series of related transactions” that includes the guarantees — i.e. the overall Cubs transaction. As the Tax Court explained, the requirement of a business purpose “appl[ies] to the function of the partnership as a whole”; “[i]t is not intended to apply to every agreement into which the partnership or its partners enter.” SA.109. The rule simply does not “contemplate[ ]” that “level of minutiae.” SA.109. When a taxpayer enters into a series of related transactions that depend on each other, the taxpayer likely would not enter into each individual transaction on its own, so it would be highly artificial to try to assess the purpose of each transaction in isolation.

The government has two responses, but neither has merit. First, it cites (Br. 67) decisions involving the economic-substance doctrine that contain statements like “the transaction to be analyzed is the one that gave rise to the alleged tax benefit.” Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1356 (Fed. Cir. 2006); see, e.g., Baxter v. Comm'r, 910 F.3d 150, 162-63 (4th Cir. 2018); Black & Decker Corp. v. United States, 436 F.3d 431, 441 (4th Cir. 2006). None of those decisions involved the general anti-abuse rule. The decisions also do not help the government, because they do not explain whether the “transaction” is the overall partnership transaction or some component of that transaction.

Here, the transaction that “gave rise to the alleged tax benefit” was the entire Cubs transaction. Coltec, 454 F.3d at 1356. The government says (Br. 66) the guarantees were needed to make the payment to Tribune a debt-financed distribution. But that is equally true of the other parts of the Cubs transaction, such as forming the partnership, taking out the loans, and distributing the proceeds to Tribune.

Second, the government contends (Br. 61-62) that the Tax Court incorrectly limited “the transaction” to the “partnership formation” or “the function of the partnership as a whole.” SA.109. It did not. Its references to CBH's “formation” and “function” were shorthand for “the Cubs transaction as a whole,” because the partnership formation, loans, guarantees, and distribution all occurred on the same day. SA.110.

b. If there were any doubt about what constitutes the “transaction,” it would be resolved by the “examples in the regulation,” which “establish that a partnership must have a genuine business purpose,” “not that every component of the partnership's formation have a separate business purpose.” SA.108-09.

In one example, a partner seeks to withdraw from a partnership. 26 C.F.R. § 1.701-2(d)(example 9). The partners choose the assets to be distributed and to have the partnership fail to make an election for the “principal purpose” of reducing the withdrawing partner's tax liability. Id. The example states that those choices should be respected, because the partnership's conduct had a legitimate business purpose. See id. That confirms that the correct unit of analysis is the overall transaction (the partner's withdrawal from the partnership), and not specific components of that transaction (the choice of assets or choice not to make an election). See also SA.109 (citing additional examples).

The government asserts (Br. 64) that the examples are consistent with its position, but it does not elaborate. It also argues (id.) that the examples “do not establish any limitations on the [rule's] plain text,” but that misses the point, which is that the examples confirm that the relevant unit of analysis is the overall transaction. SA.109.

c. As the Tax Court recognized, the government's position makes no sense. In effect, the government asserts that it can redline each component of each partnership transaction if that component, standing alone, does not have a nontax purpose. And there is no limit to the “level of minutiae” the government will use, SA.109 — as long as any component leads to a tax benefit, the government says it can deem a transaction abusive.

The result would be that no partner could take any step for tax-planning purposes. That flies in the face of a century of tax decisions from every level of the federal judiciary that firmly and unequivocally state the opposite. E.g., Gregory, 293 U.S. at 468-69; Coltec, 454 F.3d at 1357 (“structuring a real transaction in a particular way to provide a tax benefit” is “legitimate”); N. Ind. Pub. Serv. Co. v. Comm'r, 115 F.3d 506, 511 (7th Cir. 1997)(“A taxpayer has a legal right to conduct his business so as to decrease (or altogether avoid) the amount of what otherwise would be his taxes.”).

3. The Transaction Had a Substantial Business Purpose Under Any Standard

The Tax Court found that Tribune had a valid business purpose regardless of whether the unit of analysis is the overall Cubs transaction or the individual guarantees. SA.110-11. The record amply supports the Tax Court's findings.

a. If the unit of analysis is the overall Cubs transaction, the transaction satisfies the general anti-abuse rule. The Tax Court found that the Cubs transaction “was not a sham and resulted in significant economic out-comes to Tribune and RAC” and that “[n]o evidence shows that CBH lacked a business purpose.” SA.110. In the Tax Court, the government conceded that the overall Cubs transaction had several legitimate business purposes, B.607-08, and it does so again on appeal, admitting that “the Cubs Transaction, as a whole, clearly resulted in significant economic outcomes,” Opening Br. 65-66.

b. Even if the guarantees were considered in isolation, the Tax Court found that they had a substantial business purpose — to ensure the ultimate repayment of CBH's loans. SA.111. The business purpose of a guarantee is “to provide an ultimate payor on a loan if the original obligor is unable to pay.” Id. A guarantee “ensures that the guarantor will shoulder the ultimate economic burden of the debt.” Id.; see Inland Mortg. Cap. Corp. v. Chivas Retail Partners, LLC, 740 F.3d 1146, 1149 (7th Cir. 2014).

The Tax Court found that Tribune's guarantees were not illusory. They were legally valid, meaning that “Tribune bore ultimate responsibility” for CBH's loans. SA.111; see SA.96. At all times, Tribune had “sufficient assets” to satisfy the guarantees. SA.105. And the guarantees “had economic value.” SA.113. The government's expert valued them up to $24 million, B.578, and they “had a real-world effect” on S&P's rating of Tribune's creditworthiness between 2012 and 2016, SA.113.

c. The government quibbles with the Tax Court's findings but does not come close to showing clear error.

First, the government argues (Br. 68-70) that it is not enough that the guarantees had the business purpose of guaranteeing CBH's loans. It says the Tax Court should have gone beyond that objective fact and probed “why” Tribune subjectively wanted to guarantee CBH's loans. Id. at 68. But the rule does not require that psychoanalysis; it says only that each transaction “must be entered into for a substantial business purpose.” 26 C.F.R. § 1.701-2(a)(1).

Here, the government does not dispute that a business purpose of Tribune's guarantees was to ensure that CBH's creditors would be paid in full. SA.111. The rule does not forbid the partner from also having a tax-related motive, or require that the business purpose be more important than the tax-related motive. See UPS v. Comm'r, 254 F.3d 1014, 1019 (11th Cir. 2001)(“A 'business purpose' does not mean a reason for a transaction that is free of tax considerations. Rather, a transaction has a 'business purpose' . . . as long as it figures in a bona fide, profit-seeking business.”).

An example in the regulations confirms this point. In that example, the partners seek to distribute property to one of the partners, A. See 26 C.F.R. § 1.737-4(b)(example 2). A ordinarily would owe tax on the distribution. Id. So, for the “principal purpose of avoiding such [tax],” the partners have A guarantee an existing partnership debt, so that the distribution would be a debt-financed distribution and A would owe no tax on it. Id. The example states that the transaction should be respected, because the partnership incurred the debt for “a substantial business purpose” and A's agreement to guarantee the debt “ha[d] substance.” Id. This example confirms that guaranteeing a partnership's debt is itself a sufficient business purpose under the regulations, even when the partner had a tax-related purpose as well.

Second, the government observes (Br. 69) that the lenders did not ask for the guarantees and that the terms of the loans did not change because of the guarantees, which the government argues shows that the guarantees lacked business value. But it is undisputed that Tribune structured the transaction as a debt-financed distribution from the outset and that Tribune and RAC approached the lenders with the guarantees already baked into the transaction. SA.17-18, 48. Nonetheless, the senior lenders “haggled” over nearly every term in the guarantees. SA.31. “Numerous drafts” were exchanged, resulting in a contract “twice the length of the draft [Tribune] initially proposed.” SA.31. This cannot be squared with the government's suggestion that the lenders did not care about the guarantees.

Third, the government again relies (Br. 69) on the internal Tribune accounting analysis, this time pointing to its statement that RAC received “no perceived benefit” from the senior-debt guarantee. But that guarantee was not supposed to benefit RAC; it was supposed to benefit the senior debtholders. SA.111. That said, Thomas Ricketts testified that he viewed the guarantees as a “credit enhancement,” particularly given the unfavorable market conditions at the time of the Cubs transaction. B.541.

Fourth, the government repeats its argument (Br. 70-71) that the Court should focus only on the experts' valuations of the senior-debt guarantee and not the subordinated-debt guarantee. That is incorrect because the subordinated-debt guarantee still had economic value even if the subordinated debt is treated as equity for tax purposes. See p. 56, supra. And even if the analysis were limited to the senior-debt guarantee, the Tax Court found (based on ample record evidence) that that guarantee had economic value. See pp. 56-57, supra.

Finally, the government argues (Br. 72-73) that the Tax Court erred by relying on S&P's analyses of Tribune's creditworthiness because the analyses occurred after the guarantees were in effect. But the fact that S&P assigned value to the guarantees while they were in effect confirms that they had economic value at the time Tribune provided them. The government also argues (Br. 72-73) that the S&P analyst who rated Tribune's credit did not understand every detail of the Cubs transaction. But the analyst relied on Tribune's disclosure in its financial statements, A.1725, which explained the material features of the Cubs transactions and the guarantees, B.385, and the analyst followed S&P's standard rating practices, B.597-99. The Tax Court heard all of the evidence and concluded that S&P's analysis showed that the guarantees “had a real-world effect on Tribune's credit rating.” SA.113.

The Tax Court's conclusion that Tribune's guarantees had valid business purposes and meaningful economic value was not clear error. There thus is no basis for disregarding the guarantees under the general anti-abuse rule, just as there is no basis for disregarding them under the specific anti-abuse rule.

II. The Subordinated Debt Was Debt, Not Equity

The question on cross-appeal is whether the subordinated debt should be treated as debt or equity for tax purposes. If it is equity, the portion of the distribution it funded does not qualify as a debt-financed distribution. The Tax Court erred in deeming the subordinated debt equity.

Standard of Review

This Court recognized that its precedents have “variously described” the question whether an investment is debt or equity “as one of fact and one of law.” VHC, Inc. v. Comm'r, 968 F.3d 839, 842 (7th Cir. 2020)(quoting In re Larson, 862 F.2d 112, 116 (7th Cir. 1988)). The “clearly erroneous standard” applies to “questions of fact” and the “de novo standard” applies to “questions of law.” Larson, 862 F.2d at 117. Thus, in this case, factual determinations (such as the finding that the subordinated debt had fixed amounts of interest and principal) should be reviewed for clear error, and legal determinations (such as whether certain facts favor debt or equity) should be reviewed de novo.

A. The Parties Intended the Subordinated Debt to Be Debt

1. Whether an Investment Is Debt or Equity Depends on the Parties' Intent

The key distinction between debt and equity is that a debt investor “expects repayment regardless of the debtor corporation's success or failure,” whereas an equity investor “expects to make a profit” if “the company is successful.” Larson, 862 F.2d at 117; see, e.g., Saviano v. Comm'r, 765 F.2d 643, 646 (7th Cir. 1985). The question is the parties' “intent” at the time of the investment. Busch v. Comm'r, 728 F.2d 945, 948 (7th Cir. 1984); see Friedrich v. Comm'r, 925 F.2d 180, 183 (7th Cir. 1991).

This Court considers various “objective factors” as “indications of intent.” Busch, 728 F.2d at 948; see Roth Steel Tube Co. v. Comm'r, 800 F.2d 625, 630 (6th Cir. 1986). The Tax Court identified thirteen relevant factors in Dixie Dairies Corp. v. Commissioner, supra, and considered those factors here. This Court has not identified a comprehensive set of factors, but it has used some of the factors identified by the Tax Court. See, e.g., VHC, 968 F.3d at 842-843; Friedrich, 925 F.2d at 180-84. The ultimate question in reviewing the factors remains the parties' intent. Busch, 728 F.2d at 948.

The Tax Court recognized that various factors were “intended to help [it] answer” the fundamental question of whether the subordinated debt was “subject to the fortunes” of the business (equity) or “represent[ed] a strict debtor-creditor relationship” (debt). SA.57. Yet, in applying the factors, the Tax Court focused on the minutiae of each factor rather than the overall question of the parties' intent. As explained below, the court's analysis of many of the factors is flawed. But more importantly, the court's analysis failed to recognize that the parties to the transaction clearly intended the subordinated debt to be debt.

2. The Parties Intended for CBH to Repay the Subordinated Debt Regardless of CBH's Success

Undisputed evidence showed that the parties to the transaction clearly intended for the subordinated debt to be debt.

The debt instrument showed that CBH intended to repay the subordinated debt no matter its success. The amounts of interest and principal were fixed — the amounts would not increase if the partnership was financially successful. A.829-36. CBH was required to repay the interest and principal even if it was not successful. A.829-36. If it could not do so, then the subordinated debtholder would have the same priority as CBH's general creditors — and a higher priority than CBH's equity holders. B.125, B.586. Those are all hallmarks of debt. See Larson, 862 F.2d at 117.

The only condition standing in the way of repayment was that the subordinated debt could not be paid until after the senior debt, and so the subordinated debtholder's rights to enforce the debt were subordinated to the senior debtholders' rights. A.1179. But a subordination agreement between lenders does not alter the borrower's obligations to repay the subordinated debt. That is why subordinated debt still is debt. Green Bay Structural Steel, Inc. v. Comm'r, 53 T.C. 451, 457 (1969).

The parties to the transaction always treated the subordinated debt as debt. Both Tribune and CBH always reported the subordinated debt as debt in their audited financial statements and tax returns. B.155, B.161, B.291, B.385, B.431. And like the senior debt, Tribune guaranteed the subordinated debt, so that the debt would be repaid even if CBH did not pay. SA.111. Similarly, RAC always described the subordinated debt as debt, including in its submissions to MLB. B.163, B.178, B.532.

Further, both Tribune and RAC treated the subordinated debt as debt when RAC bought out Tribune's 5% interest in the Cubs. Specifically, the amount RAC paid Tribune was based on CBH's enterprise value less the senior and subordinated debts. SA.35. So Tribune received less than it would have if the subordinated debt had been equity. All of those facts are undisputed.

The Tax Court did not account for the fact that the amount RAC paid Tribune to buy out its share in CBH was based on treating the subordinated debt as debt. And although the Tax Court recognized that the parties labelled the subordinated debt as debt and CBH paid the debt according to its terms, SA.59, SA.75, it concluded that the parties' actual intent was for the subordinated debt to function as equity, SA.75-78. That conclusion was premised on multiple legal errors, as explained below.

3. Interested Third Parties All Understood the Subordinated Debt to Be Debt

Here, third parties that cared about the nature of the subordinated debt all viewed it as debt. That shows that the parties clearly intended for the subordinated debt to be debt and acted accordingly. The third-party evidence distinguishes this case from the mine-run of cases that raise debt-equity issues, which generally involve related-party transactions where whether investments are debt or equity does not matter to anyone else. See, e.g., VHC, Inc., 968 F.3d at 842; Larson, 862 F.2d at 113; Ill. Tool Works v. Comm'r, 116 T.C.M. (CCH) 124, at *31 (2018). Yet the Tax Court did not account for the third parties' conduct at all in its analysis. See SA.58-90.

The senior lenders treated the subordinated debt as debt when they negotiated the terms of the senior debt and the subordination agreement. They limited the total subordinated debt to $298.75 million, A.650, and specified that borrowing in excess of that amount would be a default under the senior debt agreement, A.663. If the subordinated debt actually had been equity, the senior lenders would have welcomed more of it because it would have reduced CBH's debt-equity ratio and thus the likelihood of default. See Steinman v. Hicks, 352 F.3d 1101, 1106 (7th Cir. 2003). Further, the senior debtholders would not have cared about the terms of the subordination agreement if the subordinated debt were equity, because equity is paid after debt. B.586.

MLB also treated the subordinated debt as debt. Under MLB's rules, MLB and a super-majority of team owners had to approve the Cubs transaction because it involved transferring control of the Cubs. SA.13. The MLB Commissioner presented the Cubs transaction to the owners for approval. See A.478. In that presentation, the Commissioner expressly included the subordinated debt in the team's debt. A.481. MLB paid significant attention to the proposed debt, because it did not want a team to have so much debt that it threatened the team's stability. A.405-08. So it would have mattered to MLB if the subordinated debt actually were equity. Yet no one within MLB questioned that the subordinated debt was debt. B.531-32.

S&P also treated the subordinated debt as debt. In 2009, S&P rated CBH's creditworthiness and the risk of default. A.823. In that analysis, S&P included the subordinated debt in calculating CBH's debt load. A.824. Then, between 2012 and 2016, S&P evaluated Tribune's creditworthiness as an issuer of publicly available securities. E.g., A.1011. In those analyses, S&P treated a portion of the subordinated debt as a liability on Tribune's balance sheet because of Tribune's guarantees. E.g., A.1013. Whether the subordinated debt was debt or equity mattered to S&P, because that was critical to understanding CBH's and Tribune's true financial positions.

The bankruptcy court in Tribune's bankruptcy likewise treated the subordinated debt as debt. The court had to approve the Cubs transaction because the transaction was not part of Tribune's ordinary business. SA.13; see B.14-15. The court evaluated CBH's proposed debt structure and determined whether Tribune's guarantees of CBH's loans made business sense for Tribune and its creditors. B.18. The nature of the subordinated debt mattered to the bankruptcy court, because that was critical to understanding the guarantees' potential effect on Tribune's finances.

Thus, everyone involved in the Cubs transaction viewed the subordinated debt as debt, even third parties that would have preferred the debt to be equity.

B. Each of the Factors Considered by the Tax Court Showed That the Subordinated Debt Was Debt

The Tax Court's approach was to review each of the thirteen Dixie Dairies factors in isolation and then count up which favored debt and which favored equity. The factors can be broadly grouped into four categories:

See Dixie Dairies, 74 T.C. at 493. The Tax Court concluded that seven of these factors favored equity, three favored debt, and three were neutral. SA.90.

The Tax Court missed that “[t]he object of the inquiry is not to count factors, but to evaluate them” as indicators of the parties' intent. Tyler v. Tomlinson, 414 F.2d 844, 848 (5th Cir. 1969). Further, with respect to the seven factors supposedly favoring equity, the court's analysis of six of the factors relied on legal misunderstandings, and its analysis of the remaining factor relied on a clearly erroneous factual finding. The court's analysis of the three supposedly neutral factors also rested on legal misunderstandings.

1. The Parties Treated the Subordinated Debt as Debt

The first two factors — the name given to the instrument and the parties' intent — assess how the parties treated the subordinated debt. The Tax Court's conclusion that the parties' intent favored equity rests on several legal errors.

Name given to the instrument. It is undisputed that the parties consistently characterized the subordinated debt as “debt.” The debt instrument was called “a sub debt note,” SA.59, which is a paradigmatic form of a debt, see, e.g., Estate of Mixon v. United States, 464 F.2d 394, 403 (5th Cir. 1972). The Tax Court thus correctly recognized that this factor favors debt. SA.58.

Parties' intent. As explained, undisputed evidence showed that the parties viewed the subordinated debt as debt. See pp. 76-80, supra. The Tax Court gave three reasons for reaching a contrary conclusion, SA.74-78, all of which are based on legal errors.

First, the Tax Court observed that Tribune's and RAC's ownership interests in CBH (5% and 95%) did not match their equity contributions (12.3% and 87.7%) if the subordinated debt is treated as debt, but would match if the amount of the subordinated debt is treated as equity. SA.76-78. But this does not show that the subordinated debt was equity. It is black-letter law that partners' ownership shares can differ from their shares of equity contributions. See, e.g., Del. Code Ann. tit. 6, § 18-301(d). In particular, a partner can obtain an ownership share solely by providing debt financing or contributing services, see, e.g., Belgard v. Manchac Techs., LLC, 92 So. 3d 660, 664 (La. Ct. App. 2012), as the IRS has recognized, see Rev. Proc. 93-27, 1993-2 C.B. 343. So a partner seeking to obtain a 95% ownership interest could contribute any combination of equity, debt, or services to make up that amount. And its total contribution need not align with its ownership interest. See id.

Here, RAC decided to both make an equity contribution and arrange debt financing to obtain its 95% ownership share. See B.432. In other words, RAC's contributions to CBH were both providing equity and procuring the subordinated debt from RAC Finance, and RAC chose to have those add up to its 95% ownership share. But that does not mean that RAC viewed the debt to be equity; RAC (along with everyone else) consistently treated the subordinated debt as debt. Thus, the fact that the ownership shares aligned with the combined equity and debt contributions says nothing about the parties' intent as to whether those contributions were debt or equity.

Second, the Tax Court noted that when RAC bought out Tribune, Tribune's payout was calculated based on its 5% ownership share of CBH, rather than its 12.3% share of equity contributions. SA.77. Again, there is no requirement that ownership share and equity contributions align, and they often do not. RAC paid Tribune 5% of CBH's value because that was the amount to which Tribune was entitled as a 5% owner of CBH. B.112. The fact that its equity contribution was different from 5% was irrelevant. Under the Tax Court's logic, a partner that owned a 10% ownership interest but had not made any equity contributions would not be owed any money if its share were bought out. That would not make sense.

Third, the Tax Court stated that RAC treated the subordinated debt as equity when it considered selling the subordinated debt to other investors. SA.75-76. The Tax Court relied solely on a prospectus CBH prepared. SA.75-76. It stated that the prospectus showed that RAC viewed the subordinated debt as equity because it “emphasized the inherent risks involved in buying pieces of the sub debt, including CBH's 'ability' to pay (rather than its obligation) and the possibility that investors could suffer a 'complete loss on their investment,' ” and noted that investors would have some privileges “typically afforded to team owners” such as priority parking and box suites. SA.75-76 (quoting B.164-242).

The prospectus's description of the subordinated debt as an investment that could lose value did not show that it was equity. From a lender's perspective, making a loan is an “investment” — a debt investment. E.g., Sierra Club v. FERC, 38 F.4th 220, 229 (D.C. Cir. 2022)(comparing “debt investment” to “equity investment”). Other prospectuses for debt instruments similarly refer to a purchase as a possible “investment” — including the prospectus for the senior debt in this case, which indisputably was debt. A.1112. Further, like any investment, an investment in the subordinated debt could be lost. So the boilerplate warning in the prospectus about the risk of loss does not suggest either debt or equity.

The Tax Court's focus on the prospectus's reference to CBH's “ability” to pay instead of its “obligation” to pay similarly is mistaken. The Tax Court cited a section of the prospectus that described the potential risks. B.237. CBH's ability to pay was a potential risk; its obligation to pay was not a risk. So it would not have made sense for the prospectus to talk about CBH's obligation to pay in the section on risk. Elsewhere, the prospectus referred to the subordinated debt as one of CBH's “obligations.” E.g., B.186.

The Tax Court's reliance on the privileges that came with the subordinated debt, such as priority parking, also is misplaced. The privileges were a way to make the debt a more attractive investment. B.600-02. The Tax Court's statement that the privileges were “typically afforded to team owners” is unsupported; similar privileges are available to corporate sponsors and season ticketholders in sports stadiums across the country. And the fact that investors were offered these inducements to purchase the debt simply does not answer the question whether CBH intended to repay the subordinated debt regardless of its success.

2. CBH's Obligations and Performance Favored Debt

The second set of factors considers the borrower's rights and obligations. They are the presence or absence of fixed maturity date; the source of repayment; the use to which the investment is put; and whether the borrower has failed to pay. The Tax Court held that the maturity-date and use factors favored equity and the source-of-payments factor was neutral, but its analyses rest on legal errors.

Maturity date. The subordinated debt had a fixed maturity date. A.829-30. That is another hallmark of debt. Mixon, 646 F.2d at 505. But the Tax Court took the view that the maturity date was not actually fixed, because the subordinated debt could not be paid before the senior debt and the senior debtholders could (in theory) unilaterally extend the time for payment on the senior debt. SA.61-63.

The Tax Court misunderstood the nature of subordinated debt. The defining characteristic of subordinated debt is that it does not get paid before the senior debt, and it is common for senior debtholders to be able to unilaterally change the terms of the senior debt. See 3B Am. Jur. 2d Legal Forms § 41:87 § 6 (2023)(model subordinated debt agreement). Those provisions protect the senior debtholder, but they do not change the creditor's obligations to repay the subordinated debt. The Tax Court's reasoning would turn all subordinated debt into equity, which is not the law.

Source of payments. An investment is debt if its repayment does not depend on a particular source of funds being available or on the recipient achieving a certain level of earnings. Mixon, 464 F.2d at 405. Here, the subordinated debt note stated that it ultimately had to be paid off without regard to the source of payments, and without regard to CBH's profitability. A.830-35. The Tax Court recognized that, SA.66, yet it treated this factor as neutral. It took the view that, because CBH prioritized paying other ongoing expenses before paying the subordinated debt interest, the source of payment for the interest was restricted, SA.67.

The Tax Court failed to recognize that CBH ultimately would have to repay the interest regardless of the source of payment. If CBH did not have enough cash flow to make an interest payment, the interest would be added to the principal. A.830-31. This feature is called a “payment in kind,” and it is a common feature of debt instruments. See, e.g., 26 C.F.R. § 1.6045-1(n)(2)(ii)(F)(2023). Then, the principal was to be paid without regard to the source of payments. SA.67. So ultimately, repayment did not depend on the source of payments — which means this factor should have favored debt.

Use of funds. In general, if an investment was used for a capital expense, that could indicate equity; if it was used for operating expenses, that could indicate debt. PepsiCo P.R., Inc. v. Comm'r, 104 T.C.M. (CCH) 322, at *96 (2012). Here, the subordinated debt was not used for either — it was used to fund the special distribution to Tribune. So this factor is not relevant in this case.

The Tax Court stated that this factor favored equity, because the special distribution “was not an everyday operating transaction” but was part of a “significant change in the ownership of assets.” SA.87. By focusing on whether the transaction was commonplace, the Tax Court missed that the reason for the capital/operating expense distinction is risk, not regularity. See PepsiCo, 104 T.C.M. (CCH) 322, at *96. Using an investment for a capital expense often is riskier than using it for an ongoing expense, but there is a possibility of a larger return. That indicates equity.

Here, although the special distribution was a one-off, it was not made for the purpose of securing an outsize return. Indeed, businesses and individuals alike routinely use both debt and equity to make major, one-off purchases. See Nestlé Holdings, Inc. v. Comm'r, 70 T.C.M. (CCH) 682, at *26 (1995), rev'd on other grounds, 152 F.3d 83 (2d Cir. 1998). So the fact that the subordinated debt was used to fund the special distribution did not say anything about whether it was debt or equity, and this factor should not have any weight in this case.

Failure to pay. There was no dispute that CBH timely made all payments on the subordinated debt, and the Tax Court correctly recognized that this factor favored debt. SA.88.

3. The Lender's Rights Favored Debt

The third set of factors considers the lender's rights — its right to enforce payment; its right to participate in management; and the identity of interest between it and the debtor. The Tax Court viewed the first and third factors as supporting equity and the second factor as neutral, but its analysis is based on legal errors.

Right to enforce payment. It is undisputed that RAC Finance had the right to enforce payment on the subordinated debt after the senior debt was paid. A.833-34. This is a key characteristic of debt. Gokey Props., Inc. v. Comm'r, 34 T.C. 829, 835 (1960). But the Tax Court stated that the enforcement factor favors equity because RAC Finance's rights to enforce payment were subordinated to that of the senior lenders. SA.68-69.

The Tax Court's conclusion was based on a legal error. The defining characteristic of subordinated debt is that it is paid after the senior debt, see, e.g., 3B Am. Jur. 2d Legal Forms § 41:87, §§ 1-2 (model subordinated debt agreement), and as explained subordinated debt still is debt, Green Bay Structural Steel, 53 T.C. at 457. The fact that RAC Finance's right to enforce payment of the subordinated debt was subordinated to the senior debtholders did not alter its legal right to collect payment from CBH, so cannot support a showing of equity.

The Tax Court attempted to distinguish Green Bay Structural Steel on the ground that the holder of the subordinated debt in that case had more rights to exercise remedies than RAC Finance had here. SA.69. But there is no difference between the rights of the subordinated debtholders in Green Bay Structural Steel and in this case. The subordinated debtholder's rights to exercise remedies in Green Bay Structural Steel were expressly limited by the rights of the senior debtholders. 53 T.C. at 453-54. The subordinated debt here had materially identical terms. A.833.

Further, by comparing the rights of the subordinated debtholders only to the rights of the senior debtholders, the Tax Court missed that after the senior debt was repaid, the holders of the subordinated debt had full rights to exercise remedies on the same terms as other debtholders and ahead of equity holders. That is why subordinated debt is understood to be debt.

Right to participate in management. It is undisputed that the holder of the subordinated debt did not have the right to participate in management, which belongs to equity holders. SA.71. The Tax Court discounted this factor because RAC controlled the management of both CBH and of the subordinated debtholder RAC Finance. SA.71. But the question is whether the subordinated debtholder has management rights by virtue of the subordinated debt, not whether the debtor and creditor have common management. See Monon R.R. v. Comm'r, 55 T.C. 345, 359-60 (1970).

Here, RAC had management rights because it was a member of CBH, but that did not give RAC Finance a seat at the table. If RAC Finance had sold a part of the subordinated debt, the buyer would not have had any management rights in CBH.

Identity of interest factor. This factor looks at whether there is identity of interest between the owners of the borrower (here RAC and Tribune) and the creditor (here RAC Finance). Slappey Drive Indus. Park v. United States, 561 F.2d 572, 583-84 (5th Cir. 1977). This factor favors equity when the owners are the creditors and they advance funds in amounts that align with their ownership interests. Id. Here, Tribune was not a creditor, so the interests of the owners and creditors did not align. This factor thus should favor debt, not equity.

The Tax Court ignored that Tribune had not made any loans at all. It instead stated that the identity of interest factor favored equity because CBH and RAC Finance were “interrelated[ ].” SA.80. The Tax Court did not explain its reasoning, other than to say that it did not “intend to imply that related parties such as family members cannot enforce debts against other family members.” SA.80. But it is hard to see what else the Tax Court meant, and its decision is inconsistent with the black-letter rule that “affiliated” parties can create “genuine transaction[s].” Kraft Foods Co. v. Comm'r, 232 F.2d 118, 124 (2d Cir. 1956).

4. The Risks of the Subordinated Debt Favored Debt

The final set of factors addresses the risk profile of the investment. They are the seniority of the investment in relation to other creditors; the borrower's capitalization; the borrower's ability to obtain loans from other lenders; and the risk involved in making the investment. The Tax Court held that the seniority factor was neutral and the ability-to-obtain-loans and risk factors favored equity. Its conclusions on the status and risk factors are based on legal errors, and its conclusion as to the ability-to-obtain-loans factor is clearly erroneous.

Seniority of the investment. It was undisputed that if CBH were liquidated, the subordinated debt would have had the same status as all of CBH's other unsecured debts and would have ranked above CBH's obligations to its equity holders. B.586. In fact, the subordinated debt was second only to the senior debt. So this factor should have favored debt, because the subordinated debt would have been repaid ahead of equity.

The Tax Court nonetheless stated that this factor was neutral because the subordinated debt was “positioned so closely between debt and equity.” SA.73. That cannot be squared with the terms of CBH's LLC agreement, which stated that the subordinated debt would be paid before equity. B.125.

Borrower's capitalization. The Tax Court held that CBH was adequately capitalized. Its debt-to-equity ratio was about 4:1, which was in line with other MLB teams. SA.82. So this factor favors debt, as the Tax Court correctly recognized. SA.82.

Ability to obtain loans from other lenders. This factor assesses whether the borrower would have been able to obtain similar financing from other lenders. Here, Tribune's and CBH's expert explained that the interest rate on the subordinated debt was commercially reasonable and that the debt contained attractive features, such as the payment-in-kind feature that required CBH ultimately to pay the interest. A.1447-52.

The Tax Court concluded that the outside-terms factor favored equity solely because RAC Finance ultimately did not sell the subordinated debt to outside parties. SA.85-86. It stated that “Petitioners did not show that any third party expressed genuine interest in buying the sub debt.” SA.86. Its conclusion was clearly erroneous, because it ignored the undisputed evidence that many third parties expressed interest in buying the subordinated debt. RAC Finance received interest totaling $110 million, which was more than it was considering selling. B.448. CBH's witness testified without contradiction that RAC Finance ultimately decided not to sell because it did not want any other investors involved. B.536-37. This factor should have favored debt.

Risk. It was undisputed that CBH expected to repay the subordinated debt. A.1457. This factor also should have favored debt. See Ill. Tool Works, 116 T.C.M. (CCH) 124, at *47.

The Tax Court stated that the subordinated debt was risky, which favored equity, because in its view RAC Finance had limited options to enforce the subordinated debt. SA.89-90. In support of that view, it relied on (1) the fact that RAC Finance's ability to enforce the subordinated debt was subordinated to the senior debtholder's rights and (2) its view that family members would be reluctant to enforce debts against other family members. SA.89-90.

But the first is a characteristic of subordinated debt, and the fact that a debt is paid after another debt does not make it equity, particularly where the debt has the same seniority as other unsecured debt. The second is unfounded; related parties can create genuine debt. Nestlé Holdings, 70 T.C.M. (CCH) 682, at *25. Here, if CBH had not paid, RAC would have had a fiduciary obligation to RAC Finance to seek to enforce the subordinated debt on RAC Finance's behalf. See William Penn P'ship v. Saliba, 13 A.3d 749, 756 (Del. 2011). If it did not, it would forego Tribune's guarantee, as the guarantee required it to try to collect payment from CBH first. There was no basis for the Tax Court to discount those legal obligations.

C. The Tax Court's Flawed Analysis Should Be Reversed

The Tax Court erred because it treated the thirteen factors as the entirety of the analysis, as opposed to guidance in answering the ultimate question of the parties' intent. It missed the fundamental point: CBH intended to repay the subordinated debt regardless of its success, and RAC Finance intended that the subordinated debt be enforceable against CBH.

The Tax Court also ignored key evidence of that intent, such as the evidence of third-party conduct — perhaps because that evidence did not fit neatly into one of the Dixie Dairies factors. In other places, it strained to analyze factors that had no obvious application to this case. E.g., SA.86-88 (use of the investment factor); see Dixie Dairies, 74 T.C. at 493-94 (warning that “all of the factors are not relevant in each case”). And it repeatedly viewed the key characteristics of subordinated debt — that subordinated debt is repaid after senior debt and the subordinated debt-holder's rights are subordinated to the senior debt-holder's rights — as evidence of equity. SA.62, SA.68. That reasoning would make all subordinated debt equity for tax purposes.

The end result is that the Tax Court concluded that the subordinated debt was equity, when for a decade all of the sophisticated parties involved in this transaction understood it to be debt and entered into legally binding contracts, worth hundreds of millions of dollars, based on that understanding.

The Tax Court's rote application of the Dixie Dairies factors, if affirmed, will create many problems beyond this case. Many businesses routinely enter into heavily negotiated transactions that involve issuing debt. Those companies will not be able to confidently rely on debt structures in their transactions if, a decade after the fact, a court can recast the debt using a mechanical approach to the Dixie Dairies factors. That problem will be particularly acute for transactions that involve subordinated debt and multiple layers of debt, impairing critical forms of financing on which many businesses rely. This Court should reverse the Tax Court's holding on the subordinated debt.

Conclusion

The Court should affirm the Tax Court's holding that the distribution to Tribune was a debt-financed distribution to the extent of the senior debt. The Court should reverse the Tax Court's holding that the subordinated debt was equity and not debt, and accordingly hold that the distribution to Tribune also was a debt-financed distribution to the extent of the subordinated debt.

Respectfully submitted,

Joel V. Williamson
Timothy S. Bishop
Thomas L. Kittle-Kamp
Anthony D. Pastore
MAYER BROWN LLP
71 S. Wacker Drive
Chicago, IL 60606
(312) 701-7229
jwilliamson@mayerbrown.com

Dated: August 8, 2023

Nicole A. Saharsky
Minh Nguyen-Dang
MAYER BROWN LLP
1999 K Street NW
Washington, DC 20006
(202) 263-3052

Phillip M. Goldberg
FOLEY & LARDNER LLP
321 N. Clark Street, Suite 3000
Chicago, IL 60654
(312) 832-4549