by Carter Ruml on August 18, 2010
At KYEstates, we’re happiest reporting on taxpayer victories, but if we have to report a loss, it mitigates our disappointment when the case is interesting. Anschutz v. Comm’r, 135 T.C. No. 5 (July 22, 2010), is that sort of case: an interesting taxpayer loss. In this instance, a very expensive taxpayer loss (likely exceeding $21 million). (Out of professional courtesy, we hope the ruling is not also occasion for a correspondingly expensive claim under any legal opinions….).
Anschutz involved Anschutz Company and its sole shareholder Philip F. Anschutz, the well-known Los Angeles-based entrepreneur and natural resources investor. In the late ’90s, Mr. Anschutz needed to raise cash to fund his acquisitions of a number of professional sports venues and teams, including the Los Angeles Kings hockey team and the Staples Center in LA. Mr. Anschutz owned large equity positions in the Union Pacific railroad and Anadarko Petroleum. An investment bank, Donaldson Lufkin & Jenrette (DLJ) was only too happy to help Mr. Anschutz’s advisors consider a variable prepaid forward contract and stock lending agreement arrangement as a way to use these stock positions to raise the needed cash.
(A side note: DLJ is actually the “late DLJ”, having been absorbed into Credit Suisse First Boston in 2001. For humorous investment banking nostalgia, see “Remember the Titans” at Leveraged Sellout.)
In 1999, Anschutz Company had made an election under Section 1362 to be taxed as an S corporation. The Anschutz Corporation (TAC) was a qualified subchapter S subsidiary (“Q-sub”) of Anschutz Company. TAC was the entity that entered into the transactions with DLJ in 2000 and 2001. Because TAC was a Q-sub of Anschutz Company, the consequences of the income tax treatment of TAC’s transactions with DLJ directly affected Mr. Anschutz’s personal income tax return.
Before reviewing the structure of the transactions with DLJ, let’s consider the bigger picture, shall we? Because the S-elections had been made in 1999, in 2000 and 2001 both TAC and its parent were within the 10-year built-in-gains period under Section 1374, an exception to the general pass-through rule for S corporation taxation. Section 1374(a) imposes a corporate-level tax on the net recognized built-in gain of an S corporation that has converted from C corporation to S corporation status. (The built-in gain is measured by the appreciation of any asset over its adjusted basis at the time the corporation converts from C corporation to S corporation status.)
TAC’s equity holdings had substantial built-in gains. An outright sale of the equities would trigger these built-in gains. A transaction promising to raise cash in relation to the equity positions without triggering a sale for income tax purposes (and thereby avoiding the undesirable double taxation of the built-in gains, once at the corporate level and then again at Mr. Anschutz’s level) would be very attractive.
That’s the sort of transaction DLJ was pitching.
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