Proceeds from Sale of Basketball Team Are Not Reduced by Unpaid Deferred Comp

(Parker Tax Publishing March 2022)

The Tax Court held that a limited partnership that sold substantially all of the assets of an NBA basketball team could not rely on the economic performance requirement of Code Sec. 461(h) to deduct its deferred compensation liability with respect to certain team players because that liability had not been paid. The court also concluded that the partnership could not offset or reduce its amount realized on the sale by the amount of the deferred compensation liability. Hoops v. Comm'r, T.C. Memo. 2022-9.

Background

On March 30, 2000, Hoops, LP (Hoops) was established as a Delaware limited partnership by and between Heisley Member, Inc. (Heisley Member), a Nevada corporation, and Heico Holding, Inc. (Heico), a Delaware corporation, for the purpose of acquiring, owning, operating, and conducting a sports franchise within the rules established by the National Basketball Association (NBA). Heisley Member has been Hoops' only general partner since its formation and was designated the tax matters partner for Hoops' tax year ending December 31, 2012.

On May 11, 2000, Hoops acquired the Vancouver Grizzlies, a professional basketball franchise. In 2001, the Vancouver Grizzlies moved to Memphis, Tennessee, and the name of the franchise was changed to the Memphis Grizzlies (collectively, Grizzlies). The Grizzlies are a member of the NBA. Hoops owned and operated the Grizzlies from the date it acquired the franchise until it sold the franchise in 2012.

In 2012, Memphis Basketball, LLC (the Buyer) agreed to purchase substantially all of the assets and to assume substantially all of the liabilities and obligations of Hoops. Hoops sold substantially all of its assets and transferred substantially all of its liabilities and obligations to the Buyer in the 2012 sale. One of the liabilities, the Buyer assumed was the liabilities and obligations under certain binding agreements, which included NBA Uniform Player Contracts for Zach Randolph and Michael Conley.

Randolph earned deferred compensation of $4,800,000 for performance of services for Hoops during the 2009-10 NBA season, due to be paid by Hoops as determined on dates after the 2012 sale. Additionally, for the services Randolph performed for Hoops during the 2010-11 NBA season, he earned a deferred compensation of $5,200,000, also due to be paid by Hoops as determined on dates after the 2012 sale. Randolph earned deferred compensation of $1,835,122 for performance of services for Hoops during the 2011-12 season due to be paid by Hoops as determined on dates after the 2012 sale. On November 2, 2010, Conley entered into an NBA Uniform Player Contract with Hoops. The contract provided for Conley to earn deferred compensation and, during the 2011-12 season, Conley earned deferred compensation of $804,878 that was due to be paid by Hoops as determined on dates after the 2012 sale.

In computing its gain on the 2012 sale, Hoops reported a total amount realized of $419,394,032, consisting of $200,690,000 of cash, $218,704,032 of liabilities assumed by Buyer, and other adjustments. Hoops reported an adjusted basis of $120,370,493 in the assets that it sold to Buyer and recognized gain of $299,023,539 on the 2012 sale.

As of the date of the 2012 sale, the deferred compensation liability had an accrued value of $12,640,000. For purposes of computing the amount realized by Hoops on Buyer's assumption of the deferred compensation liability, Hoops discounted the sum of the future payments to be made to Randolph and Conley with a discount rate of 3 percent. The computations Hoops calculated, applying that 3 percent discount rate to the present value of the total future payments owed to Randolph and Conley, totaled $10,673,327 as of the date of the 2012 sale. Hoops included $10,673,327, the present value of the deferred compensation liability, in its amount realized in computing its gain on the 2012 sale.

Hoops Amended Return Claims Deduction for Deferred Compensation Liability

On an amended 2012 tax return, Hoops claimed an additional deduction of $10,673,327 relating to the deferred compensation liability. Hoops explained that it was claiming the additional deduction because no deduction was claimed on the original 2012 tax return under Reg. Sec. 1.461-4(d)(5) to reduce the partnership's deferred compensation liability included in the amount realized. The IRS disallowed the additional deduction.

Generally, Reg. Sec. 1.461-4(d)(5)(i) provides that if, in connection with the sale or exchange of a trade or business by a taxpayer, the purchaser expressly assumes a liability arising out of the trade or business that the taxpayer but for the economic performance requirement in Code Sec. 461(h)(1) would have been entitled to incur as of the date of the sale, economic performance with respect to that liability occurs as the amount of the liability is properly included in the amount realized on the transaction by the taxpayer.

The parties agreed that the compensation at issue was a nonqualified plan of deferred compensation, the deductibility of which is governed by Code Sec. 404(a). Generally, in order to be deductible under Code Sec. 404(a), Reg. Sec. 1.404(a)-1(b) provides that compensation must be expenses which would be deductible under Code Sec. 162 (relating to trade or business expenses) or Code Sec. 212 (relating to expenses for production of income) if it were not for the provision in Code Sec. 404(a). Additionally, compensation, which would otherwise be deductible, is further subject to the limitations under Code Sec. 404(a)(5) as to the amount deductible for any year. Code Sec. 404(a)(5) provides that, in a case of a nonqualified plan, a deduction for deferred compensation paid or accrued is allowable for the tax year for which an amount attributable to the contribution is includible in the gross income of the employees participating in the plan.

Hoops argued that the economic performance rules allowed it to deduct the deferred compensation liability for the year of the sale. Specifically, Hoops argued that the timing rule in Code Sec. 404 is incorporated into the economic performance requirement of Code Sec. 461(h) and, in the instant case, is accelerated under the sale provision in Reg. Sec. 1.461-4(d)(5)(i).

In the alternative, Hoops argued that, if the Tax Court found that the deferred compensation liability was not deductible for the year of the 2012 sale, then either the deferred compensation liability should not have been included in the sale price or Hoops should be entitled to offset or reduce its amount realized on the 2012 sale by the amount of the deferred compensation liability.

Analysis

The Tax Court held that, with respect to its sale of the Grizzlies, Hoops' reliance on the sale provision in the economic performance requirement of Code Sec. 461(h) was misplaced and Hoops was not entitled to an additional deduction of $10,673,327. The court noted that the parties all agreed that Hoops incurred the deferred compensation liability, as of the date of the 2012 sale, because all the events had occurred that establish the fact of the deferred compensation liability, the amount could be determined with reasonable accuracy, and economic performance occurred. However, the court observed, the regulations under Code Sec. 461 instruct that if, as in Hoops' case, the taxpayer uses an accrual method of accounting, other applicable guidance applies. In this case, the court said, Code Sec. 404(a)(5) governs the deductibility of, and prescribes the manner in which, a deferred compensation liability is taken into account. As the court observed, under the plain text of Code Sec. 404(a)(5), a deduction for deferred compensation is taken into account only for the tax year in which an amount attributable to the contribution is includible in the gross income of the employee and then only to the extent allowable under Code Sec. 404(a). The court concluded that Hoops was not entitled to deduct the deferred compensation liability for the year of the sale because no amounts attributable to the compensation were includible in the gross income of Randolph or Conley.

This result remains the same, the court stated, regardless of the fact that Hoops files its returns using the accrual method of accounting. Thus, the court concluded that Hoop's reliance on the sale provision in the economic performance rules was misplaced because it is the Code Sec. 404(a)(5) limitation as to the amount deductible for any year that precludes deduction for the year of the 2012 sale, not any purported failure to satisfy the economic performance requirement.

The court also disagreed with Hoops' alternative argument that accrued expenses assumed by a buyer should be included in the sale price only if they were deducted by the seller. The court noted that the parties agreed that Randolph and Conley had already performed the services and, therefore, Hoops had an obligation to pay the deferred compensation. When the Buyer assumed the deferred compensation liability, the court noted, Hoops was discharged from its obligation to pay deferred compensation as a result of the 2012 sale. Thus, pursuant to Code Sec. 1001, Hoops was required to take into account the amount of the deferred compensation liability in computing its gain or loss from the sale.

For a discussion of the rules relating to nonqualified deferred compensation plans, see Parker Tax ¶135,525. For a discussion of the economic performance requirement as it relates to the deduction of expenses, see ¶241,740.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com

We hope you find our professional tax research articles comprehensive and informative. Parker Tax Pro Library gives you unlimited online access all of our past Biweekly Tax Bulletins, 22 volumes of expert analysis, 250 Client Letters, Bob Jennings Practice Aids, time saving election statements and our comprehensive, fully updated primary source library.

Try Our Easy, Powerful Search Engine

A Professional Tax Research Solution that gives you instant access to 22 volumes of expert analysis and 185,000 authoritative source documents. But having access won’t help if you can’t quickly and easily find the materials that answer your questions. That’s where Parker’s search engine – and it’s uncanny knack for finding the right documents – comes into play

Things that take half a dozen steps in other products take two steps in ours. Search results come up instantly and browsing them is a cinch. So is linking from Parker’s analysis to practice aids and cited primary source documents. Parker’s powerful, user-friendly search engine ensures that you quickly find what you need every time you visit Our Tax Research Library.

Dear Tax Professional,

My name is James Levey, and a few years back I founded a company named Kleinrock Publishing. I started Kleinrock out of frustration with the prohibitively high prices and difficult search engines of BNA, CCH, and RIA tax research products ... kind of reminiscent of the situation practitioners face today.

Now that Kleinrock has disappeared into CCH, prices are soaring again and ease-of-use has fallen by the wayside. The needs of smaller firms and sole practitioners are simply not being met.

To address the problem, I’ve partnered with a group of highly talented tax writers to create Parker Tax Publishing ... a company dedicated to the idea that comprehensive, authoritative tax information service can be both easy-to-use and highly affordable.

Our product, the Parker Tax Pro Library, is breathtaking in its scope. Check out the contents listing to the left to get a sense of all the valuable material you'll have access to when you subscribe.

Or better yet, take a minute to sign yourself up for a free trial, so you can experience first-hand just how easy it is to get results with the Pro Library!

Sincerely,

James Levey

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com