The face of goodwill.

Photographer: Jeff Gross/Getty Images

Ballmer Got a Tax Break. So Do Lots of People.

Kavitha A. Davidson is a former Bloomberg View columnist.
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Earlier this week, the Financial Times reported that new Los Angeles Clippers owner Steve Ballmer could stand to recoup around $1 billion in tax deductions from his purchase of the team.

Here's how FT's Arash Massoudi and Alan Livsey describe the benefit:

An FT analysis of US tax laws shows that Mr Ballmer could claim about half of the purchase price in current terms over the next 15 years against his taxable income. The deduction can be claimed under a little-known feature of the tax code covering so-called active owners of sports franchises.

The exemption for sports teams was brought into law about a decade ago to resolve concerns over how media rights were accounted for, tax experts said. But they also create a powerful incentive for wealthy individuals to indulge in projects they are passionate about, in effect subsidised by the US government.…

Under an exception in US law, buyers of sports franchises can use an accounting treatment known as goodwill against their other taxable income. This feature is commonly used by tax specialists to structure deals for sports teams. Goodwill is the difference between the purchase price of an asset and the actual cash and other fixed assets belonging to the team.

In this case, Mr Ballmer can spread the goodwill over 15 years and reduce his tax liability on his other income by a certain amount for each of those years.

Using a conservative model that assumes Mr Ballmer could account for $1.5bn in goodwill and a re-investment rate of 7 per cent, the potential tax shelter equates to about $1bn in current terms. 

The report got little play at the beginning of the week but has since picked up steam, with outlets including Yahoo Sports and NBC Sports chiming in. Considering recent outrage over the National Football League's classification as a nonprofit and Major League Baseball's longstanding antitrust exemption, it's not surprising to find the press and public weary of the law providing special treatment for the booming business of sports. As NBC Sports's Dan Feldman quipped, "Because nobody deserves a tax break like billionaire owners of sports teams."

I'm the first one to scream from the rooftops when a team or league is receiving some unique benefit at the public's expense. I've repeatedly called out the federal government for specifically including "professional football" in the tax code, as well as local and state governments for needlessly subsidizing stadium construction. And while it's true that Ballmer does stand to benefit from tax deductions stemming from the Clippers purchase, the FT's characterization of goodwill as an "exemption for sports teams" -- implying that teams serve as anomalous tax shelters -- isn't entirely accurate. (It's also worth noting that the FT article initially claimed that Ballmer would get tax "credits," since corrected to deductions.)

In a proposed transaction, the valuation of a team, as with any other business, is based on evaluating the worth of both tangible and intangible assets. According to the late Gerald W. Scully in his book "The Market Structure of Sports," the use of goodwill in the acquisition of sports teams dates back to the early 1950s, when the Internal Revenue Service bought into the idea that player contracts (intangible) should be amortized due to their straight-line depreciation over time. Player contracts were often deemed to comprise 90 to 100 percent of a team's value, a generous practice sanctioned under IRC 167. With the top marginal tax rate hovering around 91 percent, franchises did serve as a substantial tax shelter, evidenced in the instability of ownership during the period. According to Scully, between 1950 and 1975, the average team remained in the hands of a single ownership entity for just 11.7 years.

In the 1970s, a combination of new labor dynamics and a federal clampdown on tax advantages significantly hollowed the shelter. The Tax Reform Act of 1976 effectively limited the amount of a team's valuation attributable to players' contracts to 50 percent (IRC 1056(d)), and the top marginal tax rate was around 70 percent. This was seen by some as singling out sports teams; no other industry had such specific restrictions placed on the allocation of assets in determining a business's worth, having only to submit to a nebulous and subjective IRS test of "reasonableness."

By 2003, the sports landscape was completely transformed. Franchise worth consisted of several other factors than player contracts, most notably lucrative television contracts. By then, the IRS had established the terms of goodwill under IRC 197, allowing the amortization of intangible assets over a 15-year recovery period in an acquisition of a company -- with the exception of, among others, sports teams.

The next year, Congress enacted H.R. 4520, also known as the American Jobs Creation Act of 2004. (This is presumably what FT is referring to when it writes, "the exemption for sports teams was brought into law about a decade ago.") Section 886 struck the section of the tax code excepting professional sports, as well as the 50-percent limitation on intangible asset allocation. Contrary to the FT's framing of the goodwill benefit to owners as "an exception in US law" favoring sports, what this change was really a provision bringing transactions involving sports teams under the same umbrella as those in other industries. In its explanation of the provision, the Joint Committee on Taxation concluded, "Thus, the same rules for amortization of intangibles that apply to other acquisitions under present law will apply to the acquisitions of sports franchises."

The reasoning for amending the code to include sports teams was to resolve disputes between the IRS and potential buyers on how much of a franchise valuation could be attributed to amortizable assets. A 2003 IRS memo on evaluating sports acquisitions noted, "Currently, a particular dispute exists between taxpayers and the Service concerning whether a sports franchise's rights to media revenues as evidenced by media contracts in place at the time of acquisition are amortizable." The JCT estimated that doing away with the sports exception would raise $382 million over 10 years, money saved by not expending government resources resolving these disputes. And on a philosophical level, Congress believed that the rules "should apply to all types of businesses regardless of the nature of their assets."

It's somewhat understandable that the FT managed to jump to their conclusion that the goodwill rule was yet another government concession to the wealthy and powerful sports industry. The Jobs Creation Act was rife with massive corporate giveaways under the dubious guise that it would spur job creation and the repatriation of foreign income. (It didn't.) It's not a stretch to imagine that between giving a tax holiday and billions of dollars in refunds to the likes of Pfizer, IBM and other corporate campaign donors, Congress managed to slip in some civic relief to its friends in front offices.

But rather than serving as an example of how the U.S. government singles out sports for special subsidies, the goodwill treatment described by FT simply demonstrates a benefit enjoyed by most corporations. It's completely reasonable to question the wisdom of allowing a wealthy purchaser of a business to offset some of the taxes on his income from another business -- but again, that's not unique to sports. 

That said, it's equally fair to wonder whether sports should be treated as any other business when it comes to goodwill. For one, because of the nature of sports, it's possible that team values consist of a far higher proportion of amortizable assets than traditional businesses. And, while sports make up an undoubtedly wildly profitable industry, teams themselves straddle the line between business and plaything for the ultra-rich.

"Pro sports teams defy conventional valuation," Eric M. Nemeth, a tax lawyer specializing in sports transactions, said in a phone interview. "Folks that don't have money don't buy sports teams to make money. The people that buy sports teams already have made their money. That right there is a strong indication that there's a different business model at work here. I think it's completely reasonable to treat them differently."

Nemeth added that since sports teams benefit from "quasi-public-private partnerships" and various federal exceptions that allow them to operate as a "cartel," their tax benefits should be scrutinized under a separate lens from other businesses: "This is a closed entertainment industry." 

It's not as though reversing owners' goodwill benefits would deter potential buyers. As Nemeth noted, in addition to healthy profits, owning a team offers wealthy individuals several immaterial benefits, such as celebrity and caché. Ballmer had been trying to buy an NBA team for years; the tax consequences are simply gravy, albeit very, very rich gravy.

"This is an ultra-, ultra-exclusive club," Nemeth said. "Some very wealthy people, exorbitantly wealthy people, they want a sports team. The fact that there's a tax benefit to doing it makes the accountants happy, but a reversal of those tax benefits would probably have very little impact on the ability to sell teams at these prices. There are other factors driving it, other revenue factors, and the ultimate intangible: People like owning sports teams."

Given that, FT's assertion that goodwill benefits "create a powerful incentive for wealthy individuals to indulge in projects they are passionate about, in effect subsidized by the US government" isn't totally off. We just need to understand that unlike most other benefits afforded teams and leagues, this isn't a case where we're treating sports outside the realm of traditional business. Maybe it should be.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Kavitha A. Davidson at kdavidson19@bloomberg.net

To contact the editor on this story:
Tobin Harshaw at tharshaw@bloomberg.net