The Missing piece of the MLB revenue discussion

In these digital pages and elsewhere, writers have (appropriately) taken to task Major League Baseball’s contention that teams will take a loss if games are played without fans.

I’m not going to directly address that contention today; Craig Edwards dismantled it sufficiently and thoroughly over at Fangraphs, and you should read what he wrote. Instead, I’d like to focus on an important factor in this discussion that MLB teams aren’t talking about, but which we should all be aware.

A Major League Baseball team is not a discrete business entity. Often, baseball teams aren’t single business entities at all. An instance of this came up in the lawsuit filed by Miami-Dade against the Marlins arising out of the sale from Jeffrey Loria to the Bruce Sherman/Derek Jeter group:

When we last looked at this case, the Marlins, under the new ownership group helmed by Bruce Sherman and Derek Jeter, rather dubiously claimed British citizenship as a way of moving the lawsuit to federal court (a process called “removal”) and attempting to force arbitration. Despite the less than stellar optics and even more questionable legal basis for the argument, the team nonetheless went all-in on their position that the team was, at least in part, a foreign citizen. In response, Miami sent Laurence Leavy – the attorney better known as “Marlins Man” for his formerly ubiquitous presence at Marlins games – and radio personality Andy Slater to the British Virgin Islands office where the team’s lawyers argued that one of the companies which owned the team, Aberneu, was ostensibly located. In a revelation that surprised no one, Aberneu, it turned out, had no offices or physical presence there – just a post office box. The Marlins, however, didn’t appreciate Slater’s involvement, and responded by revoking Slater’s press pass.

In other words, Aberneu, one of the entities which owned the Marlins, was what we call a “shell corporation”: a business entity which often doesn’t own assets or comply with corporate formalities, usually as a vehicle for tax avoidance or a liability shield.

To understand why this matters, we have to get into some legalese.

This is, as always, grossly oversimplified, but it should suffice for our purposes. Private ownership is the most common way that Major League Baseball teams are held. In other words, unlike many corporations, which often have shares that are publicly owned and traded, investors create business entities, like Limited Liability Companies or Partnerships, to own their portion of the team. There are also privately held corporations, where all of the shares are owned by an investor or group of investors and aren’t publicly traded.

There are many reasons that investors create companies to own their property instead of owning that property directly. For example, a company may be organized under the laws of a state which provides friendlier laws or taxes, like Delaware. This allows an investor to pay less in taxes than they would if their company was domiciled (essentially, where its home is) in the same state as the investor. Additionally, something called the “corporate veil” allows for the shielding of liability of shareholders from prospective plaintiffs. In other words, the reason Athletics outfielder Dustin Fowler sued Chicago White Sox, Ltd., and not Jerry Reinsdorf, is that the legal entity “Chicago White Sox Ltd.” is distinct from Reinsdorf and protects him from being sued directly.

Now, here is where things get a bit convoluted. The more investors you have, the more corporate entities you have. After all, investors with sizable ownership stakes aren’t going to forego these tax and liability shields. For example, when the Diamondbacks were sued for allegedly illegally divesting minority partners of their ownership stakes, one of the plaintiffs was a limited liability company which owned a small part of the team. If different ownership stakes are held by different investors, that means multiple companies owning each team.

But that’s not the real problem. The benefits of corporate formation, tax advantage and liability shielding, mean that teams are often corporate conglomerates, with different aspects of the team owned by different entities, all under an overarching corporate umbrella. For example, here’s how the Complaint in the Diamondbacks case describes how that team is structured:

In other words, there are three different partnerships here: one owns the team, one owns aspects related to the team, and one owns those two partnerships. That’s a bit of an oversimplification, but it’ll do for our purposes. Add in television network deals, and it becomes even more complex; teams with ownership interests in their local sports networks (for example, the Mid-Atlantic Sports Network) usually do so through a separate corporate entity than the one which owns the team.

Couple these overlapping corporate structures with something called the roster depreciation allowance, and the holding entity for the team itself can take a loss every year.

The RDA permitted a team to deduct a player’s contract not only as a depreciating asset (amortization), but also as a current business expense – a form of double deduction accounting. I.e. – players’ compensation is carried in the expense column and also subtracted from net operating income on an amortized basis. Under the RDA from 1977-2004, owners could allocate up to fifty percent (50%) of the purchase prices to player’s contract as a depreciable asset over a five year period, i.e. – the 50/5 rule. Allocations issues and tax challenges characterized the era of the 50/5 rule, and a new law in 2004 simplified the process and brought the sports industry in line with the rest of the business world.

Under the American Job Creation Act of 2004, sports owners could depreciate all tangible property acquired in connection with the franchise under IRS Section 168 and amortize all intangible assets such as players’ contracts, sponsorship agreements, luxury suite contracts, and various other intangibles – including the franchise itself – over a fifteen year period under IRS Section 197.[1] The deduction may be claimed in whatever amounts and in whatever schedule that is elected by the taxpayer over the 15 year amortization period. For example, the Golden State Warriors were purchased in 2010 for $450 million. That purchase price can be amortized over 15 years and produce at a marginal 35% tax rate, tax savings of approximately $157,500,000 over the 15 year period.[2]

If the sports enterprise was profitable then amortization could be used to offset income. In the alternative, if the sports enterprise wasn’t profitable, the losses could be used by an individual, partnership, or S corporation against the individual’s other 1040 income.

This is really dense stuff, but we can summarize it this way. Many of these corporate subsidiaries will be designed to take an annual loss on purpose for tax reasons; MLB teams make very excellent tax shelters, as Jeffrey Loria has discovered on two different occasions. That’s one reason teams are such an excellent investment.

Paul Beeston, former Vice President of the Toronto Blue Jays, was once quoted saying, “Anyone who quotes baseball profits is missing the point. Under generally accepted accounting principles, I can turn a $4 million profit into a $2 million loss and I could get every national accounting firm to agree with me.”

All of this is to say that Major League Baseball has been deliberately ambiguous about which entities they mean when they say teams are losing money.

Which business entity do they mean when they say that a “team” will lose money? Are they talking about a particular holding company for the entity which is the team itself? Does that include separate related entities which may process parking fees, or ticket revenue, or concessions? Does it include an entity which holds an ownership stake in a local sports network? Does it mean the overarching entity which owns all of these subsidiaries?

Layers of corporate structure are designed to allow the hiding of money. At the same time, we need to know which entities’ books are the ones MLB is cracking open. The smart money says that what we’re seeing is a picture painted for our benefit by some crafty lawyers.