1968 Baseball Tax Ruling Still a Hit

The convergence of tax and accounting treatment is rare, perhaps as rare as a perfect game. But a September tax court ruling was a perfect ending t...
Robert WillensOctober 25, 2002

In 1968, Major League Baseball’s (MLB) Chicago White Sox had the second-worst record in the American League, squeaking out just ahead of the hapless Washington Senators. The ChiSox only won 67 games, the team batting average was .228, and the club’s fearsome slugger, Pete Ward, hit a grand total of eight home runs.

But there was a bright spot — and no, it wasn’t the slick double-play combo of Luis Aparicio and Sandy Alomar, Sr. That year, the White Sox front office won a tax decision over the Internal Revenue Service. The ruling (The Artnell Co. v. Commissioner of Internal Revenue) actually stemmed from the sale of the team seven years earlier, when long-time owner Bill Veeck sold the club to Arthur Allyn Jr. That 1961 transaction made the Sox a subsidiary of the Artnell conglomerate.

Essentially, the court ruled that the Sox did not have to pay taxes on season ticket revenues when they received those revenues (before the beginning of the season). Instead, the court said the club was not required to render unto Caeser until the ballgames were actually played.

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Interestingly, the White Sox win over the IRS set a precedent that ended up helping the hapless Tampa Bay Devil Rays last month.

Pay Now, Play Later

But first, a scouting report as to how the court ruling figures into today’s corporate tax environment.

Many observers contend that conforming financial accounting with tax accounting would restore some faith in corporate reporting. They argue that no responsible management team would artificially inflate earnings if doing so would result in a correspondingly higher tax bill.

Indeed, while many areas of conformity already exist, there are several differences in these accounting systems. This is attributable, in part, to the different objectives ascribed to the tax accounting system as compared to its counterpart.

The tax code is used, to some extent, as an implement of fiscal policy and is frequently employed to either encourage or discourage certain forms of behavior. These latter objectives do not, in every case, produce an outcome under which net income is measured entirely “accurately.” Historically, one glaring area of divergence has been with respect to the deduction of expenses and the timing of inclusion of income.

In financial accounting, for example, deduction is the norm and “conservative” accounting dogma almost always favors treating outlays as “period” costs. In tax accounting, however, deduction of expenses is an exception to the norm, and generally expenses must be capitalized. Conversely, in the case of advance payments, the accounting convention is to achieve “matching” (income and related expenses) through deferral of the advance payment; whereas for tax purposes, advance payments are nearly always included in the year of receipt.

On occasion, however, tax and accounting converge for these items, and the latest occasion brings us back to baseball — and the Devil Rays.

On March 31, 1995, the organization that operates the team (Tampa Bay Devil Rays Ltd.) conditionally acquired an expansion franchise to play in the American League. After taking certain steps required by MLB to demonstrate its good faith, including establishing affiliations with minor league clubs (in this case with the famed Durham Bulls), the partnership and MLB reached a final agreement with respect to the awarding of the franchise. The Devils Rays began competing in the American League during the 1998 season.

The tax dispute focuses on the 1995 and 1996 seasons, when the partnership received funds generated by customers as deposits on season tickets, reservations for personal suites, and sponsor fees. On its tax returns filed for those years, the partnership did not include these deposits in its income. Instead, Devil Rays management deferred the reporting of the deposits as income until 1998, when the games to which the deposits related were played.

The IRS, however, sought to “accelerate” the income to the years in which the deposits were received, so that taxes would be due earlier.

The government’s position seemed to be a strong one. Under the accrual method of accounting, which the Devils Rays employed, the season ticket and luxury suite revenues are received as deposits on services to be rendered in the future. Therefore, the funds are included in income in the year of receipt. Supreme Court cases, such as AAA v. United States, uphold this rule at least in cases where, with respect to the prepaid income, no fixed dates exist for the performance of the accompanying services.

The Tax Sox Scandal

That’s where the White Sox come in. In the 1968 decision by the U.S. Court of Appeals for the Seventh Circuit, Judge Fairchild permitted the White Sox to defer deposits received (income) on season tickets. Why? Because, unlike the AAA case, the White Sox had fixed dates “for the performance of the accompanying services.” Outside of rainouts, the Sox owner’s knew exactly when the team would play each of its 158 or so games.

The 1968 Artnell precedent cropped up last month in the Devil Ray’s case. A tax court judge concluded that the Tampa team’s income deferral, in which related services are rendered according to a fixed schedule, “more clearly matched” the income (from the ticket sales) with expenses incurred in the year in which the games were played. According to the September 2002 tax court memo, Judge Swift saw no distinction between the White Sox’s situation and that of the Devils Rays.

Moreover, the court concluded that the Artnell decision, despite all that has transpired since the case was decided, was still “good law.” As a result, the Devils Rays were able to defer the reporting of the deposits until the year in which they began competing in the American League (1998).

What’s more, because the Devils Rays deferred this income as matching expenses for financial accounting purposes, this case is an example of the rare confluence of tax and financial accounting.

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