IRS Targets Billionaire's Lucrative Tax Strategy
The Wall Street Journal
Monday, June 9, 2008
The Internal Revenue Service is fighting with billionaire Philip
Anschutz to force the Denver-based mogul to pay back taxes
totaling $143.6 million. The court battle is part of a broad
attempt by tax authorities to crack down on complex transactions
used to defer paying capital-gains taxes.
The imbroglio stems from transactions that Mr. Anschutz entered
into involving shares he owned in Union Pacific Corp. and
Anadarko Petroleum Corp. in 2000 and 2001. The deals netted him
cash, as well as a share of any future rise in the stock price,
with a total value of roughly $429 million. The arrangement is
also set up to protect him against losses if the stock price
He contends the deals technically weren't completed sales for
tax purposes, and thus didn't trigger tax obligations, according
to filings in U.S. Tax Court in Washington. As a result
he hasn't paid capital-gains taxes on the transactions.
Mr. Anschutz -- an oil, railroad and media investor identified
as the 41st-richest man in the
by Forbes -- isn't the only person to use such an arrangement.
Executives at companies including Starbucks Corp., Costco
Wholesale Corp., Tyson Foods Inc., IAC/InterActive Corp.,
Cablevision Systems Corp. and Apollo Group Inc. have all used
similar "variable prepaid forward contracts" to cash in shares
in these companies and related entities, according to securities
The tax treatment of these executives' arrangements isn't
public, so it isn't clear whether the transactions involved
deferral of taxes of the type the IRS is targeting. Experts say
tax deferral is a typical component of such arrangements.
The companies either didn't respond to requests for comment or
declined to comment.
These types of arrangements are particularly popular among
company founders or high-ranking executives. That's because they
help them limit the investment risk of holding a sizeable chunk
of their personal wealth in their own company's stock.
The IRS is turning up the heat. In February, the agency issued
an advisory to its agents declaring that some versions of these
prepaid forward contracts should trigger immediate taxes. The
IRS invited its agents to examine whether they should seek
substantial penalties against investors who used them. The
companies themselves wouldn't generally be targeted in the
initiative unless the companies did such transactions with
shares they owned.
Cash Up Front
In transactions like the one used by Mr. Anschutz, an executive
agrees to turn over his shares to an investment bank on a
specific date in the future, and meanwhile loans the bank the
same amount of stock. The bank gives the executive cash up
front, generally equal to as much as 80% of the shares' fair
Investors argue they don't owe taxes until they conclude the
transaction fully, by delivering the shares for good. Several
tax experts disagree. "You've got all the elements of a
completed sale: One guy's got the money, and the other guy's got
the stock," said Robert Willens, a former Wall Street tax
analyst who runs his own corporate-tax advisory firm in New York. "What more do you need for a sale?"
An IRS spokesman declined to comment on how many audits it had
undertaken of such deals.
Tax-litigation attorneys say they expect a slew of cases. "The
IRS is definitely focused on these types of transactions and I'd
anticipate seeing more of these types of cases in the future,"
said Bryan Skarlatos, an attorney at Kostelanetz & Fink LLP in New York who specializes in tax disputes. He
said his firm is representing one client whom the IRS has
challenged over such a deal, and is aware of others.
Focus on Tax Breaks
Much attention in the current presidential campaign has focused
on tax breaks for the wealthy, including the cutting of the
capital-gains tax rate to 15% early in the Bush administration.
But less noticed is how some of the wealthiest Americans
sometimes don't even pay that full 15% rate, by deferring their
taxes for many years. In Mr. Anschutz's case, the transaction is
scheduled to defer the taxes for nearly a decade.
Critics say such transactions could undermine the progressive
nature of the income-tax system, because the deferrals
effectively lower the taxes paid by the extremely wealthy.
"There's a clear progressivity issue here," said Joel Slemrod, a
tax economist at the University of Michigan's
business school and former senior tax economist for President
Reagan's Council of Economic Advisers.
Tax authorities and some members of Congress also are taking
note of other tax-deferral transactions aimed at the wealthy. In
December, the IRS began to examine the fast-growing market for
exchange-traded notes, or ETNs, which let investors buy
derivatives that are similar to mutual funds, but which can
defer tax obligations for decades. Late last year, Rep. Richard
Neal of Massachusetts, a Democratic member of the House Ways and Means
Committee, introduced a bill that would overhaul the tax
treatment for a wide array of prepaid contracts. A House
subcommittee chaired by Rep. Neal held a hearing on the issue in
Variable prepaid forward contracts are only one in a series of
arcane structures offered by investment banks to help executives
limit the risk of holding big blocks of their own company's
stock. Older variants go by such names as "costless collars" or
"exchange funds."Most of these arrangements let the investor
defer capital-gains taxes.
Starbucks Chairman and Chief Executive Howard Schultz entered
into a prepaid variable contract in exchange for $55 million
back in 2001, securities filings show. His tax position isn't
disclosed, but under normal circumstances Mr. Schultz would not
have paid taxes until he delivered the shares last year.
A Starbucks spokeswoman declined to comment.
Peter Sperling, vice-chairman of the board and a son of the
company founder at Apollo Group, a higher-education provider,
has received $182 million through similar deals since 2004,
including one entered into 10 months ago, filings show. His
assistant said Mr. Sperling couldn't be reached.
The 68-year-old Mr. Anschutz has made billions of dollars over
the years in industries including oil, telecommunications,
professional sports and newspapers. A movie company he owns
produced the current Hollywood
film "Chronicles of Narnia: Prince Caspian." (Mr. Anschutz has
partnered in ventures with News Corp., the owner of Dow Jones &
Co., the publisher of The Wall Street Journal.)
One of Mr. Anschutz's ventures was in the railroad industry,
owning and chairing Southern Pacific Railroad, which later
became Union Pacific. In May 2000, Mr. Anschutz started to trim
his substantial holdings in Union Pacific, entering into an
arrangement with a Cayman Islands
subsidiary of financial-services company Donaldson, Lufkin &
Jenrette Inc., court papers show. Investment banks benefit by
charging wealthy clients fees for services like these.
DLJ is now part of Credit Suisse Group, which declined to
In the arrangement, over the next 11 months, Mr. Anschutz
received cash and the future stock-appreciation rights in
exchange for agreeing to sell DLJ up to nine million shares of
Union Pacific and Anadarko Petroleum roughly a decade hence. The
number of shares he will ultimately deliver could vary depending
on changes in the companies' stock price.
An important part of the arrangement involved Mr. Anschutz also
loaning nine million shares to DLJ for the length of the
transaction. That would allow the investment bank to engage in a
"short sale" of the shares as a way to hedge its risk against a
loss in the original transaction stemming from a drop in the
stock price. (In a short sale, an investor sells borrowed shares
with the idea that, if the share price falls, it will be
possible to buy back the shares at a lower price and profit from
The short sales help the bank protect itself from the downside
risk created by the initial part of the transaction, in which it
agrees to buy the shares years in the future.
Between 2009 and 2010, according to the agreement, the contracts
are scheduled to end and Mr. Anschutz will have to either hand
over the shares for good or else return some amount of cash. If
he hands over the shares, only then will he will be on the hook
for the capital-gains tax hit, his attorney says in court
A year ago, the IRS sent formal notices to Mr. Anschutz
asserting he owed taxes on the arrangements. Mr. Anschutz
responded by filing a pair of lawsuits to contest the tax bill.
Mr. Anschutz's attorney argues in court filings that the deals
weren't completed sales for tax purposes, because Mr. Anschutz
could terminate the share loans and get the stock back.
The IRS's position on such deals has shifted over the years. In
2003, the agency issued guidance indicating that the
transactions didn't immediately trigger taxes. That opened the
floodgates, prompting investment banks to widely market
strategies like these.
But in 2006, the IRS publicly declared that if the deal also
included a share loan, the transaction was akin to a sale, thus
triggering immediate taxes. Since then, the number of similar
transactions has fallen dramatically, according to people who
work on these deals, and the prepaid forward contracts that also
include a share loan from the investor have ceased.
Write to Jesse Drucker at