Soon-to-be former owner of the Los Angeles Clippers, Donald Sterling has endured his share of bad press in the past several weeks. And now he’s losing his team. Although he had previously sworn to fight any forced sale of the team in court, he recently dropped his opposition to the NBA-ordered sale.

But Sterling may have the last laugh. The team, which he purchased for a mere $12.5 million in 1981 was recently sold to Microsoft’s Steve Ballmer for $2 billion. Not a bad payday at all.

You’re thinking – surely he will be soaked by Uncle Sam and tax-happy California so that his $2 billion payday will shrink to mere few hundred million. Perhaps. But the odds are that Mr. Sterling’s tax bite will turn out to be more like a scratch. Assuming that Mr. Sterling lawyers up, it is safe to say that he will take advantage of any legitimate tax break he can.

“C” Versus “S” Corporations

corporate-responsibility

Thinking too hard about the concept of one man owning a team made up of other men can make you squeamish. But in reality, what Mr. Sterling owned, and what Mr. Ballmer now owns is a corporation that represents the Los Angeles Clippers. In ordinary speech, that means that the Clippers basketball team exists as an entity separate unto itself.

The legal ownership of the Clippers was listed as the Sterling Family Trust, which has all the earmarks of a size-limited “S” Corporation rather than an unrestricted “C” corporation. “S” corporations trade stringent restrictions on size, ownership and other management features for exemption from the dreaded double taxation imposed on “C” corporations. In Mr. Sterling’s case, the potential savings could be $700,000.

Instead, Mr. Sterling and his estranged wife Rochelle would pay federal long-term capital gains tax on the sale, set at a much lower 20% rate. This would result in a tax obligation of merely $397.5 million. If the Sterlings spent at least 500 hours each year on management activities related to the team, which they have, they would also be exempt from the 3.8% net investment tax imposed by the Affordable Care Act.

Death and Taxes

Military Taxes

The southern region of California draws visitors and residents from far and near with its glitz and agreeable climate. The atmosphere is so desirable for many people that they are willing to tolerate California’s stiff 13.3 percent state income tax. Mr. Sterling’s sale could potentially net California a tax windfall of more than $264 million, because California taxes capital gains at the same rate as ordinary income.

But don’t look for Mr. Sterling to write that check just yet. Because of the circumstances of the sale, he could make a credible case that the transaction was involuntary. This is important, because an involuntary sale qualifies for special treatment as a Section 1033 conversion that would allow him to defer payment on proceeds from the sale.

Section 1033 and Eminent Domain

Eminent Domain

Section 1033 is often applied to situations such as eminent domain, not forced sales of professional basketball teams, but the involuntary nature of Mr. Sterling’s sale of the Clippers is clear. Section 1033 requires a reinvestment of the funds from an involuntary sale into similar ventures within 2 years, but the guidelines for what constitutes “similar” are relaxed. Mr. Sterling would also only be required to make an investment of $12.5 million, his purchase price, not the entire price paid by Mr. Ballmer.

If Mr. Sterling opts to pursue the Section 1033 option, his advanced age could result in a bonanza – at least as far a paying taxes on the sale of the Clippers is concerned. That’s because upon death, a step up in basis to market value occurs. And while his estate would be subject to taxation over and above the $5.34 million to which Mr. Sterling and his wife are each entitled to exclude from estate taxation, the step up would prevent his estate from being subjected to income taxation at the same time. And because the Golden State replicates the provisions of Section 1033, those punishing California state taxes could go away as well.

Crime and Punishment?

donald-sterling-social-media

The forced sale of the Clippers was intended to serve as punishment for Donald Sterling. But he stands to gain millions, the majority of which will likely escape taxation. Many individuals would welcome that type of punishment.

 

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Last week, NBA commissioner Adam Silver handed Los Angeles Clippers owner Donald Sterling a lifetime ban from the NBA and a $2.5 million fine to boot.

Winners and Losers in the Donald Sterling Scandal

Sterling Fouled OUt
Source: Click2Houston

A lifetime suspension is the harshest possible punishment a commissioner can give a team owner, and $2.5 million is the largest fine permitted by NBA laws. To boot, Silver also requested team owners to force Sterling to sell the Clippers. A step only team owners can take and that requires the votes of three fourths of the owners.

These sanctions come in the wake of a string of racist remarks by Donald Sterling, which were taped by his ex-girlfriend V. Stiviano and published by TMZ. According to reports by the gossip e-rag, Ms. Stiviano, who is being sued by Sterling’s wife for stealing $1.8 million, taped over 100 hours of conversations as leverage to “encourage” the Sterling’s to accept a settlement.

Fans, the media, and franchise owners applauded the decisive measures taken by the rookie commissioner. However, how much of a choice did Silver have? Did he make a hard call, or was he simply riding the wave of public opinion and making the only decision he wouldn’t get flak for?

Of course, the motivations behind Silver’s decision don’t determine whether it was a good or bad call. Even if Silver only suspended Sterling because he thought it was the popular choice, it wouldn’t make his sanctions any less or more appropriate. They stand on their own. Yet, you don’t have to be a complete cynic to wonder about the financial consequences the NBA, the Clippers, and the other NBA teams would have had to face had Silver taken a more lenient approach to Sterling’s outrageous comments.

What Would It Have Cost to Not Suspend Sterling?

Pile of Money
Source: BET

According the NBA Players Association vice president Roger Mason JR., players throughout the NBA were ready to boycott the playoff games, if Sterling hadn’t punished Sterling adequately. Even if the boycott had only lasted for one day, which is unlikely, it would have canceled three games: Wizards vs Bulls, and of course, Grizzlies vs Thunder and Warriors vs Clippers.

So what are three NBA games worth? Ticket revenue varies widely depending on the teams playing, venue and ticket price. In the 2012-2013 season, the New York Nicks averaged $2.3 million a game in ticket revenue, while the Oklahoma City Tunder averaged $860,000. A representative figure of the entire league is $1.4 million a game. That doesn’t include concessions, add a couple hundred thousand dollars each game for that. Of course the main source of income is not tickets and concessions but TV rights, which average $5 million a game.

Another big incentive to put a lid on the scandal was its effect on LA Clippers’ sponsors: Mercedes-Benz, CarMax, and Virgin America who terminated their sponsorships, and State Farm, Kia Motors, and Sprint, who suspended advertising. This would have hurt all NBA teams. Each of the NBA’s 30 teams contribute an equal percentage of its franchise sponsorship revenue, which is then evenly distributed back to the franchises. This flood of sponsorship cancellation more than likely scared the living daylights out of NBA team owners concerned that other sponsors would also get on the sponsorship-cancellation bandwagon.

The Clippers also happen to be in one of the largest media markets in the country, and sponsors are willing to pay a premium to get into that market. What hurts one NBA team hurts them all. Now that Silver laid down the law on Sterling those sponsors have come running back to the fold.

What Took So Long?

Donald Sterling

They say hindsight is always 20/20, but the most surprising thing about all this mess is what took the league so long? Many of the big players in the NBA business made a big deal of how shocked they were by Sterling’s comments. Really? Sterling’s racist opinions and actions have been a matter of public record for years.

Sterling paid huge settlements in 2005 and 2009 for housing discrimination lawsuits, which in both occasions were described as “one of the largest ever obtained in this type of case” and, at the time, “the largest payment ever” to the Justice Department, for a housing discrimination lawsuit. Witnesses at those cases claimed Sterling had made comments like “”I don’t like Mexican men because they smoke, drink and just hang around the house,” and “that’s because of all the blacks in this building, they smell, they’re not clean.” You can argue those statements were based on the recollection of hostile witnesses, but in both cases it was proven that Sterling harassed minorities with abusive tactics, such as not making repairs and refusing rent checks and then suing for failure to pay.

In 2011, he was again sued for employment discrimination. This time by Elgin Baylor, a Clippers executive for 22 years, who claimed Sterling wanted a white coach for the Clippers and that he regularly said he was “giving these poor black kids an opportunity to make a lot of money.” That suit was rejected by a jury – probably because Elgin Baylor had seemed happy enough to take Sterling’s money for over 20 years before suing him. Nevertheless, it’s hard to see Sterling as a credible witness. Sterling testified he hadn’t even known Baylor, an All-Star player on 11 occasions, had been invited to the Hall of Fame. Hard to believe that tidbit didn’t come up in his interview or that an NBA team owner wouldn’t know that.

How did the NBA and the NAACP react to Sterling’s treatment of one of basketball’s most distinguished players? The NBA had no comment and the NAACP gave Sterling a lifetime achievement. Sterling was about to receive another NAACP lifetime achievement award this year — yep, you guessed. He’s a big-time donor — until the tapes hit the media and it was revoked.

Ironically, The Suspension and Fines May Actually Benefit Sterling Financially

Source: LA Times
Source: LA Times

There’s no doubt Sterling’s public life and reputation are dead. He is toxic, an absolute social pariah. Public personalities and celebrities won’t touch him with a bargepole. And I can’t see many of his friends going out of their way to be seen with him in public either. His bank account, however, has never looked better. He may have been hit with a $2.5 million fine, but the NBA may have saved him hundreds of millions of dollars in taxes. How come?

As of today, Sterling is adamant The LA Clippers are not for sale, but if he were forced to sell the franchise, he could potentially claim special tax treatment because his property was “involuntarily converted.” This loophole is designed to compensate taxpayers who are forced into selling property against their will.

Forbes valued the LA Clippers at $575 million in January 2014, but most experts claim this is not an up-to-date valuation. If the sale of the Sacramento Kings ($534 million) and the Milwaukee Bucks ($550 million) – both are teams in much smaller markets than LA – is anything to go by, The Clippers could sell for much more. A price tag many pundits are throwing around is $1 billion. Not bad for a team Sterling bought for $12.5 million.

Assuming a $1 billion sale price, Sterling would save $200 million in federal income tax and $123 million in California state tax. The only catch is he would have to convert the money from the sale into what the IRS so artfully describes as “property similar or related in service or use to the property so converted” to benefit from the special tax treatment. The LA Clippers is a sports team, so the most obvious way to meet the IRS special tax treatment requirement is to buy another sports team.

Good luck, Mr Sterling, finding a sports team that wants you as its owner.