Tribune and IRS head to court on Times Mirror bill.

For all the hand wringing over Tribune Co.'s disappointing advertising revenues, cited in the decision by the Los Angeles Times to cut about 190 jobs, a much bigger shoe could drop sometime next year.

A nagging, arcane tax liability issue that dates to the media company's purchase of Times Mirror Co. in 2000 is scheduled for U.S. Tax Court in Los Angeles in December. At stake is a bill that, in the worst-case scenario, could reach $1 billion.

For its part, Chicago-based Tribune has stated repeatedly that it expects to prevail in the dispute with the Internal Revenue Service and has set aside a reserve of $180 million, plus $56 million of interest to cover its exposure.

Still, the impending trial and the potential exposure was cited earlier this month in a research note by Prudential Equity Group LLC, which said the matter could impede Tribune from reaching its $60-a-share price target over the next year.

Tribune expects a ruling to come at the end of 2005, according to filings with the Securities and Exchange Commission.

"It makes investors somewhat nervous, and they'd like it to be cleared up," said Douglas M. Arthur, media analyst with Morgan Stanley.

The fight with the IRS dates to 1998, when Times Mirror Co. disposed of two subsidiaries. Since then it has become a battle over what constitutes a "sale."

Six years ago, Times Mirror gave its Matthew Bender & Co. legal-publishing business to Reed Elsevier PLC, which in turn handed over $1.38 billion in cash.

Reed announced it had purchased Matthew Bender, and Times Mirror told Wall Street that it had gained $1 billion on the deal. But for IRS purposes, Times Mirror claimed it didn't profit on the transaction because it wasn't a sale, but a tax-free, corporate reorganization.

A second transaction involved Times Mirror's disposal of its Mosby Year Book Inc. health sciences publishing business to Harcourt General Inc. in a tax-free reorganization valued at $415 million.

In SEC filings, Times Mirror said it never took ownership of the cash generated by the deals, instead using it immediately to buy back stock.

The IRS claims it never signed off on the special transactions, meaning it could seek the taxes due on the sales. A business, the IRS claims, can't sell assets for cash without paying capital gains taxes.

Because it inherited Times Mirror's tax burden when it bought the company for $8 billion, the IRS is looking to Tribune to pay. In 2001, the IRS adjusted its definition of Times Mirror's 1998 taxable income, raising it by about $1.6 billion.

It's not clear how such a large potential liability slipped by Tribune executives--if it slipped by them--when the acquisition was being negotiated. Calls to the company's spokesman were not returned.

Confident of success

If the IRS prevails, Tribune's federal and state tax bill would total roughly $600 million, plus interest. According to Tribune filings, as of March 28 the interest it would owe in an adverse judgment was about $285 million.

Together with the principal the IRS seeks, the latest bill is about $885 million. Tribune's net income for the year ended Dec. 31 was $891 million.

The IRS gave Tribune a slight break in 2002, when it agreed not to assess penalties associated with the tax bill--just interest. An IRS spokesman declined comment on the case.

In early 2003, Tribune Chief Financial Officer Don Grenesko said on a conference call with analysts that the issue could "take a couple of years to resolve," but held to the company's view that "We still believe that this is a legitimate tax-free organization."

Such pronouncements have been made periodically by Tribune officials.

"It's been mentioned in all of their (SEC) documents and has been repeated for several years. But what is not known is its outcome, or the timing of any resolution," said James C. Goss, media analyst with Barrington Research in Chicago.

If the tax court rules Tribune is liable for the maximum amount sought by the IRS, the bill would be one of the largest ever against a corporation, said Elliot Freier, a tax partner with Irell & Manella LLP.

"Even for Microsoft, it would be painful to pay," he said. "It's not a common event. You don't see these kinds of cases come up often in a public context."

The impact of a negative ruling would certainly be severe, but Tribune has plenty of cash and assets to absorb the impact. "It wouldn't make people happy. The market is somewhat nervous about this, but the Tribune could certainly fund it," said Arthur.

One thing Tribune would likely not do is sell the Times.

"It's not something than could be unwound (from Tribune)," said Goss. "It is the biggest newspaper property in its publishing space."

The Times generated revenues of $1.13 billion in 2003, more than a quarter of the company's publishing revenues, its other major newspapers, the Chicago Tribune and Newsday, generated $798.5 million and $622.1 million, respectively.

Those revenues continue to climb--Tribune reported revenues from its newspapers for May were 3.2 percent higher than the year earlier--but not as fast as projected.

Earlier this month, Tribune said it would cut staff, reduce spending and institute newsprint conservation measures to make up for the shortfall.

Those measures hit the Times last week, when it cut 162 jobs. About 100 cuts came on the business side, while the newsroom lost about 42 employees to voluntary buyouts and 20 to layoffs.

In addition, about 30 jobs were cut at affiliates of the Times, including the Recycler, Times Community News and California Community News. All told, 190 jobs in the L.A. area were eliminated.

"It is crucial that this episode of cost cutting prove to be nothing more than that--a bump in the road, not a change in direction," Times Editor John S. Carroll wrote in a recent memo to staff.