Businesses look to use trusts to cut U.S. tax bills

Penn National Gaming Inc., which operates 22 casinos, including Hollywood Casino Toledo, recently won approval to change its tax designation, too

A small but growing number of U.S. corporations, operating in businesses as diverse as private prisons, billboards, and casinos, are making an aggressive move to reduce — or even eliminate — their federal tax bills.

They are declaring that they are not ordinary corporations at all. Instead, they say, they are something else: special trusts that are typically exempt from paying federal taxes.

The trust structure has been around for years but, until recently, it was generally used only by funds holding real estate. Now, the likes of the Corrections Corp. of America, which owns and operates 44 prisons and detention centers across the nation, have quietly gotten permission from the Internal Revenue Service to put on new corporate clothes and, as a result, save many millions on taxes.

The Corrections Corp., which is making the switch now, expects to save $70 million in 2013. Penn National Gaming Inc., which operates 22 casinos, including Hollywood Casino Toledo, recently won approval to change its tax designation, too.

Changing from a standard corporation to a real estate investment trust, or REIT — a designation signed into law by President Dwight Eisenhower in the 1950s — has suddenly become a hot corporate trend. One Wall Street analyst has characterized the label as a “golden ticket” for corporations.

’’I’ve been in this business for 30 years, and I’ve never seen the interest in REIT conversions as high as it is today,” said Robert O’Brien, the head of the real estate practice at Deloitte & Touche, the big accounting firm.

At a time when deficits and taxes loom large in Washington, some question whether the new real estate investment trusts deserve their privileged position.

When they were created in 1960, they were meant to be passive investment vehicles, like mutual funds, that buy up a broad portfolio of real estate — whether shopping malls, warehouses, hospitals, or even timberland — and derive almost all of their income from those holdings.

One of the bedrock principles — and the reason for the tax exemption — was that the trusts do not do any business other than owning real estate.

But bit by bit, especially in recent years, that has changed as the IRS, in a number of low-profile decisions, has broadened the definition of real estate, and allowed companies to split off parts of their business that are unrelated to real estate.

For example, prison companies like the Corrections Corp. and the Geo Group successfully argued that the money they collect from governments for holding prisoners is essentially rent. Companies that operate cellphone towers have said that the towers themselves are real estate.

The benefits of converting are obvious for stockholders and corporate insiders. The switch typically drives up a company’s stock price. Investors are drawn by the prospect of lucrative dividends under the new structure. The mere rumor that a company might convert has been enough to send its stock price soaring.

The trend has been a concern to advocates of the traditional trusts, who fear that the newcomers may eventually jeopardize the tax status of older funds that do not do any business other than owning real estate.

More broadly, Steven Rosenthal, a staff member at the Joint Committee on Taxation during the 1990s, and now a visiting fellow at the nonpartisan Tax Policy Center, said the trend raises questions about the purpose of corporate income taxes at a time when there are so many ways around them. The conversions are one of many strategies that businesses use to avoid paying the corporate tax rate of 35 percent.

’’What is there about a business owning real estate that suggests we should not tax them?” Mr. Rosenthal said.

This is not the first wave of companies seeking out a new type of corporate status to avoid taxes. In the 1980s, dozens of companies, including Sahara Resorts and the Boston Celtics, became master limited partnerships, another corporate form that is tax-exempt. After the practice attracted notice, Congress passed laws that limited the industries that could use the structure.

During the 1990s, hotel companies took advantage of the REIT laws, but that was soon snuffed out by a change to the laws in 1999.

It is too soon to tell how far the current round of conversions will spread. PricewaterhouseCoopers recently counted 20 companies that are at some stage in the process of converting, and there has been a steady stream of suggestions for what industry might next secure approval from the IRS.

Lawyers have also been finding creative ways to follow the letter of the law by splitting off parts of a company into subsidiaries that can be taxed. In the legal world, the most controversial such effort is being undertaken by Penn National, the casino company. It won approval from the IRS late last year to turn itself into a real estate holding company. In the process, it created a tax-paying subsidiary that holds the casino operations and pays rent to the parent company.

Mr. O’Brien, at Deloitte & Touche, said he has been talking with other casino operators that are looking at making similar moves. The ruling could also open the door for restaurant companies like McDonald’s and retailers like J.C. Penney to follow a similar route, though neither company has indicated it is considering such a move.