Sam Zell's plan to spare members of Tribune Co.'s employee stock ownership plan from taxes is now as bankrupt as, well, the company itself.

That's because Zell established Tribune as an S corporation -- whose sole shareholder is the Esop -- after an $8.2 billion take-private transaction paid $34 for each outstanding Tribune share in December 2007. And S corporations, named for the tax code's subchapter S provision, are exempt from taxes on income passed through to shareholders.

Under normal circumstances, these shareholders are liable for taxes on the passed-through amounts. Certain Esops, however, are exempt from such liabilities even on income passed to them by S corporations.

Such was the case with both the S corporation and the Esop set up by Zell. "They were positioned as totally exempt entities," says Robert Willens, who after 20 years at Lehman Brothers Inc., set up the New York tax advisory Robert Willens LLC. "Neither the corporation nor Esop shareholders would have been taxed."

But that changed, or will change, in response to Tribune's recent bankruptcy filing. Certain to undermine Tribune's S corporation status is the designation's small-business requirement. To the Internal Revenue Service, small business means fewer than 100 shareholders. And while Tribune now has just one -- the Esop -- bankruptcy court has a way of turning creditors into owners. For Tribune, with only $7.6 billion in listed assets to accommodate $12.9 billion in listed liabilities, the addition of more than 100 shareholders is a fait accompli.

In its Dec. 8 filing in the U.S. Bankruptcy Court for the District of Delaware, Tribune listed J.P. Morgan Chase Bank NA as its top creditor for having served as agent on an $8.5 billion senior facility. The list continues to creditor No. 30, Paramount Pictures Corp., which is owed $1.7 million in trade debt. But there's no doubt that a complete list detailing the indebtedness of all Tribune's eight metropolitan newspapers and 23 television stations would be many times larger.

S corporation status can also be revoked for having the wrong kinds of shareholders. So-called impermissible types, as defined in "Federal Income Taxation of Corporations and Shareholders," range from "nonresident aliens" to "a person (other than an estate, certain trusts, or certain qualified retirement plans) who is not an individual."

Willens understands this legalese to mean only U.S. individuals, rather than foreigners, partnerships or any other type of corporation, can sustain S corporations. Hence his assertion that Tribune will soon lose its "S election" and revert to being a taxpaying C corporation.

Don't expect the change to please many of Zell's 18,000 ownership partners. The company their Esop owns may have stopped making money, but losses are only temporary. On emerging from bankruptcy with a capital structure more manageable than Zell's improbably debt-heavy one, Tribune will revert to profitability. Yet rather than receive 100% of those profits, Esop ownership will have to start allocating 35% of them to the U.S. government.

The year brought dealmakers and fishermen into alignment: The best stories were about ones that got away. As DeSilva + Phillips LLC acknowledges in its recent review of media M&A in 2008: "The dollar volume of deals that failed, including Informa ($6.7 billion), Reed Business Information ($1 billion), and Cygnus Business Media ($200 million), among others, dwarfed the $2 billion dollar volume of the deals that went through."

That said, it could have been worse. In the universe tracked by DeSilva + Phillips (consumer and business magazines, medical media, trade shows and conferences, Internet, database and marketing service companies), annual deal volume of less than $3 billion has been recorded thrice since 2000: $2.7 billion in 2003; $2.9 billion in 2004; $2 billion in 2008.

And in deal count, the 108 tallied for 2008 actually topped 2000, 2002 and 2003. Though the number was down only 20% from 2007, the bank recognizes the comparison may be "misleadingly rosy." More than 25% of annual media deals historically occur in the fourth quarter, it says, whereas only 16.7% did so in that quarter last year. Moreover, managing partner Reed Phillips adds that cash flow multiples fell 25%, to 35%, as lending ratios dropped from 5.5 times Ebitda to 3.5 times.

This tighter credit helped return strategic buyers to the fore, leaving them with 53% of annual deal count and ahead of financial buyers for the first time since 2001.

Richard Morgan covers media for The Deal.