In previous blog posts, we have written about federal and state tax incentives for the entertainment industry, including the Section 199 domestic production activities deduction (DPAD) and state film tax credits. Another significant federal tax incentive is the Section 181 treatment of certain qualified film, television and live theatrical productions, which will be discussed in this blog article.
Since the mid-to-late 1990s, various participants in the U.S. film industry have become increasingly concerned about the loss of film and television production to foreign countries. The total number of U.S.-developed films and television shows that were produced abroad almost doubled, jumping from 14 to 27 percent between 1990 and 1998, and the economic losses from these runaway productions increased from $2 billion to $10 billion during the same time period. In response, Congress passed legislation that resulted in Section 181 of the Internal Revenue Code to attempt to incentivize qualified film and television production within the United States.
Section 181 has been amended and extended numerous times. It was set to expire on Dec. 31, 2014 and was once again extended retroactively from Jan. 1, 2015 to Dec. 31, 2016 by the Protecting Americans from Tax Hikes ("PATH") Act of 2015. The 2015 PATH Act also expanded Section 181 to include any qualified live theatrical production commencing after Dec. 31, 2015.
Section 181 allows producers and production companies elect to expense up to $15 million of production costs ($20 million in the case of production in certain low-income communities or distressed areas) in the year the costs are incurred rather than having to capitalize such costs and amortize them over time using one of the depreciation methods applicable to films and television productions. Here are some broad strokes of the Section 181 tax deduction:
- Seventy-five percent of the production’s compensation expense must be for services performed in the United States by actors, production personnel, directors and producers to qualify for Section 181 deduction
- Only the owner of a film, television production or a live theatrical production can make a Section 181 election
- There is a maximum of $15 million ($20 million) production cost deduction limit
- TV pilots, TV episodes (up to 44), short films, music videos and feature films all qualify for Section 181
- Principal photography must start prior to Dec. 31, 2016
To better understand the mechanics of the deduction, here is an example:
Total film production costs are $30 million. The film's principal photography started on Feb. 1, 2015 and completed on July 31, 2016. $25 million of the costs were incurred in 2015, and $5 million of the costs were incurred in 2016. The film was primarily shot in the United States (not in low-income communities or distressed areas), and the production costs include $20 million of compensation expenses, of which $17 million (85 percent) was paid to actors, production personnel, directors and producers for services performed in the United States. The film won't be released until June 2017.
Based on the facts, this film production is qualified for the Section 181 deduction.
- If the Section 181 election is made, $15 million of production costs will be deducted in 2015. The remaining $10 million of costs incurred in 2015 and $5 million of costs incurred in 2016 will be capitalized and amortized under the income forecast method once the film is released in 2017.
- If the Section 181 election is not made, all $25 million of film production costs in 2015 and $5 million of costs in 2016 will be capitalized. The total $30 million of production costs can be amortized under the income forecast method once the film is released in 2017. There will be no deductions or amortization of production costs in 2015 or 2016.
This tax provision looks simple, but there are complexities in determining qualified production costs, qualified compensation and the applicability of Section 181. The following are specific aspects to be aware of:
- Treatment of Participations and Residuals
Participations, as used in the film and television industry, are “payments made to actors, directors and other talent based on a contractually defined measure of future income for the production.” Residuals, though similar in nature, are “payments made pursuant to collective-bargaining agreements, such as those of the directors' and actors' guilds, based upon non-theatrical sales, under terms that differ between video, free television and pay television sales.” Solely for purposes of satisfying the 75 percent compensation test, the term “compensation” does not include participations or residuals. If the opposite were the case, one might more easily satisfy the 75 percent compensation test via a few days of principal photography in the United States using high-priced talent and then shooting the supporting character scenes and performing post-production and other activities outside of the United States.
- Tax Ownership Rule
Only the owner of a film or television production may make a Section 181 election to obtain the immediate tax deduction of production expenses. However, there are situations in which a film or television production may have multiple owners (in the case of co-productions). In such situations, the aggregate Section 181 deduction claimed by all of the owners combined may not exceed $15 million; hence, the owners must allocate the Section 181 deduction among themselves. In contrast, a taxpayer who only obtains a limited license or right to exploit the production or receives a profit participation interest in such production as compensation for services, usually does not qualify as an owner of the production for purposes of making a Section 181 election.
- State Non-Conformity to Section 181
Many states, such as California, do not conform to Section 181. Despite the general lack of conformity among the states, many states offer their own tax incentives designed to encourage film or television production in their states to benefit their local economies.
A producer who started principal photography of a television production or feature film at any time in 2015 or prior to Dec. 31, 2016, is now be in a position to take advantage of the benefits of Section 181. If a production is not set to start until 2017, a producer may want to consider accelerating principal photography so that it starts by Dec. 31, 2016 to take advantage of the deductions.
If you have any questions about the Section 181 provisions and how they relate to your project, or about other film and television tax issues, please contact either of us or Tax Partner Polina Chapiro at 310-873-1600.
About Dan Li (Senior Manager, GHJ)
Dan Li has over eight years of public tax and accounting experience providing tax compliance and consulting services to a wide range of clients. The industries she services includes real estate, manufacturing, wholesale trade and distribution. Her experience includes corporate taxation, Limited Liability Companies, partnership taxation, family-owned and closely held businesses, high-net-worth individuals, and state and local taxation. She also represents clients before the Internal Revenue Service, the Franchise Tax Board and other state tax authorities.
About Daniel Rowe (Principal, GHJ)
Daniel Rowe specializes in partnership and S-Corporation taxation and real estate development and investment. Prior to joining GHJ, Daniel served as tax partner at a local firm in Georgia and as tax manager at JH Cohn, LLP in New York, where he provided year-round tax planning and guidance for high net worth individuals, advised on trust and estate matters, and represented clients in federal, state and local audits. He began his career with Deloitte as an assurance and advisory services senior in Baltimore.