Section 181 replaced with the new Tax Cuts and Jobs Act (2018)
We as film producers, not CPAs nor Attorneys, have posted information freely since 2010 regardging Section 181 and IRS film production tax breaks. During this time our intent has been to educate professionals and filmmakers to the film production tax break available to Investors due to the lack of professional publications from tax professionals. Now, since CPAs have (finally) risen to publish thoughts on the new Tax Cuts and Jobs Act with regards to film production, we thought it better to convey their courtesy as published (below) and reserve comment until the new tax code documentation is thoroughly researched.
January 31, 2018
"The Film Industry and the Tax Cuts and Jobs Act".
By Chad Robinson, CPA, Partner and Jennifer M. Wescott, CPA, MBA, Senior Tax Associate,
KPM -Kevin P. Martin & Associates.
Those involved in film, television, and live theatrical productions have been mourning the loss of two key Internal Revenue Code Sections with the passage of the Tax Cuts and Jobs Act (the” Act”). However, there are several new federal provisions embedded in the over 1,000-page document that are beneficial to these industries and deserve more attention.
There are two features of the Tax Cuts and Jobs Act that have drawn all of the media attention: the new flat 21% corporate tax rate and the new 20% deduction for qualified business income of pass-thru entities. These reductions in business taxes are cornerstones of Congress’ tax reform goals. Film, television, and live theatrical productions will certainly benefit from these along with other U.S. industries.
Under the Act, a deduction is allowed for 20% of the taxpayer’s qualified business income from a partnership, S corporation, or sole proprietorship. However, the deduction generally would be limited to (i) 50% wages paid or (ii) the sum of 25% of the W-2 wages plus 2.5% of the unadjusted basis of all qualified property. The 20% deduction is claimed on the individual returns of each taxpayer and is also subject to a phase out starting at $315,000 for joint filers.
The KPM CPA's Take
Pass-thru companies like loan-outs, production companies and other entertainment companies may be eligible for the benefit of this deduction, but might phase out based on a specified individual income threshold. Additionally, consideration will need to be given to choice of entity, and companies might be motivated to change their business to generate wages for owners (S corporations) vs. other structures that don’t generate wages (partnerships).
Despite hopes to the contrary, the federal tax incentive for qualified film, television, or live theatrical productions, commonly known as Section 181, was not renewed with the passage of the Tax Cuts and Jobs Act. This federal production incentive had been available through December 31, 2016 and was not extended to calendar year 2017 or later. The popular election allowed eligible taxpayers to deduct costs of qualified productions as an expense that was not chargeable to the capital account. This deduction had been capped for any production with costs exceeding $15 million and qualification depended on the percentage of services performed in the United States by actors, directors, producers, and production personnel.
Also under the Act, unreimbursed employee expenses can no longer be claimed as a tax deduction on personal tax returns. While not specifically effecting a production company per se, this will have effects on structuring how individuals will provide services in the future. Continuing with the bad (or maybe not so bad), for taxable years starting in 2018, any disallowed loss is treated as a net operating loss. This net operating loss can no longer be carried back and the loss is limited to 80% of the annual income.
The KPM Take
The loss of Section 181 will largely be offset by bonus depreciation…more to come on that below. For the unincorporated entertainer the loss of the deductibility of unreimbursed business expenses will be a significant blow. KPM expects that more cast and crew will focus their efforts on the possible use of loan-out corporations to bring these expenses off the top at the loan-out level.
The Act also delivered another devastating blow to film, television, and live theatrical productions in addition to many other businesses. IRC Section 199: income attributable to Domestic Production Activities Deduction, known as the “DPAD” will sunset over the next two years. This provision allows for a 9 percent deduction of qualified production activities income which was calculated using domestic (U.S.) gross receipts minus allocable expenses. However, this deduction is limited to 50% of W-2 wages paid by the taxpayer during that calendar year. Although still available for 2017 calendar year taxpayers, the DPAD is repealed for taxable years beginning in 2018.
The KPM Take
No other way to put this. This is a loss to entertainment companies.
Qualified film, television and live theatrical productions have become eligible for the new 100% Bonus Depreciation treatment. Bonus depreciation now allows a 100% first-year deduction of the cost of new and used qualified property placed in service after September 27, 2017. Why is this exciting when the Section 179 deduction has been increased to $1 million with a phase-out threshold of $2.5 million- and this is indexed for inflation? Here are some reasons:
- Bonus depreciation applies to assets with up to a 20-year life.
- Bonus depreciation is not recapturable like Section 179 depreciation.
- Bonus depreciation is not limited.
- Bonus depreciation can create a loss.
Therefore, when productions have high capital expenditures and may have net operating losses, bonus depreciation will yield a more favorable federal tax result than Section 179. However, bonus depreciation is set to sunset between 2023 and the end of 2026.
The KPM Take
Bonus depreciation is not accepted by some states, so consult your tax adviser when weighing the benefits of which depreciation method to use. Know the rules for bonus deprecation. The benefits are fairly sizable!
The Act represents one of the largest changes to the tax code since 1986. Not everything is set in stone. There’s a lot going on under the new law, particularly as it relates to the entertainment industry. Honestly, the accounting industry is still working through some of the provisions and is still awaiting the IRS regulation interpreting the Act. At KPM, we have been working with companies like yours for over 50 years and we would be happy to guide you through the new law and your options.
"Tax Cuts & Jobs Act 2017 - Law, Explanation & Analysis, Detailed"
Cordasco & company P.C. CPAs. December, 2017 pgs 78-79
Bonus allowed for film and television productions and live theatrical productions. Bonus depreciation is allowed for a qualified film, television show, or theatrical production placed in service after September 27, 2017 if it would have qualified for the Code Sec. 181 expense election without regard to the $15 million expensing limit or the December 31, 2016 expiration date (Code Sec. 168(k)(2)(A)(i), as amended by the 2017 Tax Cuts Act). A qualified film or television production is placed in service at the time of its initial release or broadcast. A qualified live theatrical production is placed in service at the time of its initial live-staged performance (Code Sec. 168(k)(2)(H), as added by the 2017 Tax Cuts Act).
Property acquired before September 28, 2017 does not qualify for bonus depreciation at the 100 percent rate (Act Sec. 13201(h)(1) of the 2017 Tax Cuts Act). If a film, television show, or theatrical production is deemed acquired before that date, bonus depreciation may not be claimed since it would not be qualified property. A 50 percent rate, however, would apply to other types of qualified property acquired before September 28, 2017. The IRS may need to provide guidance on how the acquisition requirement applies to films, television shows, and theatrical productions. One possibility is that the acquisition date for this purpose may be deemed to occur, at least in the case of a film or television show, when the production “commences,” as defined below. Another possibility is to adapt the generally applicable rule for tangible property produced by or for a taxpayer that treats acquisition as occurring when physical work of a significant nature begins (Reg. §1.168(k)-1(b)(4)(iii)(B)).
The Code Sec. 181 deduction expired effective for productions commencing after December 31, 2016 (Code Sec. 181(g)) and was not extended by the new law. In the case of a film or television show a production commences on the date of first principal photography. A theatrical production commences on the date of the first public performance before a paying audience. If a section 181 election is made production costs are expensed in the tax year paid or incurred. If the production does not commence until after the December 31, 2016 expiration date, costs expensed under section 181 are subject to recapture. Under the bonus depreciation rule, production costs will now be expensed in the tax year the production is placed in service and without regard to the $15 million limit.
A taxpayer generally makes an election under Code Sec. 181 on the income tax return for the tax year in which production costs are first paid or incurred (Reg. §1.181-2(b)) and not at the later time when the production is placed in service, as defined above for bonus depreciation purposes. A taxpayer that made a Code Sec. 181 election at the time a production commenced is prohibited from claiming bonus depreciation on the same production if it is placed in service after September 27, 2017 unless the IRS grants permission to revoke the section 181 election (Code Sec. 181(b) and (c)). Automatic consent, however, will be granted without filing a letter ruling request if the taxpayer recaptures previously claimed deductions under section 181 (Reg. §181-2(d)(2)).
"How the New Tax Law Impacts the Entertainment Industry", Venable LLP
On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act (the "Act"), which is the most significant revision to our nation's tax laws since 1986. Although the legislation is intended to simplify the tax laws, some of its provisions may leave clients with more questions than answers. Set forth below is a brief summary of some of the relevant provisions for entertainment companies and talent.
Production Cost Recovery.
The following provisions will impact how production companies recover their production costs:
- Capitalization of Production Costs. Prior to the Act, a production company (or other taxpayer that creates a copyright) that was not eligible or able to deduct production costs immediately (i.e., by making a Code Section 181 election) was required to add its production costs to the tax basis of the resulting property (e.g., a copyright) and recover the cost over time using the income forecast method. Under the Act, if a taxpayer satisfies a $25 million gross receipts test, the taxpayer is not required to capitalize its production costs.
- Immediate Deduction of Production Costs. Prior to 2017, production companies generally were eligible to deduct, when incurred, qualified production costs for film, television, and live theatrical productions by making a Code Section 181 election, which limited the deduction to the first $15 million of certain U.S.-based qualified production costs ($20 million in certain circumstances). Although the Act did not renew Code Section 181, the Act added a bonus depreciation provision that generally allows taxpayers to deduct 100% of qualified production costs for film, television, and live theatrical performances in the tax year in which the production is placed in service. The key distinctions between Code Section 181 and bonus depreciation are (i) the timing of the deduction (bonus depreciation may not be claimed until the asset is "placed in service") and (ii) the removal of the deduction limit.
Deduction for Qualified Business Income.
Under the Act, sole proprietors, partners in a partnership, and shareholders of an S-corporation (but not C-corporations) may be eligible to deduct up to 20% of such taxpayer's qualified business income with respect to a qualified trade or business. In other words, an owner of a qualified business may be eligible to pay taxes on only 80% of such pass-through business income. This benefit, however, may be reduced if the company does not pay sufficient W-2 wages (under the Act, the deduction is the lesser of 20% of the taxpayer's qualified business income or a W-2 wage limit that is calculated based on the amount of W-2 wages with respect to the qualified business).
Can a business using pass-through structures, such as loanouts, production companies, agencies, or other entertainment business, qualify for this deduction? Based on the statutory language of the Act, pure loanout companies, whether for "in-front-of-camera" or "behind-the-camera" talent, may not be eligible for the tax benefit unless the total taxable income of the entertainer is below a specified threshold amount.
Other types of entertainment businesses, however, may be eligible for the deduction if the principal asset of the business is not the reputation or skill of its employees or owners. This "principal asset" determination will be the subject of much analysis, especially for such clients as production companies, management companies, talent agencies, licensing companies, etc., which have substantial outside activities and assets (such as goodwill) other than the reputation or skill of their employee/owners. In order to be eligible for the qualified business income deduction, clients may need to restructure their existing companies to increase their chances of success (e.g., loanout companies may need to be rolled into the master production company). In addition, because of the W-2 wage limitation noted above, clients that are tax partnerships may be motivated to restructure their business to generate more or additional W-2 wage income. Consideration will need to be given to maximizing the deduction in the event that clients have multiple pass-through businesses with significant payrolls.
Limitation on Active Pass-Through Losses and Net Operating Losses.
For taxable years beginning after December 31, 2017 and before January 1, 2026, use of active pass-through losses by a sole proprietor, partner, or S-corporation shareholder generally is limited to $250,000 (or $500,000 if married and filing jointly). Any disallowed loss is treated as a net operating loss, which, under the Act, may be carried forward indefinitely, but may no longer be carried back. The carryforward, however, generally may only offset up to 80% of taxable income in any given tax year. This new legislation generally will impact any entertainment business that generates losses in excess of the threshold. There are also questions regarding the full carryforward of NOLs from 2017 or earlier.
Increase in Gross Receipts Threshold for C-Corporations Required to Be on the Accrual Method.
Prior to the Act, a C-corporation loanout (not generally applicable to loanouts for actors, athletes, or performing artists) was forced to convert from the cash method to the accrual method of accounting if the C-corporation's average annual gross receipts over the immediately preceding three years exceeded $5 million. Under the Act, this $5 million average gross receipts threshold has been increased to $25 million for tax years beginning after December 31, 2017, subject to adjustments for inflation over time. This is good news, as the $5 million threshold was often inadvertently crossed and loanouts did not know that they had been forced to the accrual method of accounting. If a C-corporation loanout or other entertainment company was previously forced to convert to the accrual method of accounting under the $5 million gross receipts test, but has not exceeded the $25 million gross receipts test, the loanout may want to consider converting back to the cash method of accounting.
Choice of Entity Considerations.
Does the reduction of the corporate tax rate from a 35% maximum rate to a 21% flat rate justify converting an S-corporation loanout company to a C-corporation, after taking into account the entity-level federal deduction for state income taxes paid and assuming that a preferential qualified dividend rate applies? Although there may be other reasons for using a C-corporation, based on the new rates, it appears that individual taxpayers in the highest tax brackets who are residents of California for income tax purposes should still have a better overall effective tax rate when using a structure other than a C-corporation. Should the talent use an LLC or S-corporation separate from his/her loanout company for endorsement deals? This will depend on whether the talent can avail him/herself of the deduction for qualified business income described above.
Meals and Entertainment Expenses.
For tax years beginning prior to December 31, 2017, taxpayers generally were able to deduct 50% of the cost of meals and entertainment directly related to the active conduct of such taxpayer's business. Under the Act, for tax years beginning after December 31, 2017, taxpayers may continue to deduct 50% of meal business expenses through 2025, but may no longer deduct entertainment expenses (such as sports season tickets or premier parties) related to the active conduct of the taxpayer's business.
Limit on State and Local Income Taxes.
Under the Act, individuals generally are limited to a $10,000 deduction for state and local taxes. This change makes state income taxes much more expensive (because of the lack of a meaningful federal tax subsidy) and may motivate certain entertainers/talent to migrate to lower state-tax jurisdictions.
Disallowance of Employee Business Expenses.
Under the Act, employee business expenses can no longer be claimed as a tax deduction. For the unincorporated entertainer/talent, this can be a huge loss, because of the very substantial level of professional fees (e.g., agents, personal manager, business manager, entertainment attorney, etc.) that are typically incurred. Loanout companies generally are permitted to deduct these costs "off the top," and, for that reason, we expect that more entertainers/talent will form loanout companies, even at lower income levels. We also expect that there will be a renewed emphasis on the possible use of "executive loanouts" for executives who are also producers.
Prior to the Act, accrual method taxpayers generally could defer advance payments for entertainment services until the next taxable year pursuant to IRS Revenue Procedure 2004-34. This technique is particularly beneficial for production companies that receive up-front overhead payments or distribution advances from an unrelated party, allowing the production company to defer the recognition of such payments to the next tax year to line up with the production expense. Prior to the Act, it was clear how to change to this accounting method for advance payments, but it was not entirely clear how a taxpayer would adopt this method. The Act generally codifies IRS Revenue Procedure 2004-34 and tasks Treasury with the authority to issue guidance on how to make the election to defer advance payments, which we expect will clarify how a taxpayer should go about adopting the deferral method election.
International Tax Implications.
There are a number of international tax provisions included in the Act that may change how talent should engage in outbound international tax planning through their loanout companies (e.g., determination of foreign tax credits under the new tax regime). There are several international tax provisions affecting non-loanout U.S. entertainment companies that operate as C-corporations. These include an exemption for non-subpart F dividends paid by certain foreign corporations to U.S. C-corporations, which is coupled with a one-time deemed repatriation of earnings of certain foreign corporations. Also of note is a deduction available to U.S. C-corporations for certain intangible income derived from foreign markets. This provision provides an incentive for U.S. entertainment companies to maintain IP ownership in the United States and conduct foreign operations through corporate subsidiaries rather than pass-through entities. For more details on these and other relevant provisions, read Venable's Tax Reform Update.
Changes Considered, but Not Passed.
During the legislative process, various proposals were made that ultimately were not included in the Act—for better or worse. For example, Code Section 409A, the alternative minimum tax (AMT), and the election to achieve capital gain from the sale of self-created music copyrights were each proposed to be repealed under prior versions of the bill, but were both retained in the Act.
"Section 181 Revived"
Frankfurt, Kurnit, Klein, Selz, PC.
January 11, 2018
The new tax law, commonly referred to as the Tax Cuts and Jobs Act (the "Act"), contains some good news for producers of motion pictures, television programs and live theatrical shows and their Investors. Section 181 of the Internal Revenue Code, which expired on December 31, 2016, permitted the immediate deduction of Production costs (instead of recovering those costs under the income forecast method of depreciation). The Act revives the immediate deduction available under Section 181, but with some significant differences mostly beneficial to producers and their Investors.
Pending further updates on the Tax Cuts and Jobs Act with relation to film production, here are three significant changes to be aware of:
#1: The 100% deduction of Production costs no longer requires an election which, when made, determined the year in which the costs were deductible. Now, the year in which the 100% deduction is to be taken is the year in which the Production is "placed in service", as defined in the Act. Costs incurred after September 27, 2017 may now be deducted in full immediately if the Production is placed in service after September 27, 2017. "Placed in Service" is presumed to mean placed into distribution.
#2: Previously, Section 181 allowed a deduction of no more than $15 million of Production costs ($20 million if costs were incurred in certain locations); under the Act, the $15 million (or $20 million) limit no longer applies. There is no cap.
#3: This tax deduction treatment is now available for 5 years, instead of the shorter periods available under pre-Act Section 181. This means that when raising capital, there is now greater predictability about this tax treatment.
This site will continue to update you on Film & TV production incentives. While Setion 181 is not the same as it was, there are many items at this point we will for the time being presume are still active, until research on the new tax code suggests otherwise.
For questions related to equity investment for film and television production please contact:
Joseph Barmettler firstname.lastname@example.org , or link from our contact page.
ARCHIVAL LINKS - SECTION 181
Section 181 published IRS tax code regulation (initial pub.)(.pdf): (2007)
IRS Tax Code Link for Section 181 (3/19/2007)