Shelters in the United States

Film Tax Shelters

By Schuyler M. Moore, a partner in the entertainment department of Stroock & Stroock & Lavan. He is the author of The Biz: The Basic Business, Legal and Financial Aspects of the Film Industry and Taxation of the Entertainment Industry. He is an adjunct professor at the UCLA Law School and a lecturer at the UCLA Anderson School of Management, teaching entertainment law.

Note: this section is from March 2005

The 2004 Federal Tax Act showered gifts on the film industry, but none was more striking than the Internal Revenue Code section 181, or the film deduction, which permited taxpayers to elect a 100 percent write-off for the cost of certain audiovisual works, regardless of what media they are destined for-including theater, television, and DVD.

Though section 181 is manna from heaven for the film industry, it requires a vivid imagination to decipher its meaning-and it makes napkin deals look good in comparison. But if the level of film financing raised on the back of tax shelters in the United Kingdom and Germany the past few years serves as a guide, section 181 could result in billions of dollars of new financing for films shot in the United States and may very well stem the tide of “runaway production.”What Qualifies For a particular audiovisual work to qualify for the deduction it must meet a number of requirements. The aggregate cost of the audiovisual work, or film costs, cannot exceed $15 million-or $20 million if the film is shot in certain low-income areas. The literal wording of the statute appears to include participations and residuals as costs for purposes of the cost ceiling, and a staff member of the Joint Committee of Taxation has confirmed that this is the intended result. As a consequence, taxpayers are subject to the risk that a successful film could be disqualified retroactively.

It also appears that the deduction applies to all film costs, not just compensation paid for services performed in the United States. For example, it would likely apply to the entire cost of producing Monday Night Football, including the cost of acquiring the underlying rights.

The test is all or nothing: If the film costs exceed $15 million, you lose; you don’t get to deduct the first $15 million. Based on the legislative history, it appears that in the case of a television series the $15 million test applies separately to each episode.

Seventy-five percent of the total compensation relating to the audiovisual work must be paid for services performed in this country by actors, directors, producers, and production personnel. For a television series, only the first 44 episodes can be qualified audiovisual works. Principal photography must begin after October 22, 2004, and prior to January 1, 2009. The audiovisual work cannot include a “depiction of actual sexually explicit conduct.” Other than that, there are no other limits on content.

Deduction Limited to Owner

Based on the legislative history and a bit of interpolation, it appears that only the owner of the audiovisual work who pays the film costs can take the deduction. Apparently, a payment to purchase or license all or some of the rights to a work that has already been produced will not qualify for the film deduction.

Other Tax Provisions

More important than what is written in section 181 is what is not written, since taxpayers must consider all the other provisions and doctrines of existing tax law, including the passive-loss rules (limiting “passive losses” to the amount of “passive income”), the at-risk rules, the profit-motive requirement, and the doctrine of substance over form. Most remarkable, the film deduction does not appear to be treated as amortization or depreciation. Thus, it should not be subject to recapture at ordinary income rates.

This means that if the qualified audiovisual work is sold after being held for one year, and if it does not constitute inventory, the entire gain-including the gain attributable to the film deduction-will be taxed at a maximum federal rate of 15 percent applicable to long-term capital gains for individuals. However, a staff member of the Joint Committee of Taxation has again clarified that this was not the result intended and that a subsequent technical corrections bill will change this retroactively.

Making It Work

The home run is to finance a film on a leveraged basis that complies with the at-risk rules using a pass-through entity with investors that can immediately deduct the film deduction against passive income. The income from the film could then be deferred through a license to a creditworthy licensee, with the investors gaining the advantage of deferral and a potential upside on the film. The tax benefits would hopefully entice investors to overcome the natural aversion to the foibles of film financing.

Shelters in State Statute Topics

Resources

Further Reading

• Information about Shelters in the Gale Encyclopedia of American Law.