Form 1040
Entertainment tax issues may not be sexy, but they sure are important. Here’s a simplified summary of important tax issues people in Hollywood should know:
1. Section 181. Fuhgeddaboudit for raising film financing. In theory, Section 181 allows a deduction of the first $15 million for the cost of producing a film in the US. However, the deduction is only deductible against a limited type of income that most people do not have, and at best the benefit is a one-year tax deferral. And if you are presented with Section 181 as a leveraged tax haven (“You can deduct four times your investment!!”), run – you are in the deep black (not the gray) of the tax scale.
two. Section 168(k). Fuhgeddaboudit too. In theory, Section 168(k) allows a deduction for the cost of producing a film in the US once released, without limit. However, the deduction is being phased out at 20% per year, and only 60% of the cost will be deductible in 2024. Most importantly, Section 168(k) is subject to the same problems as Section 181, discussed above.
3. Employee vs. Independent Contractor. Almost without exception, every individual who provides non-loan services (discussed below) must be treated as an employee, especially in California due to the draconian laws there. The risk to the payer of not withholding taxes on payments to an individual is extreme, as personal liability exists for all “responsible persons” and liability cannot be discharged in bankruptcy.
4. Loans. Loans (where individuals provide services to others through wholly owned companies) continue to be honored as independent contractors, but only if the individuals are above-the-line talent such as writers, directors, actors or producers. Most film companies will not honor loans for below-the-line crew, and loans don’t work for film company executives. Loans need to be corporations (not LLCs), and an S corporation is generally the best choice to minimize the 3.8% Medicare surcharge and the risk of double taxation.
5. Unreleased films. There were several articles last year about completed studio films that were put on the shelf and never released. The writer of the first article assumed it was for some nefarious fiscal reason, and all the other articles repeated this theory, angering even Congress. But it’s not like that. Unless the film is sold to a third party, studios don’t get a tax deduction when they put a film on shelves, so they do it for some other reason.
6. Investment Contracts. For reasons that escape me, most film investments are structured as some form of investment contract, as opposed to a contribution to an entity for an equity stake in the entity (as is done for all other industries). The tax problem with this approach is (a) the production company is taxed upon receipt of the investment (the transaction is treated as the sale of a profit interest) and (b) the investor may not be able to deduct the investment until the contract end. the investment, and even then the deduction may be a capital loss, which is only deductible against capital gains. Most people ignore these issues and producers usually treat the investment as a reduction in the film’s costs.
7. Pre-Sales Deposits. It is common for distributors to pay deposits during production. These payments are generally taxable, just like payments under investment contracts, and again, most people ignore them and treat the deposits as a reduction in film costs.
8. State Production Subsidies. Many states offer generous subsidies for film production, often in the form of state tax credits that are then sold. Both the IRS and the courts have held that the proceeds from the sale of these tax credits are immediately taxable, and true to form, most people ignore it and treat the proceeds as a reduction in movie costs. Notice a theme here?
9. Capital gain on film sales. A common question is whether the gain on the sale of a film qualifies as capital gain. In general, the gain can only be a capital gain if (a) the transaction involves the transfer of exclusive rights in at least one display medium in at least one country during the full term of the copyright and (b) the rights have been detained for at least a year. It certainly helps to call the transaction a “sale” and in all cases there will be “recapture” of previous deductions as ordinary income.
10. Entity Choice. Here are my votes on the best entity to use for tax purposes depending on what the entity does:
The. Loans: Corporation n.
B. Film production or distribution: LLC.
w. Foreign individual or company doing business in the US (including an investment in a US LLC): Delaware Corporation C. And while we’re at it, a US LLC must never accept a foreign individual or partner as a member, or the LLC will become responsible for the foreign member’s US and state taxes.
11. California rules of origin. Did you know that California is a tax haven for studios? It’s true, since even if all of your properties and employees are here, only about 5% of your total income is taxed in California due to California’s sourcing rules, which allocate income to where the movies are seen. An open question is whether non-California talent working on a film in California can use the same rules to minimize California taxes (my vote is yes).
For anyone brave enough to read it (or who needs help with insomnia), I have a tax treatise creatively titled Taxation of the Entertainment Industry that I’m happy to send for free; Just send me an email at smoore@ggfirm.com with a subject that says “tax.”
