26 Dec Section 181 is Back for Film, TV and now Theatrical Productions
Congress Gave Certain Entertainment Industry Investors
A Christmas Present for 2015 and 2016!
Section 181 is Back for Film & TV Projects and Now Theatrical Projects, Too.
By Marc Jacobson
Now, certain investors in film and theatrical projects that begin production in 2015 or 2016 may deduct their investment in the year in which the entity that receives the money actually spends the money. While tax on the profits will always have to be paid and the tax benefit of the deduction, once recouped, also creates taxable income, certain investors will get a current deduction, which is always welcome, because it reduces the investor’s current tax liability.
Not every investor is eligible for the benefit of this deduction. Some prominent bloggers gloss over this requirement. Only investors who (a) have qualifying passive income, generally from real estate rents and income are eligible for this benefit, and then only up to the amount of their passive income in that year, or (b) are producers who pursue producing as an active trade or business, can reap this benefit. A doctor or dentist, successful stockbroker, and the like, who does not have passive rental income and who may be the traditional source of film, TV and theater investment, is not able reap the benefit of this deduction.
Revised section 181 of the Internal Revenue Code (the “Code”) provides that investors in Film & TV Productions, and now, thankfully, Theatrical Productions, may deduct their investment in the year incurred, provided certain steps are taken and rules are followed. When we read the Consolidated Appropriations Act of 2016 and the Protecting Americans from Tax Hikes Act of 2015 that President Obama signed into law on December 18, 2015, we don’t see any mention of the passive activity rules. We don’t see it in the text of the old or new Section 181 of the Code, but we do see it in the accompanying regulations. But any tax preparer worth her salt will tell you that while Section 181 is clear on its face and makes no mention of the passive activity rules, the taxpayer and her preparer must consider the entire Code when preparing a tax return. That includes things like the Alternative Minimum Tax, as well as section 469 of the Code entitled “Passive Activity Losses and Credits Limited” and its accompanying regulations.
The Code limits the benefit of deductions for Passive Activity. Most investors in Film, TV and Theatrical Productions invest their money, watch carefully what happens with the “show,” then sit back and wait for a return of capital and hopefully a profit, paid out ideally over the life of copyright. That is passive activity, completely legitimate and welcomed by the producers of and the investors in the show. But the Code says if you do that, and you do it in Film, TV and now, thankfully, Theatrical Productions, you only get to deduct that investment against passive income received that year from real estate investments, and only up to the amount of that real estate passive income.
So, if the investor had passive rental income of $50,000 but invested $75,000 in the qualifying Film, TV or Theatrical Production, only $50,000 would be deductible. If the investment were $35,000, then the full amount of the investment would be deductible because the passive income exceeded that amount. All of this, of course, assumes that the entity that receives the investment, owns the property, spends the money, makes the proper election in a timely fashion, and otherwise complies with the law.
The only other method, by which the investment can be deducted, is if a person who is already active in the trade or business of the production makes the investment. The Tax Court in Storey v. Commissioner outlined how a documentary filmmaker was found to be a producer and thus eligible to reap the benefit of Code section 181. It is instructive for the rest of us, about what constitutes being active in a trade or business sufficient to qualify as a producer eligible for the current deduction.
The following assumptions show how this works on a film production with a cost of $2 million, received and spent entirely in one calendar year, where the traditional model applies where the investors recoup their money in full, first, before any “profit participation” is distributed to talent or other contributors to the film:
- The production follows the steps necessary to qualify under section 181 when filing its tax return for the year in question.
- The investors each have passive rental income in excess of their individual investment.
- All of the investors are in a tax bracket of 50%
- The production then receives license income of $1.5 million, significantly less than the cost of production.
In this example, the investors in the aggregate had a net after-tax risk of $1.0 million, since the deduction “saves” them 50% of the actual cost of the investment. When the production receives $1.5 million as license income, the investors will receive cash of $1.5 million, an amount in excess of their tax-advantaged investment, thus creating taxable income. Although the production’s license income is less than the cost of production, the investors are “in profit” before the picture itself reaps a cash on cash profit. This surely will continue to be an incentive for such investors to invest again with that producer and with other producers as well.
The reinstatement of Section 181 for 2015 and for 2016 is a welcome incentive for producers and will likely help create more films, more TV shows, and now more live theatrical events. It is only for a certain few, however. Further, its effect is to only accelerate the deductibility of the investment, which is only meaningful for as long as the show does not return the investment or a profit. Tax will always need to be paid on income in excess of the tax-advantaged investment. Consult your tax advisor for more information.
 This article is © 2015 Marc Jacobson, All Rights Reserved.
 This blog is only to alert people to the overall limitations on the benefit of the investment, not to discuss all the steps to be taken to qualify for the deduction.