Entertainment Tax Issues for Dummies

Entertainment tax issues may not be sexy, but they are certainly 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 for a limited type of income that most individuals do not have, and at best the benefit is a one-year tax deferral. And if you’re presented with Section 181 as a leveraged tax haven (“You can deduct four times your investment!”), run – it’s deep black (not gray) on the tax scale.

2. Section 168(k). Fuhgeddaboudit too. In theory, Section 168(k) allows a deduction for the costs of producing a film in the US once it is released, without limit. However, the deduction is reduced by 20% annually and in 2024 only 60% of the costs will be deductible. More importantly, Section 168(k) is subject to the same problems as Section 181, discussed above.

3. Employee vs. Independent Contractor. Almost without exception, any individual who provides non-lending services (discussed below) should be treated as an employee, especially in California because of the draconian laws there. The risk to the payer of failing to withhold taxes on payments to an individual is extreme, as there is personal liability to all “responsible persons,” and this liability cannot be discharged in bankruptcy.

4. Lending. Lending companies (where individuals provide services to third parties through entire companies) are still respected as independent contractors, but only if the individuals have above-average talent, such as writers, directors, actors or producers. . Most film companies don’t honor loans for below-the-line crew, and loans don’t work for film company executives. Lenders must be corporations (not LLCs), and an S corporation is usually the best choice to minimize the 3.8% Medicare surcharge and the risk of double taxation.

5. Unreleased films. There have been countless articles over the past year about completed studio films that were shelved and never released. The writer of the first article assumed this was for some nefarious tax reason, and all the other articles repeated that theory, even causing Congress to revolt. But it’s just not true. Unless the film is sold to a third party, the studios don’t get a tax deduction by shelving a film, so they do this for another 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 ownership interest in the entity (as is done for all other industries). The tax problem with this approach is (a) that the manufacturing company is taxed upon receipt of the investment (treating the transaction as a sale of a profits interest) and (b) the investor may not be able to deduct the investment until the agreement is terminated . the investment, and even then the deduction may be a capital loss, deductible only against the capital gain. Most people ignore these issues, and production companies typically view the investment as a reduction in film costs.

7. Pre-sale deposits. It is common for distributors to make deposits during production. Such payments are generally taxable, as are payments under investment contracts, and again, most people ignore this and treat the deposits as a reduction in film costs.

8. State production subsidies. Many states offer generous subsidies for film production, usually in the form of state tax credits that are then sold. Both the IRS and the courts have ruled that the proceeds from the sale of these tax credits are immediately taxable, and true to form, most people ignore this and consider the proceeds as a reduction in film costs. Do you see a theme here?

9. Added value on the sale of film. A common issue is whether the profit on the sale of a film can be regarded as capital gain. In general, the gain can only be capital gain if (a) the transaction involves the transfer of exclusive rights to at least one exhibition medium in at least one country for the entire term of the copyright and (b) the rights have been owned by at least one 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. Choice of entity. Here are my votes on the best entity to use for tax purposes, depending on what the entity does:

A. Loans: S company.

B. Film production or distribution: LLC.

C. Foreign person or company doing business in the US (including an investment in a US LLC): Delaware C corporation. And while we’re at it, a U.S. LLC should never accept a foreign individual or partner as a member, otherwise the LLC becomes liable for the foreign member’s U.S. and state taxes.

11. California source rules. Did you know that California is a tax haven for the studios? It’s true, because even if all their property and employees are here, California only taxes about 5% of their total income due to California’s purchasing rules, which allocate revenue to where the movies are viewed. 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 need help with insomnia), I have a tax treatise creatively titled Taxation of the Entertainment Industry that I’d be happy to send out for free; Send me an email at [email protected] with the subject line “tax.”