Law Firm of Kaye & Mills

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Deducing the Deduction

Sometimes in this section of our newsletters we take on subjects that are too complicated for complete analysis in such an abbreviated forum. This is without doubt the case here. However, the new tax treatment for investments in motion pictures has generated tremendous interest and we are compelled to give it mention. The law is complex and there are many issues yet to be settled. The most important point we can make at this time is that care must be taken before deciding to take advantage of these recent changes.

Late in 2004, under the unlikely name of the American Jobs Creation Act, a new tax law was enacted permitting a tax deduction in the current year of the entire cost of certain film and television production expenses. The new law was heralded by many in the industry as a most welcome incentive for keeping film and television production in the United States. Its actual effect is less certain.

There are a number of requirements that must be met in order to take advantage of this new tax provision, including:

  • The individual taking the deduction must be "an owner" of the project;
  • The individual taking the deduction must make an election to deduct the film costs instead of using normal income amortization;
  • A minimum of Seventy-five percent (75%) of the services on the production must be performed in the United States;
  • The aggregate cost of the project cannot exceed $15 million in most cases (it is not clear from the language of the law when and what development and pre-production costs can be deducted, or whether deferments, residuals and other such items are "costs");
  • For television series, only the first forty-four (44) episodes can qualify; and
  • The project cannot include the depiction of actual sexually explicit conduct.

Here is an example of how it works:

An investor puts $1 million into a qualifying production. The investor may elect to deduct the entire $1 million from their taxable personal income for the year in which the production expenses are incurred. With a 35% federal personal income tax, the investor ends up with a tax savings of $350,000. Of course, the investor will eventually have to pay tax on money subsequently earned from the exploitation of the completed project.

What happens from there is less certain. One possibility is that the recoupment can be treated as a capital gain (if the investor holds the film for at least a year), which is subject to a tax rate of only 15%. However, some tax attorneys believe the IRS will not allow such treatment. It may be some time before this issue is sorted out by regulation and by court action.

Until this and other ambiguities are resolved, taking advantage of the new law could prove risky. Care must be taken to insure the investment is structured properly and the investor is fully apprised of the uncertainties involved. At its best, this new tax law will foster more domestic production; at its worst, the new system will yield little benefit for investors and would-be investors in the entertainment industry. Kaye & Mills can help you to sort through this unsettled area.

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NOTE: These articles and excerpts are provided on the condition that they cannot be referred to or quoted in any legal proceeding. The reader is strongly urged to consult with a lawyer for legal advice on these matters. Any reliance on the information or excerpts by someone who has not entered into a written retainer agreement with the lawyer providing this information is at the reader's or recipient's own risk.