0. IRC Sections 181 & 199 Tax Deductions for Domestic Production Activity
September 2009
Gina G. McLeod
Deloitte Tax LLP
(213)

1. Contents Section 181: Section 199: Basics Qualified Production
Production Cost Limit
Production Content
Production Time Frame
Production Completion Not Required
Other Considerations
Section 199:
Domestic Production Gross Receipts
Qualified Production Activities Income
NEW: Emergency Economic Stabilization Act of 2008
Requirements for Passthrough Entities

2. Section 181 – Deduction for Qualified Film and Television Production Costs

3. § 181 Basics
Enacted and updated to make domestic production more attractive to independent filmmakers & television producers who might otherwise move production from the U.S. to other countries
Permits the owner of a qualified film or television production to elect to deduct production costs in the year they are paid or incurred

4. Qualified Production Seventy-five percent test:
Film or television production is “qualified” if 75% of total compensation of the production is compensation for services performed in the U.S. by actors, directors, producers, and other relevant production personnel
“Total compensation of the production” is the total amount of compensation paid for services performed anywhere by actors, directors, producers, and other relevant production personnel but does not include deferments, residuals and participations
“In the U.S.” includes services occurring in the 50 states, District of Columbia, territorial waters of the continental U.S., or airspace above the continental U.S. and its territorial waters

5. Production Cost Limit The revised § 181 only applies:
To the first $15 million of costs for each qualifying production; or
$20 million if a significant amount of production costs are incurred in certain designated areas
Designated areas:
Areas designated as low-income communities, or
Areas eligible for designation by the Delta Regional Authority as a distressed county or isolate area of distress
Significantly incurred:
At least 20% of first-unit principal photography incurred in designated area; or
At least 50% of total days of principal photography occur in designated area

6. Production Cost
Production costs that must be taken into account (for both amount of deduction and production cost limit) are the amounts that would otherwise be required to be capitalized under § 263A
Includes:
Development costs
Costs of obtaining financing
Participations & Residuals
Completion bond costs
Allocation of depreciation and G&A overhead to production activity
Does not include:
Distribution costs
Production or overhead fees retained by the production company
Prints and Advertising

7. Production Content
Audio-visual work cannot include a depiction of “actual sexually explicit content”
No other content limitations so should apply to:
Reality programming
Live broadcasts
TV Series (each episode individually up to 44 episodes)
Commercials
Video games?

8. Production Time Frame
Deduction under the revised § 181 is allowed for the cost of producing qualified film and television productions for which principal photography begins after December 31, 2007, and before January 1, 2010
Production costs incurred before or after this period may be deducted so long as principal photography commences during the period

9. Production Completion Not Required
No requirement that production to be placed in service in order for producer to begin deducting production costs
No requirement that production ever be placed in service or completed
However, at the time election is made and in any year that a deduction is claimed, taxpayer must have a reasonable basis for believing that production:
Will be set for production;
Will be a qualified film or television production; and
Will not exceed the production cost limit

10. Other Considerations
Must “own” the film to be entitled to the deduction
“Benefits and burdens”
Limited license or right to exploit is not enough
Passive Activity Loss limitations
At-risk rules
Tax shelter rules
Economic substance requirements
Recapture
Election required

11. Section 199 – Production Activity Deduction

12. § 199 Basics
Creates a deduction equal to a fixed percentage times the lesser of:
“Qualified Production Activities Income” (QPAI), or
Taxable Income
Fixed percentage is:
2005 – %
2007 – %
2010 and later 9%
Deduction not more than 50% of allocable qualified wages
Effective for taxable years beginning after Dec. 31, 2004

13. Introduction - QPAI QPAI equals:
“Domestic Production Gross Receipts” (DPGR)
Less Allocable:
Cost of goods sold
Other expenses, losses, or deductions
Specific rules for treatment of certain expenses such as interest, research and development costs, charitable contributions and taxes

14. Domestic Production Gross Receipts
DPGR – Gross receipts derived from:
Any lease, rental, license, sale, exchange, or other disposition of:
Qualifying production property (QPP)
“Qualified films” produced by the taxpayer
Safe harbor : 50% of the compensation for production services rendered in the U.S.
Substantial in nature production activity
Electricity, natural gas, or potable water;
Gross receipts from construction of real property and related engineering or architectural services

15. Production services rendered “in the US”
The film must be produced in significant part in the United States
For this purpose, “the United States” means:
Fifty states and D.C.
Territorial waters
Adjacent seabed and subsoil
Does not include U.S. territories or possessions
50% of compensation must be for US services:
Actors, directors, production personnel
Any other compensation required to be capitalized under IRC 263A
Substantial in nature

16. DPGR DPGR does NOT include receipts derived from:
Property that is leased, licensed, or rented by the taxpayer for use by any related party
Any service revenue
Rental of real property

17. Production Period - No Time Restriction
There is no time restriction on when Qualified Film is produced
Qualified films produced in prior years can produce DPGR in the current year, subject to the current year QPAI, TI and wage limitations
So long as the appropriate US content requirements were satisfied at the time of production
Implications:
Availability of records validating the US compensation for prior year films – limitation is record retention limited not statute limited
Is the current owner/licensor the original producer?
Separate legal entities for production of new content may cause T/P to have wage limitation issues

18. NEW: Emergency Economic Stabilization Act of 2008
Effective Date: Tax years beginning after 12/31/07
199(b)(2)(d) – for purposes of the W-2 wage limitation, wages includes all compensation for specified service
199(c )(6) – qualified film includes any copyrights, trademarks, or other intangibles
199(d)(1)(A)(iv) – partner owning at least 20% shall be treated as having directly engaged in any film produced by the partnership (or S Corp)

19. Determine Qualified DPGR
Requirements to determine qualifying status item by item
A taxpayer is not permitted to aggregate product
either by division,
by product line, or
even by transaction
Film by Film qualification
No blending of acquired and produced films
No averaging of daily programming content
Revenue must be specifically linked to a particular program
Requires information from advertising traffic system to each programming hour
Requires some reasonable allocation of a content license, (i.e., cable carrier fee for a 24/7 station would only be qualified to the extent of produced programming)

20. Passthrough Entities In general, QPAI calculated at the partner level.
Items of DPGR, COGS, and related expenses allocated to partner.
Exception where passthrough eligible for small business simplified overall method.
A partner or shareholder’s distributive share of QPAI may be less than zero.
Imposes reporting requirement on all partnerships, not just those with DPGR activity.
But Treasury reserves right to simplify in IRB.

21. Passthrough Entities Additional K-1 reporting requirements. DPGR
Non-DPGR
CGS allocable to both
Directly allocable items
Nondirectly allocable items
Interest
R&E expenses
Stewardship expenses
Asset information for interest
W-2 wages.

22. Any tax advice included in this written or electronic communication was not intended or written to be used, and it cannot be used by the taxpayer, for the purpose of avoiding any penalties that may be imposed on the taxpayer by any governmental taxing authority or agency.
Copyright © 2006 Deloitte Development LLC. All rights reserved.