0 IRC Sections 181 & 199 Tax Deductions for Domestic Production Activity September 2009Gina G. McLeodDeloitte Tax LLP(213)
1 Contents Section 181: Section 199: Basics Qualified Production Production Cost LimitProduction ContentProduction Time FrameProduction Completion Not RequiredOther ConsiderationsSection 199:Domestic Production Gross ReceiptsQualified Production Activities IncomeNEW: Emergency Economic Stabilization Act of 2008Requirements for Passthrough Entities
2 Section 181 – Deduction for Qualified Film and Television Production Costs
3 § 181 BasicsEnacted and updated to make domestic production more attractive to independent filmmakers & television producers who might otherwise move production from the U.S. to other countriesPermits 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 areasDesignated areas:Areas designated as low-income communities, orAreas eligible for designation by the Delta Regional Authority as a distressed county or isolate area of distressSignificantly incurred:At least 20% of first-unit principal photography incurred in designated area; orAt least 50% of total days of principal photography occur in designated area
6 Production CostProduction 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 § 263AIncludes:Development costsCosts of obtaining financingParticipations & ResidualsCompletion bond costsAllocation of depreciation and G&A overhead to production activityDoes not include:Distribution costsProduction or overhead fees retained by the production companyPrints and Advertising
7 Production ContentAudio-visual work cannot include a depiction of “actual sexually explicit content”No other content limitations so should apply to:Reality programmingLive broadcastsTV Series (each episode individually up to 44 episodes)CommercialsVideo games?
8 Production Time FrameDeduction 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, 2010Production 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 costsNo requirement that production ever be placed in service or completedHowever, 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; andWill not exceed the production cost limit
10 Other ConsiderationsMust “own” the film to be entitled to the deduction“Benefits and burdens”Limited license or right to exploit is not enoughPassive Activity Loss limitationsAt-risk rulesTax shelter rulesEconomic substance requirementsRecaptureElection required
12 § 199 BasicsCreates a deduction equal to a fixed percentage times the lesser of:“Qualified Production Activities Income” (QPAI), orTaxable IncomeFixed percentage is:2005 – %2007 – %2010 and later 9%Deduction not more than 50% of allocable qualified wagesEffective for taxable years beginning after Dec. 31, 2004
13 Introduction - QPAI QPAI equals: “Domestic Production Gross Receipts” (DPGR)Less Allocable:Cost of goods soldOther expenses, losses, or deductionsSpecific 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 taxpayerSafe harbor : 50% of the compensation for production services rendered in the U.S.Substantial in nature production activityElectricity, 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 StatesFor this purpose, “the United States” means:Fifty states and D.C.Territorial watersAdjacent seabed and subsoilDoes not include U.S. territories or possessions50% of compensation must be for US services:Actors, directors, production personnelAny other compensation required to be capitalized under IRC 263ASubstantial 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 partyAny service revenueRental of real property
17 Production Period - No Time Restriction There is no time restriction on when Qualified Film is producedQualified films produced in prior years can produce DPGR in the current year, subject to the current year QPAI, TI and wage limitationsSo long as the appropriate US content requirements were satisfied at the time of productionImplications:Availability of records validating the US compensation for prior year films – limitation is record retention limited not statute limitedIs 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 12/31/07199(b)(2)(d) – for purposes of the W-2 wage limitation, wages includes all compensation for specified service199(c )(6) – qualified film includes any copyrights, trademarks, or other intangibles199(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 itemA taxpayer is not permitted to aggregate producteither by division,by product line, oreven by transactionFilm by Film qualificationNo blending of acquired and produced filmsNo averaging of daily programming contentRevenue must be specifically linked to a particular programRequires information from advertising traffic system to each programming hourRequires 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-DPGRCGS allocable to bothDirectly allocable itemsNondirectly allocable itemsInterestR&E expensesStewardship expensesAsset information for interestW-2 wages.