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IRC Sections 181 & 199 Tax Deductions for Domestic Production Activity Gina G. McLeod Deloitte Tax LLP (213) September 2009
Copyright © 2006 Deloitte Development LLC. All rights reserved.1 Contents Section 181: Basics Qualified Production Production Cost Limit Production Content Production Time Frame Production Completion Not Required Other Considerations Section 199: Basics Domestic Production Gross Receipts Qualified Production Activities Income NEW: Emergency Economic Stabilization Act of 2008 Requirements for Passthrough Entities
Copyright © 2006 Deloitte Development LLC. All rights reserved.2 Section 181 – Deduction for Qualified Film and Television Production Costs
Copyright © 2006 Deloitte Development LLC. All rights reserved.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
Copyright © 2006 Deloitte Development LLC. All rights reserved.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
Copyright © 2006 Deloitte Development LLC. All rights reserved.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
Copyright © 2006 Deloitte Development LLC. All rights reserved.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
Copyright © 2006 Deloitte Development LLC. All rights reserved.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?
Copyright © 2006 Deloitte Development LLC. All rights reserved.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
Copyright © 2006 Deloitte Development LLC. All rights reserved.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
Copyright © 2006 Deloitte Development LLC. All rights reserved.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
Copyright © 2006 Deloitte Development LLC. All rights reserved.11 Section 199 – Production Activity Deduction
Copyright © 2006 Deloitte Development LLC. All rights reserved.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 – 20063% –2007 – 20096% –2010 and later 9% Deduction not more than 50% of allocable qualified wages Effective for taxable years beginning after Dec. 31, 2004
Copyright © 2006 Deloitte Development LLC. All rights reserved.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
Copyright © 2006 Deloitte Development LLC. All rights reserved.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
Copyright © 2006 Deloitte Development LLC. All rights reserved.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
Copyright © 2006 Deloitte Development LLC. All rights reserved.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
Copyright © 2006 Deloitte Development LLC. All rights reserved.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
Copyright © 2006 Deloitte Development LLC. All rights reserved.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)
Copyright © 2006 Deloitte Development LLC. All rights reserved.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)
Copyright © 2006 Deloitte Development LLC. All rights reserved.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.
Copyright © 2006 Deloitte Development LLC. All rights reserved.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.
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.
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