Section 181 of the Internal Revenue Code (IRC) was first introduced in 2004 and, with some gaps in time, lasted through its expiration at the end of 2016. It has provided benefits to both producers of movies and television programs (and, for a shorter period of time, to producers of live stage productions) and — under pass-through legal structures such as limited liability companies — to their investors. Now, with the enactment at the end of 2017 of the sweeping new federal tax law, commonly referred to as the Tax Cuts and Jobs Act (the Jobs Act), §181 has been given new life, with a couple of additional benefits and a couple of additional twists.
First: When can the deduction for production costs be taken? Under §181, prior to the Jobs Act, production costs incurred during a year could be deducted for such year if the costs were incurred with a reasonable certainty that the production would be completed (as a practical matter, the year in which funds for the budgeted costs had been fully raised and were beginning to be spent on production costs). That meant that unlike income forecast depreciation (the alternative in effect prior to §181’s enactment), costs could be deducted even before a film was released, a television show broadcast or a live stage production had it first paid public performance.
Of course, if a project was not yet in release in the year in which production costs were incurred, there would not yet be revenue to report to take advantage of the deduction for cost of production. In that case, the production costs would produce a loss that could be carried forward and used to offset income when revenue started to come in or, alternatively, investors in a pass-through entity such as an LLC that owned the copyright to the project could take immediate advantage of the loss as a deduction against other qualifying passive income (subject to applicable limitations). And if the deduction for costs of production were not fully used against other qualifying passive income, then it could be used to offset project income when the revenue comes in.
Under the Jobs Act, the deduction occurs when the production is “placed in service,” which is defined in the Jobs Act. For a film or television project, it is the year in which a film is initially released; for a television project, it is the year in which it is first broadcast, streamed or otherwise made available to the public; and for a live stage production, the year in which it has its initial live staged performance (note: not “opening,” so previews presumably count). There is now greater certainty about the year in which the costs can be deducted.
Second, under §181 prior to the Jobs Act, an election had to be made to take advantage of the section on the tax return for the first tax year in which there was a reasonable certainty that the project would be completed. No affirmative election, no 100% deductibility. Under the Jobs Act, the 100% deductibility is assumed, so no election needs to be made; the tax return is just filed claiming deduction of 100% of production costs in the year in which the production is placed in service.
This approach removes the uncertainty under the pre-Jobs Act §181 about when a production has a reasonable certainty of being completed. The drawback is that production costs cannot be deducted before the year in which a project is placed before the public — as they could have been under §181 before the Jobs Act, if those costs were incurred prior to a project becoming available to the public but after there was a reasonable certainty of being completed. For example, if a film started principal photography in one year, the financing to cover the budget had been raised, and the project was not released until the next year, production costs could have been deducted if a Section 181 election were made, to the extent incurred in each year.
Third, the Jobs Act provides that this 100% deductibility of production costs incurred after Sept. 27, 2017, will be in effect for five years for productions placed in service from Sept. 28, 2017, until Dec. 31, 2022 (after which there is a declining deductibility over the next several years). This five-year window means that producers can raise money pointing out the deductibility of 100% of production costs with greater certainty about this potential benefit to investors. This is particularly so for investors investing in a production through an LLC who expect to have other qualifying passive income during this five-year period against which (subject to applicable limitations) they can offset the tax loss from the LLC production company arising in the tax year the production is placed in service or, alternatively, can use the deduction to offset income in a fund for a number of film, television or live stage productions.
We mentioned above the potential benefit to producers and investors from a fund to finance several motion picture, television or live stage productions. If the production company produces only one production, the likelihood is that the 100% deduction for the costs of production will not be fully utilized in the first year in which each project is placed in service. (Very few projects in these fields recover from revenues their full cost of production in the first year of public release.)
As a result, there will be loss carry-forwards (unless the excess costs of production over revenues in the first year of release are deducted by investors against other qualifying passive income outside the fund). These loss carry-forwards will be available to defer taxes in subsequent years to the extent the production generates future revenues. If the production is part of a film fund that will produce several motion picture, television or live stage productions, the deduction for production costs will be available to offset the revenues from all the projects financed by a fund until all the costs of production across all projects have been deducted from all revenues from all projects in the fund; in other words, a deferral of taxes until an investor has fully recovered his or her or its investment in the fund.
This tax deferral with respect to income from all projects in a fund could become a useful marketing aspect in raising financing for a fund, particularly in light of the five-year period for 100% deductibility offered by the Jobs Act.
Note that the new §181 treatment discussed in this article is part of the Jobs Act as amendments to the new bonus depreciation rules. The new treatment therefore does not actually appear in §181, which remains in the IRC for purposes of cross-reference in the Jobs Act’s bonus depreciation rules. So to understand fully the resuscitation of §181, that section in the IRC needs to be read together with the applicable bonus depreciation rules in the Act, which apply to a variety of industries.
Also note that after Dec. 31, 2022, the Jobs Act provides for ongoing bonus depreciation at a rate that declines 20% per year, that is, 80% of costs for a project put in service in 2023, 60% for a project placed in service in 2024, etc. It appears that the balance of costs incurred in the applicable year can still be depreciated in accordance with pre-Jobs Act rules, so, for example, for a film, television or live stage project, income forecast depreciation could be used for the portion of costs of production which are not eligible for immediate deduction in the year the project is placed in service.
But wait: Despite the enactment of the Jobs Act, Congress was not yet done with §181: As part of the Bipartisan Budget Act of 2018 (the Debt Act), passed on Feb. 9, 2018, Congress added an amendment to §181 making it retroactive to Jan. 1, 2017. It did not, however, give any indication about how that retroactivity — generally, permitting immediate expensing of production costs for a project commencing production in 2017 — is to be reconciled with the provisions of the Jobs Act permitting deduction of costs incurred after Sept. 27, 2018, in the year in which the project is placed in service.
This article is written based on the terms of the Jobs Act as read by the authors of this article. Given how recently the Jobs Act was passed and the length of the Jobs Act, and now the confusion created by the Debt Act, IRS regulations providing guidance about how the Jobs Act is to be interpreted — and how the Jobs Act and the Debt Act can be reconciled — have not yet been issued. Such regulations may affect the guidance offered by this article, if and when the IRS issues regulations. In addition, the IRC is still subject to further Congressional amendment between now and Dec. 31, 2022 (and thereafter).
***** Thomas D. Selz is a founder of the law firm Frankfurt Kurnit Klein & Selz PC, with offices in New York City and Los Angeles. His entertainment practice includes advising on structured financing for film, TV, live stage productions, publishing and sound recordings. Bernard C. Topper Jr. is counsel at Frankfurt Kurnit who specializes in tax, including tax matters affecting the entertainment industry.
The views expressed in the article are those of the authors and not necessarily the views of their clients or other attorneys in their firm.