Triumphant in its goal, the Act benefits producers and production
companies by granting an immediate tax deduction for the
full
costs of a production in the year the costs are incurred (as
opposed to having to spread or amortize those costs over a
period
of years). Deducting the costs up front while deferring the income
from the film until later years when it is actually incurred will
significantly reduce or eliminate taxable income for the film in
the first years of exploitation.
Also,
production costs are not just defined as the film’s budget.
Costs may include all direct and indirect costs of producing the
film, including, without limitation, development costs, an
allocation of general and administrative costs based on a portion
of production expenses, depreciation of property used in the
production, and financing costs. (On the other hand, there may be
items in a film’s
budget that would not be considered film costs such as overhead
and producer fees if retained by the production company, as
well as deferments, participations and residuals.)
The
new federal tax program applies to those films that have
production budgets of up to 15-million dollars and spend at
least
75 percent of their total “qualified compensation” on work
performed in the
United States
. “Qualifying compensation” includes
payments for the services performed in the
U.S.
by actors, directors, producers and production personnel. The
budget threshold
increases up to $20 million where the production and expenditures
are in designated “depressed areas” and communities.
The
relatively modest budget limits of the federal tax program (one
million dollars) makes this a user-friendly tool for independent
film producers, many of whom cobble
financing from a variety of investment sources including private
equity investors. In the typical
scenario, where a film is co-produced by numerous investors, the
deduction for qualifying expenditures must be apportioned among
the investors/owners of the film in a manner that reflects each
investor’s proportionate investment and economic interest in the
project.
Tim
Williams, head of production at GreeneStreet Films, believes that
the law may stimulate investment to production companies with
slates of pictures which are able to offset the tax credit against
income generated by multiple films. “It definitely could give
an
investor a tangible reason to invest,” he says.
As
a practical matter, the tax incentive is elective; producers can
run numbers with or without the new incentive and determine
whether to elect to expense the production costs in the first
year. That said, no formal election is necessary since the mere
act of deducting costs on the appropriate tax return constitutes a
valid election. In other words, deducting the production
costs
(which would otherwise be capitalized) on the tax return will
qualify as electing to take advantage of this incentive.
Electing
to use the new law also simplifies the process. Under prior law,
film expenses were most often depreciated under the income
forecast method. For first-time filmmakers and start-up production
companies, predicting revenues for the ten years after the film is
completed is much more art than science. Alternatively, film
expenses could also be depreciated over 15 years, far exceeding
most
films’ revenue streams. Using the deduction up front, a producer
or production company can use the tax loss to offset other passive
income with any excess to be carried over to future years.
For
example, if a producer pulls together $100,000 each from 20 of his
or her friends and family for a two-million-dollar budget,
each
of the investors can deduct a pro rata share of the
film’s expenses from any passive income he or she has. Assuming
the film
generates 1.5-million dollars in sales (and all of that money
flows to the investors) in each of the first two years, the income
share to each investor is $75,000 each year so the investor would
not owe any tax the first year and will still have $25,000 to
offset income
in the second year. Under the old law, without forecasting film
revenues, only 1/15 of the $100,000 would be deductible each
year
— so instead of having a tax loss in the first year, each of the
investors would owe tax on over $68,000 each of the first two
years. Where a production company does not have outside investors,
the production company would be treated as a sole investor
and
entitled to take 100 percent of the entire deduction instead of a
pro rata share.
The
American film industry received yet another gift over the past
year. This gift came courtesy of the 25 percent increase of the
Canadian currency against the
United States
dollar. As a consequence, foreign film productions in
Canada
have declined 40+ percent
from the peak years of 1999 and 2000.
Through
the efforts of the DGA, SAG, AFTRA and other industry-related
groups, filmmakers can now reap similar tax benefits enjoyed
by their colleagues in other countries and offer added financial
benefits to their investors.
STATE
TAX INCENTIVES
Presently,
over 30 states offer some form of sales tax exemption for
production companies. Many states have started passing
additional tax incentive legislation to attract filmmakers. These
incentives include wage-based rebates providing production
companies with a credit for salaries paid to state residents as
well as investment tax credits that allow resident investors to
earn credits for investing in in-state productions. Some states
even offer loans and outright grants. Many states offer some form
of incentive combinations.
Hawaii
,
Louisiana
,
New Mexico
and
Pennsylvania
offer the most aggressive incentive programs. Several
states,
including
Florida
,
Illinois
,
New Jersey
,
New York
,
Pennsylvania
and
South Carolina
have passed new incentive legislation during
the past year. Here is a list some of the “production
friendly” states and a synopsis of the incentives
provided:
ARKANSAS:
100 percent
refund on sales and use taxes paid by a qualifying production that
spends more than $550K in six months or $1M in a twelve month
period.
FLORIDA:
The
Entertainment Industry Financial Incentive Program exempts a
qualified production from sales and use taxes; the
Florida Film Office’s grant program applies against 15 percent
of qualified expenses. However, it should be noted that
Florida
only appropriated $2.8 million to the fund this year and that
money was gone within weeks.
HAWAII:
Act 221
(which is set to sunset on 12/31/05) provides for a 100 percent
business investment tax credit (up to $2 million),
an exclusion of royalties from gross income, a refundable 4
percent production expense incentive and a 100 percent hotel room
tax
credit for qualifying productions.
This
may be the single-most powerful film incentive in the country
because of the 100 percent investment tax credit (compared to
Louisiana’s 15 percent investment tax credit), but many states
such as Missouri and New Mexico offer more attractive
production
expense incentives. In order to qualify for 100 percent of the
credits, the company must (i) use a Hawaiian name or word in
the
title of the project, (ii) utilize Hawaiian scenery, culture or
products on screen, (iii) produce a feature film spending a
minimum of
$2 million or a television pilot/episode/series spending a minimum
of $750,000, and (iv) secure distribution covering 66 percent of
the national U.S. coverage, based on EDI or Nielsen or
domestic/foreign distribution for films.
ILLINOIS:
The Film
Production Services Tax Credit provides a 25 percent tax credit on
Illinois
wages limited to the first $25K paid
to each
Illinois
employee of the production; however, the Act was originally set to
sunset on 1/1/05, but has been extended
for a year.
Illinois
also offers a hotel tax exemption for stays exceeding 30 days.
LOUISIANA:
The
Motion Picture Incentive Act provides filmmakers with an exemption
from sales and use taxes if expenditures
exceed $250K in one year. The Act also provides for an employment
tax credit equal to 10 percent of the total aggregate
payroll
for employed residents when production costs are between $300K and
$1 million, or 20 percent when production costs exceed
$1 million.
Louisiana
also has an investment tax credit, providing
Louisiana
taxpayers who invest in a film production a tax credit
of 10 percent of their actual investment if it is between $300K
and $8 million, or 15 percent if it is greater than $8 million.
NEW
MEXICO:
The
state has three major tax incentives: (i) A 15 percent tax rebate
based on all the expenditures the production
has within the state that have a state tax attached. (ii) The
“Film Investment Program” which is an interest free loan up to
$7.5M
per project which is applicable to films and television. To
qualify, at least 60 percent of the below-the-line payroll has to
be paid
to
New Mexico
residents and the film must be substantially shot in
New Mexico
(about 85 percent). (iii) The Workforce Training
Program provides for the return of 50 percent of the salary of
cretin New Mexican crew members as an incentive to promote
crew
member skill set enhancement. Theses incentives are not exclusive,
and may be combined.
NEW
YORK:
The
New York
tax credit is targeted to promote the business within large sound
stage production facilities.
If 75 percent of a film’s stage work is produced, in an
qualified facility, producers receive a tax credit of 10 percent
against all the below-the-line costs that are associated with that
stage work. To secure a 10 percent tax credit of all the
below-the-line production costs in
New York
, a production must spend either $3M at the stage, or shoot 75
percent of the location work in
New York
.
This includes preproduction, production and postproduction.
Additional incentives include, all production consumables and
equipment rentals are exempt from state sales tax, exemption for
hotel stays exceeding 180 days, free permits, parking and police
in NYC.
(Please note that
New York City
recently enacted a new program providing for as much as 12.5
million in annual tax credits for
production in
New York City
.)
NEW
JERSEY:
Sales and use
tax exemptions on tangible property, machinery and equipment;
sales tax exemption on hotel stays exceeding 14 days. The Film
Production Assistance Program allows film projects to qualify
eligible for loan guarantees of up to
30 percent of the bank financing cost of the project, or $1.5
million, through the New Jersey Economic Development Authority.
PENNSYLVANIA:
The Film
Production Tax Credit provides a 20 percent tax credit for
production expenses incurred in-state
provided that 60 percent of production expenses are incurred
in-state. All production consumables and equipment rentals
are
exempt from state sales tax.
The
authors wish to thank Matthew Lehrer and Art Chang who assisted
with the research and preparation of this article.
