In the Tax Extender and Disaster Relief Act of 2019, passed in December of 2019, Congress revived several credits and deductions, including Internal Revenue Code Section 181, that offers tax benefits for digital and live media producers. Section 181 gives production companies the ability to expense costs as incurred as opposed to requiring those expenses be deferred and only recognized when the project is placed into service, as was required under the Tax Cuts and Job Act of 2017(TCJA).
The US tax code generally treats the creation of a film the same as creating a building or any other asset; it is an asset that is capitalized until it is put into use and then depreciated over its useful life. When money is invested and spent on the creation of the movie, no expense is recognized. The asset remains on the books until it is used or sold. When the asset is used or sold, it is depreciated, which means the asset's value is lowered systematically and rationally, and an expense is recognized.
In 2004, the Jobs Creation Act included an incentive to invest in the entertainment industry, Section 181. This section of the tax code changed the treatment of how costs were capitalized or expensed for certain qualified television and film productions. This change allows a media production to expense all production costs as incurred instead of capitalizing and depreciating the costs over the life of the asset. This section had been allowed to expire, but was renewed in December 2019 and is now applicable to productions commencing before December 31, 2020.
What this means is that the money spent on the creation of media is allowed to be taken as an expense when it is paid, often creating a loss for the production company, which can then offset profits from other investments. This offset gives an immediate tax benefit by reducing the company's tax liability.
In addition to the immediate tax benefit, there is also the benefit of improved expense recognition in regards to the uncertainty of revenue that will be generated form a production. Media production often experiences a discontinuity between when the costs of creating a production occur and when the revenue it generates (or fails to generate) is received. The use of Section 181 mitigates this problem by allowing producers to deduct the production expenses in the year the costs are incurred instead of waiting for revenue that is not guaranteed.
The restored Section 181 is available to productions of qualified, television, films, and theater productions with more than 75 percent of costs within the United States. It can be retroactively applied and is extended through the 2020 tax year. What will happen after the 2020 tax year is still uncertain. Also, Section 181 limits the deductions allowed on production costs at $15 million, or in specific expenditures in low-income areas that cap can be raised to $20million. Any expenses that exceed the $15millino or $20million cap can be deducted using the bonus depreciation rules available under the TCJA after the production is placed into service.
The opportunity to use Section 181 can dramatically change how an investor views the risk profile of a film project. Because the money invested and spent is expensed as incurred, it will create a loss that can pass through to the investor, giving them a tax benefit in the same year as the production. So, if $1,000,000 is invested in a film that is spent on production, then a $1,000,000 loss will pass through to the investors. Assuming the investor has an off-settable income of greater than $1,000,000, their income is reduced by that $1,000,000. If the investor was in the 35% tax bracket, that offsetting would result in a reduction of their tax liability of $350,000. And this is without the film ever selling a single copy.
Filmmakers can capitalize on the return of Section 181 by offering its benefits to potential investors. To do this, the filmmaker should create a separate entity for the production of the film that will have its tax filings structured as a pass-through entity. When money is spent on the production, it will be recognized as an expense in the year of the production. These expenses, without revenue, will lead to a loss that will pass through to the owners/investors. This pass-through loss will then offset other income and save them money. By offering investors this immediate and ensured benefit, it lowers the overall risk of investing in film and increases the likelihood of investment.