On February 8, 2007, the IRS introduced comprehensive guidance for US filmmakers and television producers regarding the implementation of a new deduction for U.S. production costs.
Under the terms of the temporary and proposed rules, Section 181 of the Internal Revenue Code of 1986 (the “Code”), allows taxpayers to deduct, as opposed to capitalize, costs of production provided such costs do not exceed US $15 million per qualified production. In order to qualify, the production must pay at least 75% of the total compensation paid to actors, directors, producers, and other relevant staff for services performed in the United States.
The temporary rules clarify that only the owner of the production can make an election to deduct production costs and note further that the owner is a person who would ordinarily be required to capitalize production costs under Section 263A. Further, even if Section 263A is not applicable in a given situation, the temporary rules provide that the deduction amount is calculated as if Section 263A applied.
Production need not have started or be completed in order for a producer to take advantage of the deduction. Rather, the producer need only be able to illustrate a “reasonable basis” for believing the production will be set, that it will qualify, and that it will not exceed the cost limitation.
Under the proposed rules, producers will be able to deduct the costs of acquiring a production. Also included in the definition of production costs under the rules are: costs associated with obtaining financing, loans incurred for completion, as well as premium costs for completion guarantees. The proposed rules provide that participation and residual compensation to actors and other relevant staff must also be included as production costs.
The temporary rules provide a higher production limit, up to US $20 million, for productions made in certain low-income communities and distressed counties. In order to utilize the higher limit, the costs associated with production must have been “significantly incurred” in those areas. There are two tests to help taxpayers determine if such costs are “significantly incurred.” The first test is satisfied if 20% of the production costs go toward first-unit principal photography in certain areas. For the second test, 50% of the total number of days of principal photography must take place in a qualified area. The tax breaks are only applicable for a five year period. The rules cover productions for which principal photography begins after October 22, 2004, and prior to January, 1, 2009.
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