For certain audio visual works (referred to herein as "Qualified Audio-Visual Works") that commence principal photography from January 1, 2008 through December 31, 2013, Section 181 permits a 100% write-off (the "Film Deduction") for the first $15 million of the cost ("Film Costs") of such works, regardless of what media they are destined for (e.g., theatrical, television, DVD, etc.) and regardless of whether the particular expenses were incurred before or after the dates set forth above (as long as commencement of principal photography falls within those dates). It seems likely that Section 181 will be extended, since it has been repeatedly extended so far, even retroactively to prior years (although it is hard to see how that approach encourages U.S. production other than by clairvoyants).
Seventy-five percent of the total compensation relating to the audio-visual work paid for services performed by actors, directors, producers (which probably includes executive producers and associate producers), writers, composers, choreographers, casting agents, camera operators, set designers, lighting technicians, make-up artists, and other persons directly involved in the production of the film, whether employees or independent contractors ("Total Compensation") must be paid for such services rendered in the United States ("U.S. Compensation").
The regulations permit the current deduction of all costs, including development and preproduction costs, relating to a film if the taxpayer reasonably believes that (a) the film will ultimately be a Qualified Audio-Visual Work and (b) the film will be set for production (referred to in the industry as "greenlit"). However, the deduction of these costs must be recaptured as ordinary income in any subsequent taxable year during which both these requirements are no longer met.
Only the taxpayer that owns the Qualified Audio-Visual Work for tax purposes (based on owning the benefits and burdens of the work) and pays the Film Costs can take the Film Deduction, even if it pays an independent production company to physically produce the work. Thus, the Film Deduction applies to the taxpayer that is otherwise required to capitalize the Film Costs.
The taxpayer is required to make a binding election to deduct the Film Deduction in lieu of normal income forecast amortization with respect to each particular Qualified Audio-Visual Work. The election must be made by the due date (including extensions) of the tax return for the first tax year in which qualifying costs for such work could be deducted.
More important than what is written in Section 181 is what is not written, since taxpayers must consider all the other provisions and doctrines of existing tax law, two of which are discussed below.
If the production activity constitutes a trade or business, as seems likely to be the case, the Film Deduction will be subject to the passive loss rules with respect to certain taxpayers, including individuals and personal service corporations. Individuals and personal service corporations that do not "materially participate" in the activity can only deduct passive losses, including the Film Deduction, to the extent of "passive income," which generally is limited to income from real estate and from passive interests in businesses held by pass-through entities. Passive income also includes income from the Qualified Audio-Visual Work. If the Film Deduction is restricted under the passive loss rules, the excess carries forward and may be deducted when it is "freed up" by future passive income or upon disposition of the taxpayer's interest in the activity.
For individuals and Closely Held Corporations, the Film Deduction will also be subject to the at-risk rules. Under the at-risk rules, the taxpayer may only take a deduction for direct investment and borrowed amounts for which the taxpayer has ultimate direct recourse liability. For example, if any portion of the Film Deduction is funded with debt, the taxpayer must have ultimate liability for that debt directly to the lender, without a right to reimbursement from any third party. Such a liability will be included in the "at-risk" amount even if the risk is ameliorated with future license payments from a creditworthy licensee.
Even if the passive loss rules and at-risk rules do not restrict the Film Deduction, the net result is to merely accelerate the deduction of Film Costs by about one year, since most Film Costs would be deductible in the year the film is released, at least for independent films. Thus, Section 181 is not a boon for film financing, and is generally not even worth a stamp to write home about. It would be much more useful if it were a credit (like state tax credits), and it would certainly make economic sense for such a federal credit to preempt all state tax credits, in order for the U.S. to efficiently compete against the world for film production instead of the states squabbling among themselves.