The actual highest federal and state marginal tax rate in high tax states like California and New York is now a whopping 55 percent by the time you get done with all the hidden and complex add on taxes, phase ins, and phase outs. So it is worth thinking of how to save taxes, and there are some fairly simple ways for film companies.
The first, and easiest, is with a little-known subsidy for export activities called a "Domestic International Sales Corporation" (a "DISC"), which lets film companies save almost 50 percent of their federal taxes on income from outside the U.S. attributable to films produced in the U.S. These days, more than 70 percent of worldwide film income is from outside the U.S., so this is a no-brainer. It works for any film company that is a pass-through entity for tax purposes (such as an LLC or S corporation) and that has net income from sources outside the U.S. attributable to the sale, rent, or license of either (a) tangible property or (b) films or TV shows. This benefit even applies to sales companies where all the activity is in the U.S. The procedural requirements are (a) formation of a separate C corporation (the DISC), (b) entering into a DISC commission agreement between the film company and the DISC, and (c) complying with fairly simple IRS requirements. The DISC does not need any actual substance (such as employees), as the DISC rules are designed to avoid restrictions on export subsidies under the General Agreement on Tariffs and Trade (GATT) with minimal impact on normal operations.
For companies that have offshore activities, such as film production or sales activities, it is also possible to defer all tax indefinitely by using techniques that have now become well publicized due to their use by all the large IP companies, such as Google and Apple. All that is needed is a foreign corporation with trade or business activities offshore, and as long as the company avoids certain hurdles (known as the Subpart F rules) no tax is owed until the profits are brought back to the U.S. as dividends, allowing tax free reinvestment for growing companies. Even when dividends are paid, if structured properly, the federal tax rate can be reduced by almost half on the dividends, resulting in a permanent benefit.
Another tax savings is provided by Section 199, which provides for an exclusion of 9 percent of worldwide net income attributable to films and TV shows if at least 50 percent of the total compensation relating to production is for U.S. services, with a cap on the exclusion equal to 50 percent of the total W-2 wages paid by the film company during the tax year.
For films and TV shows that commence principal photography in 2013 and are produced in the U.S., Section 181 permits a 100 percent write-off for the first $15 million of the cost 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 after 2013 (as long as commencement of principal photography commences in 2013).
While California is generally a high tax state, it is actually a tax haven for film companies, which is why most of the studios are based in California. In particular, for C corporations and non-California residents, California only taxes income that is "attributable" to California, and income from the licensing of intangible rights, such as films, is allocated to the point of exhibition to the ultimate consumer, not to the location where production or sales activity occurs. Thus, even if a film company produces a film in California and licenses it from an office in Los Angeles, the film company's net income will be allocated to California based on the ratio of the income from California consumers compared to worldwide. Given that California is less than 5 percent of the worldwide market for films, less than 5 percent of the film company's income is subject to tax in California.
So a quadruple whammy can be achieved by producing films or TV shows in the U.S., since the film company will qualify for (1) using a DISC, (2) the Section 199 exclusion, (3) the Section 181 deduction, and (4) almost an exemption from state taxes if it is based in California. Add state tax credits on top of that, and it is a tax tea party!