100% SAME-YEAR TAX DEDUCTION FOR FILM INVESTORS

SYNOPSIS:
The American Jobs Creation Act of 2004 creates an extraordinary new tax incentive for film producers who make low- and medium budget films (under $15.0 or $20.0 million) in the U.S. The new law allows producers of qualifying films to elect out of the uniform capitalization rules which mandate that film costs be deducted gradually over a film’s useful life or be matched to a film’s projected income. Costs of qualifying films can now be deducted in full in the year they are incurred. The purpose of the new tax law is to stimulate investment in domestic film production operations and make domestic film production more competitive with foreign production options.

Overview of New IRC § 181.
Section 244 of the Act, entitled “Special Rules for Certain Film and Television Productions,” adds a new section, Section 181, to the Code subpart “Itemized Deductions for Individuals and Corporations.” Section 181, entitled “Treatment of Certain Qualified Film and Television Productions,” gives the taxpayer an election to deduct, in the year the expenses are incurred, the costs of any “qualified film or television production.” The new rules are in effect as of the date of enactment, October 22, 2004, and are applicable to qualified productions commencing before 2009. Section 181 has three principal limitations on this incentive: a dollar limitation of $15.0 or $20.0 million; the production must be a “qualified film or TV production”; and an exclusivity of the deduction/amortization.

Pre-§ 181 Film Production Tax Accounting.
In order to appreciate the impact of the newly allowed method of calculating deductions for film production operations, an overview of the pre-§ 181 law is helpful. In general, under the law prior to October 22, 2004, the costs associated with producing a film could not simply be fully deducted in the year they were incurred.[18] Instead, like most costs associated with producing property, the costs (both direct and indirect) had to be capitalized, with some exceptions. Under the tax rules prior to H.R.4520, the cost of producing the film was recovered by one of two depreciation/amortization methods: the income forecast method, and the straight-line method. Because H.R. 4520 effectively nullifies the law which mandates capitalization of the great majority of film production costs and prohibits their current-year deduction (i.e., IRC § 263A(b)) an examination of the statutory framework and the authoritative interpretations regarding itemized business deductions is the logical starting place.

Effect of the § 181 Deduction Election: A Textual Analysis.
While nothing in the bill or the new statute expressly indicates that § 263A capitalization is no longer required for motion pictures, that conclusion is the only logically coherent interpretation. A strict construction of § 263A and the new § 181 yields the following paradoxical result: first, per § 181 a taxpayer who produces a motion picture may now deduct all production costs in the year they are incurred, and treat such costs as expenses “not chargeable to capital account;” and two, per § 263A the same taxpayer must “capitalize” the same costs and must charge them to a “capital account.” Inferentially, the drafters must mean that § 263A is no longer applicable to motion pictures with respect to which the taxpayer has made the § 181 election. An amendment to § 263A to clarify capitalization is no longer required for § 181 film production costs is in order. Fortunately, the Committee Report on H.R. 4520 speaks more clearly to the issue by expressly indicating that the § 181 deduction is “in lieu of capitalizing the cost and recovering it through depreciation allowances.” And while the meaning of “chargeable to capital account” in § 181(a)(1) is not embellished, the Regulations that explain § 263A are instructive in their definition of “capitalize.” Additional reassurance is found in § 181 itself, in paragraph (b), which provides that the § 181 deduction is mutually exclusive of all other depreciation and amortization deductions.