The IRS has issued temporary and proposed regulations relating to deductions for the cost of producing film and television productions under Code Sec. 181. The regulations affect taxpayers that produce films and television productions within the United States, and became effective February 9, 2007.
Code Sec. 181, which was added by the American Jobs Creation Act of 2004 (P.L. 108-357) and modified by the Gulf Opportunity Zone Act of 2005 (P.L. 109-135), generally permits owners of qualified film or television production to elect to deduct production costs in the year the costs were paid or incurred instead of capitalizing and recovering such costs through depreciation allowances. The aggregate costs must not exceed $15 million for each qualifying production or $20 million if a significant amount of the production costs are incurred in certain designated areas. A film or television production is a qualified film or television production if 75 percent of the total compensation of the production is compensation for services performed in the United States by actors, directors, producers and other production personnel (i.e., the 75-percent test).
Because for several years independent filmmakers and television producers have moved production activities outside of the United States, motivated by various incentives offered by foreign governments, Code Sec. 181 was enacted to make domestic production more attractive to these taxpayers.
The temporary regulations clarify that only the owner of the film or television production may elect to deduct production costs under Code Sec. 181. The owner of the production is deemed to be the person or persons otherwise required to capitalize production costs under Code Sec. 263A. The regulations also require that, at the time the election is made and in any year that a deduction is claimed, the taxpayer must have a reasonable basis for believing that the production will be set for production. Further, costs of acquiring a production and costs of obtaining financing are included in the definition of production costs, while distribution costs are excluded. Participations and residuals costs are production costs for purposes of the production cost limit (Temporary Reg. Â§1.181-1T(a)).
The temporary regulations adopt two different tests for establishing when production costs have been significantly incurred in a designated area. The first test, which is based upon production costs, establishes a 20-percent threshold for the "significantly incurred" standard. The 20-percent-cost-based test compares the production costs incurred in first-unit principal photography that takes place in a designated area to all production costs incurred in that first-unit principal photography. Under the second test, which is based on the total number of days of principal photography, the "significantly incurred" requirement is deemed satisfied if more than 50 percent of the total days of principal photography takes place in a designated area (Temporary Reg. Â§1.181-1T(b)).
Further, the temporary regulations provide the same Code Sec. 181 election requirements and transition rules as those set forth in Notice 2006-47, I.R.B. 2006-20, 892. However, they also require that the taxpayer have a reasonable basis for claiming the deduction. In the case where the production is owned by a partnership, the election is made at the partnership level. A taxpayer may revoke the Code Sec. 181 election by filing a statement with the return for the tax year, in which the election is effective, identifying the production for which the election is revoked (Temporary Reg. Â§1.181-2T).
For purposes of defining a production, the temporary regulations adopt the broader statutory definition under Code Sec. 168(f)(3) and specifically provide that a production includes any film or videotape production the production cost of which is subject to capitalization under Code Sec. 263A. In addition, the regulations provide that a service is preformed in the United States for purposes of the 75-percent test if the principal photography to which the service relates occurs within the fifty states, the District of Columbia, the territorial waters of the continental United States, or the airspace above the continental United States and its territorial waters. A special rule applies to animated productions (Temporary Reg. Â§1.181-3T).
Finally, a special recapture provision requires the recapture of any production costs previously deducted under Code Sec. 181 in the year the election is voluntarily revoked or the production fails to meet the Code Sec. 181 requirements (Temporary Reg. Â§1.181-4T).
The temporary regulations apply to qualified film and television productions with respect to which principal photography, or in the case of animated production, in-between animation, commenced on or after February 9, 2007, and before January 1, 2009 (Temporary Reg. Â§1.181-6T).
Effect on Other Documents
Notice 2006-47, I.R.B. 2006-20, 892, is modified by removing section B.2. in the INTERIM PROVISIONS of that notice.
Rev. Proc. 2002-9, 2002-1 CB 327, is modified and amplified to include the automatic changes in methods of accounting in Temporary Reg. Â§1.181-1T(d)(2) and (e)(1) in the Appendix of that revenue procedure.