In December’s Tax Extender and Disaster Relief Act of 2019, Congress gave new life to a number of credits and deductions that had died in the TCJA tax reform package. Among those that rose from the dead, like the ever-popular zombies of film and fiction, is a provision that offers tax benefits for producers of digital and live media: Internal Revenue Code Section 181.
Section 181 augments the bonus depreciation allowed under the TCJA by giving production companies the ability to deduct certain expenses on an “as and when occurred” basis, rather than requiring these expenses to be deducted only when the production is placed in service (i.e., official release dates, airings or the commencement of public performances).
The newly restored deduction is available to taxpayers who incur expenses in the production of qualified television programs, films and live theater productions (qualified productions being those where a minimum of 75 percent of compensation costs are generated in the U.S.).
Section 181 is retroactive in its repeat appearance and extends through the 2020 tax year. Additional guidance from the IRS should address questions about whether and how taxpayers can in fact claim Section 181 deductions on an amended 2018 return, given that the tax code forbids making elections on this type of return.
Unlike the bonus depreciation added with the passage of TCJA, IRC Section 181 limits deductions for production costs to $15 million. That cap rises to $20 million for specified expenditures in designated low-income areas or those that qualify as distressed. Any costs above the relevant threshold can be deducted using bonus depreciation rules once a production meets the in-service standard.
While the cap on deductions would seem to make Section 181 almost irrelevant when unlimited bonus depreciation is available, the timing differences specified by the two laws give added significance to Section 181’s return. By allowing production companies to deduct expenses in the year they are incurred, Section 181 can make a big difference in their annual net income.
The entertainment industry often experiences a discontinuity between the costs of creating a production and the revenue it generates (or fails to generate). Section 181 mitigates this problem by allowing media producers to deduct the expenses associated with a particular production in the year the costs are incurred – or to utilize bonus depreciation or standard 10-year amortization techniques if those alternatives are more beneficial to the company’s long-term financial position, current tax situation or ability to attract investors.
Avoiding the dramatic swings in income that a Section 181 deduction can create is, in certain cases, more advantageous than deducting expenses immediately. The fact that TCJA forbids companies from carrying back net operating losses to a previous year only makes this problem worse. But with three separate tax treatments to choose from, the entertainment industry now has plenty of alternatives for handling deductions for production costs in the optimal fashion.
Before choosing to utilize a Section 181 deduction, media producers should examine their state’s laws. Many states, including Georgia, previously recognized Section 181 deductions on state returns while others, such as California, did not. Similarly, some but not all states allow bonus depreciation. That difference creates the potential for a dramatic mismatch between state and federal tax returns.
Georgia will likely review the federal tax extenders in late February or early March. Lawmakers’ eventual decision could have a significant impact on the net cost of in-state productions, especially in light of the fact that Georgia does not currently allow bonus depreciation.
We’ll have to stay tuned to see how the issue plays out. In the meantime, reach out to the tax advisors at Mauldin & Jenkins to learn whether the reprise of the federal Section 181 deduction should affect your tax planning strategy.