Tax Reform’s Impact on the Theater and Film Industry

By Christopher A. Cacace  |  December 27, 2017

While individuals and businesses in the theater and film industry were watching and listening to news of the Tax Cuts and Jobs Act (H.R. 1) bill unfold, the Marks Paneth Theater, Media & Entertainment Group was working with government and industry groups on provisions in the bill specific to the industry, as well as monitoring the broader legislation.

Now that the President has signed H.R. 1 into law, we can clearly identify what sections of the bill will impact our clients the most, as outlined by our Tax Services group last week. The four areas of reform that will most directly affect the theater and film industry are

• Expensing provisions for production companies
• A revised, though complex, way to tax pass-through income
• Cross-border taxation
• Individual and corporate tax changes

Expensing Provisions for Production Companies

Since 2004, Section 181 allowed film production companies to immediately expense their production costs. This tax-savings vehicle was expanded to include theater production companies with the passage of the Protecting Americans from Tax Hikes Act of 2015.

Section 181 was originally passed with a “sunset” date and required an extension every few years to push back its expiration. This was typically done through an extenders bill that renewed it for a few years at a time. The latest expiration date was at the end of 2016, at which point Section 181 was not renewed.

Included in H.R. 1 is a provision that permits film and theater production companies to expense their costs of production, making them eligible for “bonus depreciation” similar to what is offered to capital-intensive businesses. The tax benefit is comparable to the expired Section 181 and is effective September 27, 2017.  The bill also clarifies when such a deduction may be taken, eliminating the ambiguities and common implementation problems in Section 181.

Taxation of Pass-Through Income

H.R. 1 has created a new method of computing income for pass-through entities. The new law allows owners of a qualified trade or business to take a deduction of up to 20% of the qualified business income.  Qualified business income needs to be effectively connected with the conduct of a trade or business within the United States.

Unless certain income thresholds are met, the new 20% deduction does not apply to “service trades or businesses”. Although guidance will be needed in the weeks and months ahead, H.R. 1 attempts to clarify the scope of “service trades or businesses” that are excluded from the new pass-through deduction.  Some performing arts services fall under this definition, but theater and film production partnerships do not. Therefore, these types of partnerships are eligible for the new pass-through deduction, subject to income limitations.

How the 20% Deduction Works

In general, for taxpayers with taxable income below $315,000 for married taxpayers filing jointly or $157,500 for others, the deduction for a film or theater production company will not be limited.  For taxpayers with taxable incomes above $415,000 for married taxpayers filing jointly or $207,500 for others, the deduction will be limited to:

a)      the lessor of (a) 20% of the qualified business income with respect to such trade or business OR

b)     The greater of 50% of the taxpayer’s pro-rated share of W-2 wages (“wages”) paid by the pass-through business OR the sum of 25% percent of the pro-rated wages plus 2.5% of the unadjusted basis, immediately after acquisition, of all qualified property.

Therefore, a taxpayer who is subject to the full above referenced limitation (taxable income above $415,000) and has a 10% interest in a production limited liability company, partnership or S corporation that pays wages of $500,000 would be limited to a deduction of $25,000 ($500,000 x 10% allocated share x 50% limitation).

Special phase-out rules apply to taxpayers with taxable income between the above thresholds.

Where Do We Go from Here?

More guidance will be needed to determine how this change affects tiered partnerships, such as when an investment partnership invests in a production partnership.

We also anticipate that there will be delays in the design and release of the various 2018 pass-through entity tax returns and K-1s, to allow time for the additional information to be included.

Cross-Border Investments

H.R. 1 replaces our worldwide system of taxation with a territorial system, and provisions include deductions for dividends received by domestic corporations from foreign corporations, potentially changing how U.S. producers structure foreign productions.

U.S. nonresidents may also be more likely to invest in the entertainment industries, since the decrease in tax rates will reduce their withholding taxes.

Individual and Corporate Tax Changes

There are numerous changes affecting the owners of pass-through businesses – both individuals and C corporations.  Rates have changed, most notably a reduction in the top corporate marginal rate from 35% to 21%.  For individuals, H.R. 1 repeals or limits certain deductions and preference items, while doubling the standard deduction. Both owners and businesses (however structured) in the Theater and Film Industry should become familiar with the rate changes and other items outlined in the comprehensive overview of the tax reform legislation prepared by our tax services group. Those changes may present opportunities for production entities and for individual taxpayers depending on their circumstances.

For more information on how these changes affect members of the theater and film industry, please contact Christopher A. Cacace, CPA, Partner in Charge of the Theater, Media & Entertainment Group, at Marks Paneth, at (212) 330-6025 or ccacace@markspaneth.com.

About Christopher A. Cacace