Independent filmmakers and producers received an unexpected holiday gift this past year. Seeking to stanch the flow of runaway productions, both federal and numerous state governments enacted innovative tax related inducements sufficient to give producers pause before fleeing to Canada or overseas.
Perhaps the most valuable present was tucked deep inside The American Jobs Creation Act of 2004, an elaborate package of tax measures passed by Congress and President Bush in October 2004. The Jobs Creation Act covers a wide variety of tax palliatives from the repeal of federal income tax breaks for foreign sales corporations to the deduction of state and local sales tax to tax breaks for agriculture, timber and fishing. However, with little fanfare and without the usual photo opportunities with celebrities and politicians, the Act included what could be the most significant tool for changing the independent film financing landscape as we know it.
The Act takes a stand against “runaway production,” which according to a study commissioned by the DGA and SAG and confirmed by the Commerce Department cost the US $10.3 billion in lost revenues in 1999. Specifically, the Act is designed to stimulate investment in film by granting a 100 percent write-off for the cost of film and television productions in the year the cost is incurred. The incentives are available for “qualified productions” commencing after October 22, 2004, and before January 1, 2009. Qualified film and television productions include any production of a motion picture (whether released theatrically or otherwise). The Act also covers miniseries, scripted, dramatic television episodes and movies-of-the-week.
The DGA and SAG spearheaded a campaign to educate elected officials about the severe damaged caused to the American film industry by fewer productions lensing in the United States. They successfully asserted that the film industry is comprised of working men and women and small businesses housed not just in Hollywood and New York, but throughout the United States. Triumphant in its goal, the Act benefits producers and production companies by granting an immediate tax deduction for the full costs of a production in the year the costs are incurred (as opposed to having to spread or amortize those costs over a period of years). Deducting the costs up front while deferring the income from the film until later years when it is actually incurred will significantly reduce or eliminate taxable income for the film in the first years of exploitation.
Also, production costs are not just defined as the film’s budget. Costs may include all direct and indirect costs of producing the film, including, without limitation, development costs, an allocation of general and administrative costs based on a portion of production expenses, depreciation of property used in the production, and financing costs. (On the other hand, there may be items in a film’s budget that would not be considered film costs such as overhead and producer fees if retained by the production company, as well as deferments, participations and residuals.)
The new federal tax program applies to those films that have production budgets of up to 15-million dollars and spend at least 75 percent of their total “qualified compensation” on work performed in the United States. “Qualifying compensation” includes payments for the services performed in the U.S. by actors, directors, producers and production personnel. The budget threshold increases up to $20 million where the production and expenditures are in designated “depressed areas” and communities.
The relatively modest budget limits of the federal tax program (one million dollars) makes this a user-friendly tool for independent film producers, many of whom cobble financing from a variety of investment sources including private equity investors. In the typical scenario, where a film is co-produced by numerous investors, the deduction for qualifying expenditures must be apportioned among the investors/owners of the film in a manner that reflects each investor’s proportionate investment and economic interest in the project.
Tim Williams, head of production at GreeneStreet Films, believes that the law may stimulate investment to production companies with slates of pictures which are able to offset the tax credit against income generated by multiple films. “It definitely could give an investor a tangible reason to invest,” he says.
As a practical matter, the tax incentive is elective; producers can run numbers with or without the new incentive and determine whether to elect to expense the production costs in the first year. That said, no formal election is necessary since the mere act of deducting costs on the appropriate tax return constitutes a valid election. In other words, deducting the production costs (which would otherwise be capitalized) on the tax return will qualify as electing to take advantage of this incentive.
Electing to use the new law also simplifies the process. Under prior law, film expenses were most often depreciated under the income forecast method. For first-time filmmakers and start-up production companies, predicting revenues for the ten years after the film is completed is much more art than science. Alternatively, film expenses could also be depreciated over 15 years, far exceeding most films’ revenue streams. Using the deduction up front, a producer or production company can use the tax loss to offset other passive income with any excess to be carried over to future years.
For example, if a producer pulls together $100,000 each from 20 of his or her friends and family for a two-million-dollar budget, each of the investors can deduct a pro rata share of the film’s expenses from any passive income he or she has. Assuming the film generates 1.5-million dollars in sales (and all of that money flows to the investors) in each of the first two years, the income share to each investor is $75,000 each year so the investor would not owe any tax the first year and will still have $25,000 to offset income in the second year. Under the old law, without forecasting film revenues, only 1/15 of the $100,000 would be deductible each year — so instead of having a tax loss in the first year, each of the investors would owe tax on over $68,000 each of the first two years. Where a production company does not have outside investors, the production company would be treated as a sole investor and entitled to take 100 percent of the entire deduction instead of a pro rata share.
The American film industry received yet another gift over the past year. This gift came courtesy of the 25 percent increase of the Canadian currency against the United States dollar. As a consequence, foreign film productions in Canada have declined 40+ percent from the peak years of 1999 and 2000.
Through the efforts of the DGA, SAG, AFTRA and other industry-related groups, filmmakers can now reap similar tax benefits enjoyed by their colleagues in other countries and offer added financial benefits to their investors.
STATE TAX INCENTIVES
Presently, over 30 states offer some form of sales tax exemption for production companies. Many states have started passing additional tax incentive legislation to attract filmmakers. These incentives include wage-based rebates providing production companies with a credit for salaries paid to state residents as well as investment tax credits that allow resident investors to earn credits for investing in in-state productions. Some states even offer loans and outright grants. Many states offer some form of incentive combinations. Hawaii, Louisiana, New Mexico and Pennsylvania offer the most aggressive incentive programs. Several states, including Florida, Illinois, New Jersey, New York, Pennsylvania and South Carolina have passed new incentive legislation during the past year. Here is a list some of the “production friendly” states and a synopsis of the incentives provided:
ARKANSAS: 100 percent refund on sales and use taxes paid by a qualifying production that spends more than $550K in six months or $1M in a twelve month period.
FLORIDA: The Entertainment Industry Financial Incentive Program exempts a qualified production from sales and use taxes; the Florida Film Office’s grant program applies against 15 percent of qualified expenses. However, it should be noted that Florida only appropriated $2.8 million to the fund this year and that money was gone within weeks.
HAWAII: Act 221 (which is set to sunset on 12/31/05) provides for a 100 percent business investment tax credit (up to $2 million), an exclusion of royalties from gross income, a refundable 4 percent production expense incentive and a 100 percent hotel room tax credit for qualifying productions.
This may be the single-most powerful film incentive in the country because of the 100 percent investment tax credit (compared to Louisiana’s 15 percent investment tax credit), but many states such as Missouri and New Mexico offer more attractive production expense incentives. In order to qualify for 100 percent of the credits, the company must (i) use a Hawaiian name or word in the title of the project, (ii) utilize Hawaiian scenery, culture or products on screen, (iii) produce a feature film spending a minimum of $2 million or a television pilot/episode/series spending a minimum of $750,000, and (iv) secure distribution covering 66 percent of the national U.S. coverage, based on EDI or Nielsen or domestic/foreign distribution for films.
ILLINOIS: The Film Production Services Tax Credit provides a 25 percent tax credit on Illinois wages limited to the first $25K paid to each Illinois employee of the production; however, the Act was originally set to sunset on 1/1/05, but has been extended for a year. Illinois also offers a hotel tax exemption for stays exceeding 30 days.
LOUISIANA: The Motion Picture Incentive Act provides filmmakers with an exemption from sales and use taxes if expenditures exceed $250K in one year. The Act also provides for an employment tax credit equal to 10 percent of the total aggregate payroll for employed residents when production costs are between $300K and $1 million, or 20 percent when production costs exceed $1 million. Louisiana also has an investment tax credit, providing Louisiana taxpayers who invest in a film production a tax credit of 10 percent of their actual investment if it is between $300K and $8 million, or 15 percent if it is greater than $8 million.
NEW MEXICO: The state has three major tax incentives: (i) A 15 percent tax rebate based on all the expenditures the production has within the state that have a state tax attached. (ii) The “Film Investment Program” which is an interest free loan up to $7.5M per project which is applicable to films and television. To qualify, at least 60 percent of the below-the-line payroll has to be paid to New Mexico residents and the film must be substantially shot in New Mexico (about 85 percent). (iii) The Workforce Training Program provides for the return of 50 percent of the salary of cretin New Mexican crew members as an incentive to promote crew member skill set enhancement. Theses incentives are not exclusive, and may be combined.
NEW YORK: The New York tax credit is targeted to promote the business within large sound stage production facilities. If 75 percent of a film’s stage work is produced, in an qualified facility, producers receive a tax credit of 10 percent against all the below-the-line costs that are associated with that stage work. To secure a 10 percent tax credit of all the below-the-line production costs in New York, a production must spend either $3M at the stage, or shoot 75 percent of the location work in New York. This includes preproduction, production and postproduction. Additional incentives include, all production consumables and equipment rentals are exempt from state sales tax, exemption for hotel stays exceeding 180 days, free permits, parking and police in NYC. (Please note that New York City recently enacted a new program providing for as much as 12.5 million in annual tax credits for production in New York City.)
NEW JERSEY: Sales and use tax exemptions on tangible property, machinery and equipment; sales tax exemption on hotel stays exceeding 14 days. The Film Production Assistance Program allows film projects to qualify eligible for loan guarantees of up to 30 percent of the bank financing cost of the project, or $1.5 million, through the New Jersey Economic Development Authority.
PENNSYLVANIA: The Film Production Tax Credit provides a 20 percent tax credit for production expenses incurred in-state provided that 60 percent of production expenses are incurred in-state. All production consumables and equipment rentals are exempt from state sales tax.
The authors wish to thank Matthew Lehrer and Art Chang who assisted with the research and preparation of this article.