As quickly as cameras flash at the Oscars, Congress passed the Tax Cuts and Jobs Act (“TCJA”) and left taxpayers holding the bag in some areas. Unlike in the movies, taxpayers cannot do a reshoot if the first take is not perfect. After almost two years, Congress may again pass additional legislation within a 48-hour period, which may resolve certain issues that have arisen in Hollywood since the TCJA.
On December 18, 2019, the House passed tax legislation as part of an omnibus package that included, among other things, extending Internal Revenue Code Section 181 (“Section 181”) retroactively from 2018 through 2020, which ultimately means that taxpayers may be able to elect Section 181 treatment for the 2019 and 2020 tax years. The Senate is expected to pass this legislation on December 19, 2019. Many taxpayers may wonder, “why do we need Section 181 if qualified U.S. film/TV productions (and live theatrical productions) already are eligible for bonus depreciation under the TCJA?”
For those who have already forgotten about Section 181, prior to the TCJA production companies were eligible to elect to deduct production expenses of certain qualified U.S. film/TV productions (and live theatrical productions) as and when incurred (subject to a $15m cap) in lieu of recovering such costs over a 10-year period. While Congress did not renew Section 181 beyond December 31, 2017, the TCJA included such qualified productions as property eligible for bonus depreciation.
While at an initial glance the Section 181 and bonus depreciation may seem to be comparable provisions, there are two key distinctions: (i) Section 181 only allows current production cost deductions up to $15m (and $20m if incurred in certain low-income or distressed areas), whereas bonus depreciation is not subject to such a cap, and (ii) production costs under Section 181 may be deducted as and when incurred, whereas bonus depreciation may not be deducted until the qualified production is placed in service (generally the initial commercial release or broadcast). While the first distinction is a substantial benefit, the second can lead to substantial timing differences for certain types of production companies (e.g., income recognition in one year with an expense recognition in a subsequent year, with no ability to carry back NOLs under the TCJA). For a more detailed discussion of such timing differences, see “Entertaining Taxes” in Los Angeles Lawyer, Entertainment Edition.
California taxpayers should be wary, as the state has never adopted Section 181 and this latest round of federal legislation is unlikely to change that. It is also important to note that California never adopted the TCJA’s bonus depreciation rules. What this means, in short, is that California taxpayers can expect a disparity between federal and state taxable income regardless of which of the above avenues they choose to deduct their production costs from a federal income tax perspective (e.g., when calculating California tax liability, taxpayers will generally depreciate production costs over a 10-year period using the income forecast method).
If passed, the extenders package would provide additional flexibility for production companies to potentially solve the above timing difference by electing Section 181 treatment in lieu of bonus depreciation. So, perhaps, taxpayers may get a “take two” at production cost recovery.
Update on 12/20/19: President Trump has signed the extenders package, including IRC 181, into law.