On March 27, Congress passed H.R. 748 – the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act). The entertainment industry, like the rest of the country, now eagerly awaits the coming aid. As production companies and other entities wade through the provisions of the bill to discover their share of the benefits, they might notice that some of the stimulus will arrive in the form of favorable changes to tax laws.
For example, one major piece of the CARES Act named the Paycheck Protection Program (the PPP) involves federally backed loans for qualifying “small” businesses that certify that the loan is necessary to support ongoing operations and will be used to retain workers and/or make defined overhead payments. The PPP further provides loan forgiveness for borrowed funds used to pay eight weeks of payroll and other qualified expenses. While businesses in the entertainment industry often do not conjure the words “small business” in our minds, many production companies, and other entities such as talent management firms, might ultimately qualify for these federally backed loans and subsequent forgiveness. For a deeper dive into the PPP provisions and who qualifies, see our earlier post.
Normally, debt forgiveness gives rise to taxable income. However, any loans forgiven through the PPP will be excluded from taxable income. Essentially, for a production company that qualifies, the federal government is not only offering free money to pay for certain expenses – it is offering tax-free money. It is unclear whether taxpayers can receive a double benefit by deducting expenses funded by a PPP forgiven loan. And, on a related note, states have not yet conformed to this exclusion, so the question remains whether any PPP debt forgiveness will give rise to taxable income in states such as California or New York. Production companies should stay tuned for the resolution of these issues.
Production entities also stand to benefit from modifications made by the CARES Act to the net operating loss and excess business loss rules, which will help temporarily alleviate potentially costly timing issues created by the Tax Cuts and Jobs Act and allow these companies to focus on the far-reaching effects of the coronavirus on their business.
Looking back, the Tax Cuts and Jobs Act of 2017 (TCJA) did not renew Internal Revenue Code Section 181, which allowed for the immediate expensing of qualified film and television production costs, generally up to the first $15 million incurred, which would have otherwise been capitalized and deducted over 10 years. The immediate expensing of costs often matched up with the recognition of income by these same entities, especially when a production company received payment of an advance royalty prior to production.
The TCJA essentially replaced Section 181 with bonus depreciation for such qualified film and television production costs and even removed the dollar limitation. But the accelerated cost recovery under these bonus rules came with a catch: the taxpayer must generally wait until the commercial release or initial broadcast of the content in order to take the deduction, as opposed to immediate expensing as incurred under Section 181.
In this new landscape, production companies, especially independent film and television production entities, may have recognized income in one year because of an advance royalty and then created net operating losses in the next year when their bonus deduction was allowed.
However, under the TCJA, net operating losses were not quite as desirable. Taxpayers could no longer carry back net operating losses arising after December 31, 2017, and a production company stuck in the situation described above could no longer simply apply the net operating loss from the second year backward to offset income from the first. The TCJA further limited the benefits of net operating loss carryforwards, as any net operating losses carried forward from that point on could offset only 80 percent of taxable income in a particular year. Last, the TCJA created the excess business loss rules, a new limitation for non-corporate taxpayers. As a result, the TCJA left production companies with a minefield of timing issues to navigate in hopes of avoiding the creation of net operating losses it could not even fully use; for a more detailed discussion of such timing issues, see “Entertaining Taxes” in Los Angeles Lawyer, Entertainment Edition.
But the CARES Act, along with the earlier enacted extension of Section 181 through December 31, 2020, will help alleviate some of these concerns for the time being. In a nutshell, the treacherous landscape described above will not come into effect until tax year 2021 (unless Congress extends Section 181).
Production entities can again invoke Section 181 for any qualified film and television costs incurred during tax years 2019 and 2020 (the election must be made with the tax return, with extension, so the ability to elect for 2018 is likely lost). Note that bonus depreciation is still likely available for any costs in excess of the Section 181 dollar threshold. Additionally, under the CARES Act, taxpayers can now carry back net operating losses created in tax years before 2021 to the prior five taxable years. Last, the 80 percent limitation on net operating losses and the excess business loss rules imposed by the TCJA are removed for tax years before 2021.
For now, the CARES Act generally eliminates the timing issue risk created by the TCJA for production entities. And for some of the production entities that could not avoid creating net operating losses, the CARES Act will allow them to carry back these losses in the way that they could have before the TCJA. However, the independent film and television production entities most affected should note that, once 2021 begins, the planning required to avoid these timing issues will likely be back in full force.