The new tax bill has lots of bad news for Hollywood (like a $10,000 limit on the deduction of state income and property taxes), but it also has some wonderful perks. Here is a simple (perhaps way too simple for tax folks) summary of just a few of the benefits that can apply to Hollywood:
100% Deduction for Certain Property and Films
Remarkably, all taxpayers can now deduct 100% of the cost of almost all new or used “Qualified Property” with no limit. The 100% allowance is phased down by 20% per calendar year for property placed in service in taxable years beginning in 2023. Qualified Property includes almost all tangible personal property if used in a trade or business, but more importantly for Hollywood it now includes films and television shows for which a deduction otherwise would have been allowable under old Section 181 (i.e., if 75% of production costs are incurred in the United States). The big changes from old Section 181 are that (a) there is no more $15 million limit and (b) the deduction is permitted at the time of the first commercial exhibition to an audience. This means that studios may now deduct the entire cost of a big-budget film upon release. Wow! The difficulty for the independent film industry is that the deduction is a “passive loss” that can only be offset against limited types of income for individuals, so most individual investors cannot use the deduction, and the corporate tax rate is now too low to entice corporate investors that are not in the industry.
Qualified Business Income
Individuals are now taxed at only 29.6% on certain “Qualified Business Income” (“QBI”) if certain conditions are met. QBI is basically business income, but it does not include compensation, so the goal of many people in Hollywood will be to convert compensation into QBI. For example, if an individual currently takes compensation from a pass-through entity they own (like an LLC or S corporation), they will now want to stop taking compensation and have the income flow through as business income. Critically, it is not clear if the IRS can impute reasonable compensation (reducing QBI) in this situation, particularly from sole proprietorships (including single member LLCs) and partnerships. QBI does not include income over a certain level from the following types of services:
- Services for the performing arts (in front of the camera or on stage, so actors are out of luck), health, law, consulting, athletics, financial services, brokerage services, or investment; and
- Any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners. This category is critical for Hollywood; if an individual is named in the contract, they almost certainly will not qualify for the lower tax rate even if the income is paid to an entity they own, so most talent will not qualify. Producers and distributors that render services to third parties may qualify if their companies are named in the contract but not the individuals, and fights over on-screen individual credit might be subdued if people have their eyes on this exception. In any event, this exception should not exclude production or distribution companies that produce or distribute their own content.
The amount of QBI increases based on how much W-2 wages are paid, so businesses that are currently treating some workers as independent contractors will want to reverse course and treat them as employees. In the case of a pass-through entity, the provision applies at the owner level, and the owners take into account their allocable share of the business income and W-2 wages of the entity.
C Corporations as Tax Shelters
There is now a flat tax rate of 21% for C corporations, and the rate is much lower for foreign income, as discussed below. This low rate creates a huge incentive to use corporations with retained earnings, since if the 23.8% tax on dividends can be delayed for just a few years, the present value of the combined corporate and dividend tax rate is less than the 37% rate applicable to compensation received by individuals. The battleground will now shift to the accumulated earnings tax (a 20% tax on earnings retained beyond the reasonable needs of the corporation), the personal holding company tax (a 20% tax on personal holding company income), and Section 269A (the IRS is permitted to reallocate income of personal service corporations formed or availed of to avoid or evade income tax). The net result is that this approach will not work if the individual shareholder is named in the contract, so most talent will not qualify, but this could work for producers and distributors.
Foreign Income
The new bill provides a massive tax benefit for foreign income received by C corporations. One provision provides a tax rate of only 13.125% on “foreign derived” income, which includes (a) foreign income from films (unless attributable to a foreign office) and (b) income from services provided by the taxpayer to a person, or with respect to property, not located within the United States, even if the services are rendered in the United States. For example, a producer or distributor rendering services in the U.S. with respect to a film produced or distributed outside the U.S. could incorporate to use this provision, although they would have to deal with other potential taxes discussed above (i.e., the accumulated earnings tax, the personal holding company tax, and Section 269A). The net result is that this approach will not work if the individual shareholder is named in the contract, so most talent will not qualify, but once again this might work for producers and distributors.Even better than that, the new bill provides for only a 10.5% tax rate to C corporations on foreign income received through foreign corporations they own. There will now be an enormous incentive for all film companies to incorporate as C corporations and have foreign income paid to foreign corporations they control.
It’s a brave new tax world for Hollywood, so enjoy the party while it lasts!
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