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Production Tax Incentives Extended, but Should Hollywood Care?

ANALYSIS: Tax code section 181 was extended retroactively, but experts disagree on who benefits - if anyone.

ANALYSIS: “Very valuable” or just “a hill of beans”? That’s the question surrounding Section 181 of the tax code, a film financing tax deduction that Congress recently renewed through 2011. Experts disagree on the answer.

Time to delve into the tax code, always a scary proposition.

Section 181, which was extended by Congress retroactive to the beginning of 2010, permits a 100% deduction for the first $15 million of the cost of films and television series that commence principal photography prior to 2012. So explains a memo by Schuyler Moore, a partner specializing in entertainment tax law in the Los Angeles office of Stroock & Stroock & Lavan.

That sounds simple, but no tax provision ever is. At the most basic level, cautions tax counsel Bernard Topper of New York entertainment law firm Frankfurt Kurnit Klein & Selz, people confuse tax deductions with tax credits. Credits reduce taxes dollar for dollar: a $100 tax credit reduces your taxes by $100.

In contrast, a deduction comes off of taxable income. That results in a lower savings. For instance, if you’re being taxed at 30%, then a $100 tax deduction saves just $30 in taxes.

Many state and foreign production incentives are tax credits, whereas Section 181 provides a deduction, which is less valuable. Still, says Topper, the combination of federal and state incentives is “fairly powerful.” He asserts that Section 181 has helped reduce foreign runaway production – the flight of film production to foreign countries. Topper’s partner Tom Selz says that combining state and federal incentives provides an “enormous benefit” to independent film producers and their investors.

Moore couldn’t disagree more. Where Selz sees a provision that’s “very valuable” to investors and has been used “fairly aggressively,” Moore sees “kind of a hill of beans” for the independent world.

Why the difference in opinion? Section 181 provides investors with “passive losses,” since most don’t actively participate in making the movie. Those passive losses can only be offset against passive income, such as income from the movie itself or from certain other investments, such as real estate or oil and gas wells.

Topper and Selz point to such investors as beneficiaries of the provision, but Moore says “most independent films lose money” and asserts that there aren’t a lot of real estate investments making money these days either. (No word on the health of oil and gas wells.) Without passive income from such sources, the investor has nothing to offset the Section 181 deductions against.

These lawyers also disagree on whether Section 181 is useful to studios. Moore says yes, noting that studios have film income that Section 181 deductions can offset. “The studios were probably dancing when the provision was renewed,” he speculated, presumably referring to gamboling executives rather than frolicking sound stages and backlots. Selz has a different view, arguing that studios already had beneficial tax provisions, so that passage of Section 181 in 2004 added nothing of importance for them.

Differences aside, all three lawyers acknowledged that retroactively extending an incentive was a bit peculiar, since you can’t incentivize something that’s already happened. And no one was quite sure who had championed the extension, which was part of a larger tax extension bill that was itself attached to the tax cut bill the president signed last month. It seems the tax code is packed with mysteries, and probably always will be.