IRS puts film tax credits in peril

Critics say ruling weakens incentive to stay in U.S.

In a blow to the attempt to curtail runaway film production, an IRS ruling has taken effect that threatens to severely undercut a tax credit designed to give financial incentives for movies made in the U.S.

In a preliminary decision Friday, the IRS decreed that participations and residuals must be counted as a production cost when film and TV show producers use a federal "runaway production" tax credit approved in 2004.

"The IRS and Treasury De-partment believe that the statute requires P&R costs to be included in the production cost limit," the IRS said in its preliminary ruling. "For example, the statute specifically provides that participations and residuals are excluded from the definition of compensation for purposes of determining whether the production was a qualified film or television production."

In effect, the IRS decision is likely to mean fewer films will qualify for the tax cut, leading some productions to avoid filming in the U.S. The decision also could hurt low-budget films that become hits, as participations and residuals are paid on revenue the film earns. A big hit could cause the film to rise above the tax credit limit, triggering a fine or other retaliation by the IRS.

The IRS ruling was issued as a "temporary" regulation. As such, it has not subjected its proposals to a public comment period or hearing. Comments on the rule are due by May 10, and the IRS could convene a public hearing on the matter. Pressure from the public could force the IRS to change its mind.

Pressure from Congress also could have an impact, and key lawmakers say they are prepared to apply it.

"After years of working to pass a tax incentive that would help keep film productions in this country, it is a huge disappointment to see regulations that virtually negate that goal," said Rep. Howard Berman, D-Calif.

Berman, a senior Democrat and chairman of the House Copyright Subcommittee, said he and other lawmakers such as Reps. Charles Rangel, D-N.Y., and Jim McCrery, R-La., recognize the importance of the tax credit. Rangel chairs the tax-writing House Ways and Means Committee, and McCrery is the panel's senior Republican.

"However, there is a new climate in Congress, and both the chairman and ranking member of the Ways and Means Committee recognize that runaway production is an extremely serious problem," Berman said. "They have indicated their interest in finding solutions that will encourage productions to stay in the U.S. We'll have to get back to work on it as soon as possible."

As part of the 2004 JOBS Act, Congress included a "runaway production" credit that allows independent producers to write off a movie in a single year if it cost less than $15 million-$20 million. Films or TV shows qualify for the credit "if 75% of the total compensation of the production is compensation for services performed in the U.S. by actors, directors, producers and other relevant production personnel."

The DGA, IATSE and SAG said Friday's ruling does not reflect the intent of Congress.

"We are extremely disappointed with today's ruling, which we believe undermines the intent of the production incentive contained in the JOBS Act legislation," the guilds said in a joint statement. "While the incentive may still prove workable for television production and for some independent films, the ruling that participation and residuals — which are often based on sales and profits that cannot be known at the time of production — must be included as original production costs undermines the use of the incentive for many independent, low-budget films. It was exactly those productions that the legislation was intended to help."

The agency said it made its decision because it feared that Hollywood could to easily manipulate its accounting.

"The IRS and Treasury Department are concerned that a blanket exclusion of participations from the definition of production costs would allow taxpayers to manipulate the total production cost (and avoid the production cost limit) by structuring compensation as participation payments," the ruling said.

But industry executives contend that there are ways to prevent any questionable activity, pointing out that many of the payments go by a set formula.