Over the past 10 years it has been well publicized that state tax incentives have been increasingly beneficial and lucrative for entertainment companies, often in the form of state film credits. We recently wrote about California’s credit changes in their attempt to remain competitive in attracting and retaining media-production activity. But what has sometimes been overlooked is the federal tax incentive afforded to media creators who operate in the United States. This incentive, known as the Domestic Production Activities Deduction (DPAD), is a generous federal tax deduction for companies, or the individual owners of companies, that produce or manufacture in the U.S. The deduction was established to incentivize U.S. manufacturing and curb the loss of jobs to overseas markets. As a result, the amount of wages paid to U.S. employees plays an important part in determining the deduction amount and will be discussed below.
The deduction is most commonly associated with traditional manufacturing or agricultural activities, but it applies just as well to the production of film, television and new media. DPAD is covered under Section 199 of the Internal Revenue Code and was established by Congress in 2004. The deduction is calculated as 9 percent of production income (known as Qualified Production Activity Income or QPAI). Below is an overview of the types of film and television-related activities that may qualify a company or its owners for the deduction, as well as a simple illustration of the calculation.
Qualified Film Revenue
In order for a company to be eligible for the DPAD deduction, also known as the Section 199 deduction, it must have qualified revenue as specified by the Internal Revenue Code. One such type of revenue is revenue associated with the production of qualified films.
Qualified films include any motion-picture film or video tape (excluding certain sexually explicit films) or live or delayed television programming. This means that in addition to movies, qualified film includes property produced and licensed by cable and network television companies. But to qualify, at least 50 percent of the compensation paid to produce the film is for services performed in the U.S. by actors, production personnel, directors and producers. This is because Congress’s purpose in establishing the 199 deduction was to ensure that production and manufacturing continued to take place in the U.S.
Qualified Receipts
Once it’s established that the property being produced is a qualified film, the question becomes what revenue from the film is considered qualified receipts (known as Domestic Production Gross Receipts or DPGR). Section 199 states revenue that qualifies as DPGR includes:
- Licensing of copyrights and trademarks with respect to the film
- Content distributed via the Internet
- DVD and Blu-ray sales of the film may be considered for the producer, even if they did not manufacture the discs themselves
But in broad terms, DPGR is proceeds from the sale, lease, license, rental exchange or other disposition of the property – or advertising and product-placement revenue related to the disposition of the property.
Revenue that is specifically excluded from DPGR includes revenue from:
- Movie theater ticket sales
- Sale of a screenplay
- Sale of film-themed merchandise
However, revenue from licensing the right to use or exploit film characters does qualify as DPGR.
Qualified Production Activity Income (QPAI) Example
A company determines its QPAI by subtracting its production-related expenditures from its DPGR. Consider a film producer with $1 million in gross revenue from licensing its film and its characters plus product-placement revenue in tax year 2015. The company also had $300,000 of direct costs to produce the film as well as $200,000 of indirect costs attributed to production. The result is $200,000 of QPAI:
DP Gross Receipts $1,000,000
Less: Direct Costs (300,000)
Less: Indirect Costs (200,000)
QPAI 500,000
The QPAI is then multiplied by 9 percent to calculate the taxpayer’s Section 199 deduction amount, which is essentially a free deduction provided by the government.
In the case above, the deduction amount is $45,000. If the producer is a C corporation, the deduction will apply at the corporate tax level and reduce taxable income by $45,000. If it is a pass-through entity, such as an S corp or partnership, the QPAI and W-2 wages can be passed to its owners to be used in calculating the Section 199 deduction on their personal returns. The reason why W-2 wages are important goes back to the purpose of this incentive, which is to keep production activities, and therefore jobs, in the U.S. Because Congress wants producers and manufacturers to employ – not contract – U.S. workers, it placed a limitation on the deduction based on 50 percent of qualified W-2 wages paid during the year. In order to qualify for the full $45,000 deduction, our producer in the example above would have to have paid at least $90,000 of W-2 wages to U.S. workers during the tax year. If it only paid $80,000 then the deduction would be limited to $40,000 (50 percent of $80,000).
There are much more complexities determining a film or television producer’s domestic production activities deduction, particularly when there are multiple producers involved in a film or when networks have films produced for them. But it is a significant tax incentive that should not be overlooked and that should be explored by any company involved in the production of film, television and new media. Especially when combined with the generous state tax incentives that currently available, the Section 199 deduction can provide significant tax savings for entertainment companies and their investors.
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About Daniel Rowe (principal at GHJ)
Daniel specializes in partnership and S corporation taxation and real estate development and investment. Prior to joining GHJ, Daniel served as tax partner at a local firm in Georgia and as tax manager at JH Cohn, LLP in New York, where he provided year-round tax planning and guidance for high-net-worth individuals, advised on trust and estate matters, and represented clients in federal, state and local audits. He began his career with Deloitte & Touche, LLP as an assurance and advisory services senior in Baltimore.
