Investing in Films Produced in Pennsylvania
Tax Treatment of Film Costs
Currently, under IRS code section 181, up to $15 million of the costs of film production can be deducted as incurred, instead of being matched against future income. This creates a tax loss for investors in the year funds are disbursed. This code section, however, will expire on December 31, 2013. When IRS code section 181 expires and film production companies no longer have the benefit of IRS code section 181, production companies will need to capitalize costs of film production and offset on a pro-rata basis against the income generated in future periods.
PA Film Tax Credit
Pennsylvania offers a 25% tax credit (applied to PA qualified production expenses) to production companies for qualified projects that spend at least 60% of their budget in PA. In certain cases and if specific criteria are met, the project may qualify for an additional 5% tax credit. The credit is saleable by the company making the film, and in the past has yielded approximately 90% of the film tax credit as cash.
As an example, if a production company spent $2 million in PA qualified expenses, they would receive a $500,000 tax credit. When the tax credit is sold, the production company could expect to receive approximately $450,000 in cash from the purchaser of the tax credit, thereby reducing the total cost of the production from $2,000,000 to $1,550,000.
Pre-sale of Distribution Rights
Depending on the talent, and quality of the script, the rights to the distribution of the film can be sold prior to the principal shooting of the film, reducing the total cost exposure of developing the film. There are several options in distribution such as, foreign and domestic markets. Contracts with the more established distribution companies are bankable which allows funding to be available even earlier in the process.
Reduction of Investment Risk for Investors
Following is an example of how an investor could reduce their risk related to their investment in a film production.
Example: A film project has a total budget of $2,000,000 (all PA expenses are assumed) and the investor agrees to fund the project for the full amount of $2,000,000.
The investor could request collateral in the form of:
- $450,000 cash from the sale of the tax credit upon completion of the project.
- $500,000 pre-distribution payments (this will vary based on the specific film)
Additionally, when IRS code section 181 is applicable, additional benefits are obtained based on the ability to expense all production expenses in the year incurred.
When IRS Code Section 181 is in Place - Rules for Deductibility of Losses by Investors (Note - loss deduction is always limited to the actual amount invested):
Passive Investor - Not active in the film and spends < 750 hours being involved in the film - losses resulting from the film investment will first offset only passive income. Any remaining losses are carried forward and can offset future passive income or future income generated by the film investment.
Active Investor – Person spends > 750 hours involved in the film (producer) - losses resulting from the film investment can offset other investment income, not just passive income. Any remaining losses are carried forward and can offset future income generated by the film investment.
Example – A person invests $100,000 in a film. If the investor is in the top tax bracket, which is now 39.6%, this would generate $39,600 of a current tax benefit, assuming that there is income available to offset the loss against. Any unused losses would be carried forward to future years.
