The Power of Entertainment Tax Credits

Editor: Michael D. Koppel, CPA/PFS/CITP, MSA, MBA

State & Local Taxes

In recent years, Atlanta and other towns in Georgia have evolved into a mecca for feature film and television productions. The transformation of Georgia from the land of peaches and peanuts to the location for Oscar- and Emmy-caliber movies and TV shows could be credited to the Georgia Legislature and the Georgia Department of Economic Development’s film, music, and digital entertainment tax credit (Ga. Code §48-7-40.26(c)).

As Hollywood came to realize that filming on location outside a soundstage in Los Angeles could save money, even given the travel and relocation costs, a number of states have courted entertainment production companies. Many states have created tax credits to attract productions to their states. The most powerful incentives over the last decade have been state income tax credits.

The promise of increased economic activity has motivated states to create the credits and make their administration more efficient. According to Lee Thomas, director of the Film, Music and Digital Entertainment division of the Georgia Department of Economic Development, the additional economic output related to Georgia’s program in 2007 was around $244 million, and by 2012 it had grown to $3.1 billion (Ramati, “Buzz for 42 Heightens as Premiere Approaches,” The (Macon) Telegraph (April 6, 2013)).

Technical Aspects

Some states have attempted to persuade production companies to film in their locales by offering sales tax or payroll exemptions, but by far the most common state tax incentive for encouraging filming in one state over another has been the state income tax credit.

Most entertainment tax credits are designed as incentives to economic development in the state, so they are based on expenditures in the state or amounts paid to vendors or employees located in the state. Georgia’s tax credit base, for example, consists of expenditures normally incurred in a video production (e.g., camera equipment, lighting, stage and studio equipment rentals, electrical and sound recording supplies, and makeup), but also may include hotel and lodging, airfare and insurance (if purchased through Georgia-based travel or insurance agencies), purchase or rental of vehicles, and payroll of up to $500,000 per employee (Ga. Comp. R. & Regs. §560-7-8-.45).

The credits are generally limited to projects that have a minimum qualifying production expenditure total (or “spend”) in the state. The minimum amount may vary based on the type of production. For example, in Missouri the amount is $50,000 for productions under 30 minutes in length and $100,000 for productions over 30 minutes in length (Mo. Rev. Stat. §135.750), and in California it is $1 million for feature films and new TV series and $500,000 for movies of the week and miniseries (Cal. Rev. & Tax. Code §§17053.85(b)(15), 23685(b)(15)). Some states also have annual funding allocation caps, making the process for applying for and receiving an allocation of credits more competitive and, thus, less certain and riskier for the production company. However, some states, such as Louisiana, Illinois, and Georgia, have no cap, making an allocation of credits more certain and based mainly on the project and its qualifying expenditures. The actual tax credits are based on a formula, which generally is the amount of qualifying expenditures times a credit percentage.

For the most part, these tax credits serve as a deemed payment of, or direct offset to, the production company’s state income tax liability. Most states that offer these types of tax credits allow a carryforward period if the credit cannot be fully used in the year it is generated, ranging from three years (Arkansas, Connecticut, and Nevada), to five years (Georgia, Florida, Illinois, and Massachusetts). Louisiana’s carryforward is 10 years.

In addition, some states’ tax credits are “transferable.” This enhances the value of the credit because a production company does not need to have a tax liability in a state to realize a benefit. The company can sell the credits to other taxpayers who have no relationship with the film or television production but who do have tax liability in that state and can more readily and more quickly realize a tax savings.

Production companies often sell these transferable tax credits at a discount from their face value (generally 10% to 15%). Given this, the buyer of the tax credit realizes a small amount of cash on cash arbitrage, as it is paying less for the credit than it will claim as state taxes paid on its state income tax return.

The issue of transferability has aroused much debate over the past decade. Recent IRS pronouncements and court cases have ruled that if a state tax credit is transferable, it is deemed to be “property” within the meaning of Sec. 1001 (see Chief Counsel Advice 201147024; Tempel, 136 T.C. 341 (2011)). As such, it is considered a state income tax payment made with property in lieu of cash and thus is a deductible state income tax payment.

However, a negative consequence of this analysis has been that since the negotiable tax credit is deemed to be “property” for federal income tax purposes, the difference between the purchase price for the tax credits and the ultimate tax savings realized by claiming the tax credit with the state is considered gain realized from the sale or exchange of a capital asset under Sec. 1221. Thus, it is taxable for federal income tax purposes.

Whether the holding period is short term or long term is determined in the same manner as any other capital gain transaction. The holding period begins on the date of the transfer of the credits from the production company to the buyer, and the relinquishment date is the date the state income tax return is filed on which the tax credit is claimed.

Another feature of the Georgia tax credit is that it may be purchased in a year other than the year it was generated. For example, a taxpayer that realizes it has a liability for the 2012 tax year when preparing its return in 2013 can purchase 2012 Georgia film credits to claim on its 2012 Georgia state tax return.

How to Get Involved

Understanding a client’s tax footprint is important. If a practitioner operates in, or has a significant client base in, a state that offers these credits, the benefits are evident. However, a practitioner may be located in Virginia but have a C corporation client with a Georgia location and Georgia-source income, or be located in Idaho with a client that has Louisiana-source estate or trust K-1 income. Given that a transferable credit can be used shortly after purchase and can be purchased at a discount, the time value opportunity cost can be negligible.

The state entertainment tax credit market has matured to the point that several syndication funds have been established that deal solely in state entertainment tax credits. Practitioners who have questions regarding which state provides a certain state tax credit should contact the state agency that administers the tax credit application and approval process.

In addition, many CPA firms have begun offering comfort letters for the benefit of production companies and potential buyers of transferable credits. The comfort letters, which usually take the form of a tax due-diligence letter or other agreed-upon procedure attestation engagement, give the investors in these tax credits more confidence that the project itself qualifies for the entertainment credit, that the project’s projected qualifying costs meet any minimum threshold, and that the projected expenditures represented by the production company meet the statutory and regulatory requirements to be qualifying costs.

What’s the Catch?

As with all tax credits, the cost, in dollars and manpower, associated with procuring the credit should be evaluated against the tax credit’s ultimate benefit. The states know this, and many states have made their programs easier to administer than in the past. “The original entertainment tax credit that passed the Georgia Legislature in 2005 ended up being too convoluted and cumbersome,” Thomas, the program director, has told the author. “In 2008, the Georgia Legislature significantly streamlined the process into what we have today, which has been very effective in bringing large production companies and high-profile projects to Georgia.”

EditorNotes

Michael Koppel is with Gray, Gray & Gray LLP, in Westwood, Mass.

For additional information about these items, contact Mr. Koppel at 781-407-0300 or mkoppel@gggcpas.com.

Unless otherwise noted, contributors are members of or associated with CPAmerica International.