Section 181’s Extension to Live Stage Productions Doesn’t Set Clear Path for Producers, InvestorsBy Christopher A. Cacace | May 2, 2016
By Thomas D. Selz, Bernard C. Topper Jr. and Christopher A. Cacace
At the end of 2015, Congress passed, as part of a large tax extender bill, the Protecting Americans from Tax Hikes Act (PATH), H.R 2029 (http://1.usa. gov/1JPofei), an extension of §181 of the Internal Revenue Code. Section 181 has been available since 2004 to permit expedited deduction of the costs of a film or TV production. The present version of §181 permits an expedited deduction of a production’s costs up to $15 million ($20 million in certain circumstances). Since inception, this has had several sunset provisions, each of which was extended as part of year-end extender bills. The latest for the first time has extended the availability of §181 treatment to live stage productions.
Will this new provision be helpful to producers of live theatrical productions as they seek to raise funding for their shows?
First, we should note how live stage production costs, frequently incurred over several years, are deducted for tax purposes in the absence of §181. They are capitalized until the year in which the first paid public performance occurs. They are then deducted (amortized) under the so-called “income forecast method,” based on income forecasts for the production, which are required to be reviewed and adjusted at various times.
Second, §181 treatment for live stage productions applies to productions whose first paid performance commences in 2016. But the application of §181 is not automatic. It instead requires that a timely election must be made to apply §181. Generally, this will require that the election must be made on a timely filed tax return for the first tax year in which the company producing the show reports profits and losses to investors on a K-1. (Note: We are assuming, as is usually the case, that no prior tax returns for the production company have previously been filed deducting certain development expenses.)
Since this new provision of §181 for live stage productions is ef- fective only for shows with a first paid public performance in 2016, that meant that a show with such a first paid public performance could have elected to use §181 when it filed 2015 tax returns, deducting all production costs as losses (because there is no revenue until the show opens in 2016), which investors could use if they have other qualifying passive income in 2015. (But see the discussion below about the earliest date for production costs that can be used in computing such losses.) This assumes, however, that the producer expected in 2015 that the production would go forward.
(Under existing §181 regulations — Reg. §1.181-2(b) — a §181 election cannot be made until the tax year in which the producer “reasonably expects (based on all the facts and circumstances) that the production will be set for production ….” There is no “bright line” test for making this determination. A producer should consider such factors as whether the production has incurred actual production costs, whether these costs are a significant part of the budgeted production costs, and whether the production has raised all, or substantially all, of the investment for the show.)
Third, §181 treatment is only available for a live stage production with a written play (or book for a musical), and only if the seating capacity of the venue in which the production occurs has a seating capacity of not more than 3,000 people (or where a majority of houses meet that test if it is a touring production). There is an exception, though, for “seasonal productions,” that is, not presenting for more than 10 weeks in a tax year, where the venue capacity can be up to 6,500 people.
As noted above, a live stage production frequently incurs costs over many years before the opening. Section 181 addresses when the election can and must be made to take advantage of §181 treatment, but it does not explicitly state in the statute how far back costs can go when reporting losses on the first tax return for the production.
For a show opening in 2016, can a production go back to 2010 or earlier to when an option was first taken or a play first commissioned? On the face of the statute, that would seem to be proper, but unless and until there is some administrative or legal authority on this point, it is not certain how far back costs can be reported on the first tax return for the production company.
What happens with production costs for a show that does not open until after Jan. 1, 2017? The production costs will not be deductible unless §181 has been extended — as it has been each time in the past it would have otherwise expired (although frequently not until late in the next year on a retroactive basis).
Anyone wishing to use §181 for shows opening after Jan. 1, 2017, should thus review the situation each time the law is set to expire.
Some of the uncertainties could be addressed in IRS regulations, but since the law, unless extended, is set to expire at the end of 2016, one has to wonder whether the IRS will get around to issuing regulations any time soon.
Allocating Deductible Expenses
Another issue involves the following type of scenario: A producer raises money starting in 2015, and with a minimum/maximum offering, begins spending it in 2015. The producer continues raising money up to the maximum to be raised in the offering (or the expiration date of the offering as set forth in the offering materials). How are the deductible expenses to be allocated among the investors? Because the extension of §181 to live stage productions occurred only in December 2015, the possible treatment of §181 deductions among members of an LLC raising and spending money in 2015 and in 2016 would not have been addressed in the LLC Operating Agreement that is part of the offering materials.
So what are the producer and its accountant to do? One logical way of treating the deductions would be to have deductions for costs paid in 2015 allocated to those members who have paid in their capital in 2015, any unused investments rolled into 2016 and then have 2016 deductions for costs in 2016 allocated pro rata to members based on their investments in 2016, together with the rolled-over investments for which deductions had not yet been taken in 2015 (and with any reserves allocated among all investors based on respective investments).
Note, however, that investors cannot have deductions for costs incurred before they are members who have invested their capital. Without §181, where amortization of costs cannot begin until the production opens, and assuming that a producer will not continue raising money after the opening, all investors have become members by the time costs of production are to begin being deducted on their K-1 forms. So allocating amortization deductions is not an issue that would have been addressed in the Operating Agreement.
But where deductions can be taken against other qualifying passive income as costs are incurred, unless the Operating Agreement provides for staged closings, the accounting can become a nightmare if losses from paying bills needs to be recalculated each time a new investor comes in. The possible choices about how often to have closings, which needs to be disclosed in an Operating Agreement and in offering documents, likely involves individualized considerations.
But back to our problem of money being raised and spent in 2015 and 2016 where the possibility of §181 treatment for a live stage production was not contemplated in the offering documents and Operating Agreement. A producer should consider doing an amendment to the Operating Agreement and offering documents to provide for staged closings and allocations of deductions at each closing based on the rolling approach discussed above (or another approach that works for a producer and its lawyers and accountants). Although each investor will have a right to pull out his investment based on the change, the early investors will be getting all of the deductions for the early costs, so it will be to their advantage to go along with the change.
Section §181 treatment for live stage productions offers a possible incentive to invest for investors with other qualifying passive income, but some of the uncertainties noted above, and careful consideration about matters such as staged closings and allocations of deductions, need to be taken into account before the benefits of §181 are described to potential investors.
About Christopher A. Cacace
Christopher A. Cacace, CPA, is Partner-in-Charge of the Theater, Media and Entertainment Group at Marks Paneth LLP and Partner-in-Charge of the firm’s Westchester office. He is also a member of the Marks Paneth Executive Committee, which sets policy and strategy for the firm. He has a deep expertise serving theater and entertainment clients and has done so for nearly 40 years. Mr. Cacace started his career in accounting at Pinto Winokur & Pagano CPASs theater practice,... READ MORE +