Fairness in tax law is always a matter of the observer's vantage point. A narrowly drawn provision that helps us is a way of leveling the playing field. An equally narrow provision benefiting someone else is a special-interest tax loophole. This observation is often followed by speculation along the lines of, "Who did someone know/perform a sex act with/bribe to get that into the law?" My last column took some shots at certain "Christmas tree" provisions in last fall's American Jobs Creation Act, involving restaurants, NASCAR racetracks and fishing tackle box manufacturers.

That bill also contained a provision intended to boost independent film production, or so it seems. Let's see how well this stands up to closer scrutiny.

The Basics

Most PerformInk readers think about income and deductible business expenses on a cash basis. You report the income when (sometimes if) you get paid, and you take the deduction for the year in which you paid the expense or charged it on your credit card. Larger businesses, however, must use what is called the accrual method: income is recognized when it is earned (not when it is paid) and expenses are recognized when they are incurred (even if unpaid at year-end). If a business has inventory, it cannot treat the cost of the merchandise as an expense until the goods are sold (or stolen or destroyed as unsellable). The revenue and cost of goods sold are said to be "matched."

Film and television production have always accounted for the cost of creating the work as a type of inventory. But, unlike cans of peas, there is no single unit to which a cost can be assigned. Instead, the cost of producing film and television has been spread over the periods in which the work earned income. If at the end of year one you forecast that the film had earned half of the money it would ever earn, you recognized half the expense; you then made similar forecasts each year until there was no further income expected. Stage productions, musical recordings and big-budget films must still follow these rules.

Under the new rules, low-budget film and television productions can deduct these costs when they are incurred rather than when income is earned. The notion—a true one—is that a deduction now is more valuable to an investor than a deduction later. But it is equally true that many low-budget films are never released, even as direct-to-video; investors in these films can deduct the money they invested.

Does It Work?

Will this change make investing in independent film more desirable for investors? Probably, but not as much as other press accounts suggest. Another tax rule, about passive activity losses, will keep many investors from seeing any tax benefit. Simply stated (and it is a complex rule), losses from a passive investment of this sort can normally only be offset against income from other similar investments. Otherwise, the passive investor must wait until he disposes of the investment, whether by sale or dissolution of the production partnership, to deduct his loss.

Not many people have significant passive investment income, so few outside investors will find much benefit from the accelerated write-off of production costs.

So who really benefits?

Closer Reading for Subtext

The definition of "low-budget" in the new law is a mite peculiar in a couple of ways. The project's cost cannot exceed $15 million unless a significant part of the cost is incurred in certain poor communities or (and I quote, because it's too weird to paraphrase) an area designated as "a distressed county or isolated area of distress by the Delta Regional Authority" in which case the limit is $20 million. The Delta Regional Authority, for those of you comprising the 99.9999 percent of Americans who have never heard of it, is a federal-state agency that essentially distributes federal pork-barrel project money to communities flanking the Mississippi River from near Cairo, Illinois to New Orleans, plus a few isolated patches of Alabama.

A more important definitional peculiarity means that this provision is not really about low-budget film at all. Rather, it is a big loophole for producers of episodic television. They are not subject to the passive activity rule because they are actively engaged in the work.

The act is vague, but the Congressional Conference Committee report makes it clear that each "scripted, dramatic television episode" stands alone for the purpose of the $15 million limit. By this definition, just about all scripted television programs are low-budget. The only obvious exceptions would be the final seasons of shows like "Seinfeld" or "Friends."

I would not want you, gentle reader, to think that this is a complete giveaway to the studios and networks. Another clause in the act limits the direct write-off of costs to the first 44 episodes of a series. After the second season, the poor dears must use the income forecast method for all those lovely future years of syndication revenue.

Of course, by then the successful series has been passed on to hired show runners, and the producers are creating new, immediately deductible, flops.

Can't Know It All

The act and committee report use technical film and television terms too accurately to have originated in the White House, Congress, or, indeed, anywhere in government. The wording must have come from industry groups that got exactly what they wanted. But I cannot even speculate how the Delta Regional Authority got involved.

Don't Speculate

If you want some help in thinking about your deductions for the upcoming tax deadline, I will be happy to send you a free copy of my "Checklist of Potentially Deductible Items" for those in the arts. Just write, phone or e-mail me.

Are there money or tax questions you would like to see discussed in this column? Let me know, at 2835 N. Sheffield, Suite 311, Chicago, IL 60657, or call 773/525-1778 (888/525-1778 toll-free outside the Chicago area) or e-mail greg@gregmermel.com.

Greg Mermel is a certified public accountant whose clients in the arts range from individual performers to major theatre companies and suppliers. He also has been known to produce theatre.

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