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Grandfather Your Section-181 Benefit Now

by Jeff Steele

The federal Film and Television incentive known as Section §181 expires at the end of 2011.  If you have not grandfathered your film or series, then you must do so now, before the end of the year.  If you do it correctly, then your film or series (up to 44 episodes!) will remain eligible indefinitely – which can be a powerful motivator for potential investors.  You do not need to have investors to be grandfathered; you just need to memorialize a few things before year’s end.

Section-181 is a very lucrative, accelerated tax deduction that American investors can use to offset (i) Passive Income (e.g. income from residuals, royalties, real estate, oil & gas, etc.), or (ii) All Income (including wages) if the investor participates in the production.

The incentive allows investors to deduct the entire amount of their investment in the tax year(s) the money is spent, as opposed to being required to amortize it over several years.  This is not a tax credit that producers can sell for cash, nor is it a rebate check from the Feds; it is an accelerated deduction that can amount to significant tax savings for investors, which, in combination with a some state credits (like Louisiana) can cover as much as 50% of the investment risk.

Please note that this is not the convoluted Grand Army tax scheme that tried to net productions 10% of their budgets (barely covering the cost of the 50+ attorneys it took to close that deal.)  This is a straightforward election for how investors ultimately want to account for their investment – the benefit of which can be divided pro-rata across multiple investors.

One could argue that using the §181 deduction converts investor profits into ordinary income, which is taxed at a higher rate than the capital gains rate they would otherwise pay; but how many film investments go into net profit?  Are independent film investors better off mitigating potential losses or maximizing potential profits?  If I had to guess, I’d say that 20% of producers would argue that you should mitigate losses, 30% would say maximize profits.  The other 50% don’t know because they don’t understand passive income or risk mitigation, which I believe, is why indie producers never embraced Section-181.  To be fair, over the years I’ve spoken with countless investors who also had no idea the law existed.

Film Closings is working with entertainment attorney, Corky Kessler, who helped draft §181, and we have devised a package for investors and filmmakers who wish to secure this for their 2011, 2012 or 2013 projects.

To grandfather your film or television series, you need:

  • To have your LLC investor docs drafted and done, but do not need any investors.  Note: Different docs are required for accredited vs. non-accredited investors.
  • A budget and screenplay, but none need to be final and can be amended.
  • One day of principal photography with dialogue, but it need not be in the final edited film.  This does not require a full cast/crew, just shoot it handheld on HD and make it look decent.
    • The one-day needs to only be in the screenplay as originally drafted (keep the one-day in your file as proof along with the budget at the time and screenplay at the time.)
    • The one-day should be time stamped and date coded.
    • For a television series you need to only do the one-day of the pilot or original episode and then you are grandfathered for up to another 43 episodes.  The total under Section 181 is 44 episodes.

Most importantly, you need to have an entertainment attorney on board and an accountant that knows Section 181:

Failure to properly account for, or failure to declare §181-election status on the first tax return for the project, will exclude the project from Section §181 benefits.

Please contact Film Closings for assistance in securing your benefit status.

Jeff Steele
Film Closings
212 Marine Street
Suite 100
Santa Monica, CA 90405
(424) 235-5050
Jeff@FilmClosings.com

Corky Kessler
Deutsch, Levy & Engel
225 W. Washington St.
Suite 1700
Chicago, Illinois 60606
(312) 346-1460
Kessler@dlec.com
  • Russ

    This is only for US residents or production in US? Thanks.

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    • Jeff Steele

      Yes, you have to be a US resident to take advantage of Section-181.

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      • Jeff Steele

        CORRECTION: THE INVESTOR DOES NOT HAVE TO BE U.S. CITIZEN, JUST A U.S. TAX PAYER.

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  • http://www.goldcapfilms.com Joe Gold

    Hey Jeff, if you are financing an ultra-low budget film yourself through your own money and crowd funding, I believe it is possible to be eligible for a section 181 benefit without having to create an LLC. Of course, there may be other reasons to create the LLC. But I don’t think creating an LLC just to “get grandfathered in” for section 181 is wise. I spoke with an accountant who was recommended by Corky, and this accountant told me that it is possible to get a section 181 benefit for yourself with a sole proprietorship. Of course, people should speak to their own accountant. This 181 benefit would only be yourself, not for any crowd funding donors. If you want to have real investors, you will need the LLC. But I still think it’s probably smart to already have interested investors before creating an LLC.

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    • Jeff Steele

      My understanding is that if you are self financing, then you do not need to form an LLC. But you still need to properly make the 181 election. Regarding crowd funding, the “crowd” is usually providing you with free/gift money — the crowd is not investing in the film’s potential profits, so their is no investment-deduction to take.

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  • Michael

    To confirm, contacting Film Closings for assistance with securing 181 status implies getting a quote of how much you would charge for the service?
    thanks

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    • Jeff Steele

      Yes. Mr. Kessler will prepare a filing package for accredited investors.

      Film Closings will prepare a production package for the one-day w/ sound, as well as a production team to shoot it.

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  • Michael

    Another question please. If I have a single LLC but multiple projects, say 4 films, can I grandfather all 4 films under the same LLC (using above guidelines) or will I need to register a separate LLC for each film/project?
    thanks

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    • Jeff Steele

      Each film must have it’s own LLC and investor filing and register separately. They must also each have their own one-day w/ sound, and production package.

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  • Michael

    Sorry, questions keep popping up :) If I’ve been shooting a film sloooowly, over past two years, and have footage with dialogue from 2010 (but never filed 181), will that qualify or do I still need dialogue footage done in 2011? If the project started last year but LLC is created this year, can last year’s activity “belong” to the new LLC?
    thanks again

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    • Jeff Steele

      That depends on whether you’ve filed any tax returns for your LLC. If you have filed a tax return for your LLC (but did not properly make the 181 election), then you no longer qualify; if you have not filed a tax return for your LLC, then you still can — but you better do it correctly the first time or you will lose the benefit.

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  • http://www.odethemovie.net Brian Mathew Kowalchuk

    Impressive information, Jeff. Do the actors for the one-day have to be the same as those in the full/final production? Thanks.

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    • Jeff Steele

      No, it does not have to be with final cast.

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  • Daniel Shawn

    Jeff, Thank you for all your help. It was a pleasure working with you. What a relief and load off. -Daniel

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  • Vicki de Mey

    Can web series take this benefit?

    Thanks.

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    • Jeff Steele

      Yes. Web series can take advantage of Section 181.

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  • http://www.studiokinate.com Charlotte Rinderknecht

    I love your postings but this one has me scrambling to get some things finished but it begs a question in regards to principal photography. We are developing a feature animation and have started paperwork for the LLC. How does this ruling apply to animated films? Do all the drawing have to be finished by year end? We have the script, budget and director, but haven’t begun casting yet, so don’t have the voice recordings. We are developing the priliminary artwork for the pitch but need funding before any of the work can progress.
    Best
    Char

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    • Jeff Steele

      The regulations are very straightforward: one-day of principal photography with sound. You do not need final cast. Your one-day does not have to make the final cut.

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      • ari

        Jeff,

        Any chance you could provide a link to where regs cite “one-day of principal photography with sound”

        I can only find an example with 1.181-5t stating that if incur costs in year 1, but don’t start principal photography until year 2, but you expect will be a qualified film…that you can 181 in year 1.

        http://www.irs.gov/irb/2007-12_IRB/ar10.html

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  • http://Www.dv3productions.com Larry olson

    Great info thx. Do u know anything about registering the film LLC in a foreign country to take advantage of lower tax rates ?

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    • Jeff Steele

      That will not work. It needs to be a US film.

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      • Antonio

        U.S. film — does that refer to the majority of the funding coming from the U.S., or does the majority of the shooting need to happen on U.S. soil, or is it the cast/crew that needs to be from the U.S.? Or some combination of the three?

        Also, I can’t find anyone else to answer this: for the purposes of section 181, does Puerto Rico count as U.S. soil? I know it’s tricky because for some things P.R. counts as foreign and for others it’s considered domestic. If the movie is shot in P.R. (LLC is registered there) but a chunk of the funds come from U.S., or even if all the funds come from residents of the island… See my confusion? P.R. is a territory, U.S. dollar, USPS, US Army… but international flights, own Olympic team… Thanks in advance for any info you may have!

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        • Jeff Steele

          To qualify for Section-181:
          – The funds do not need to come from the U.S.
          – The financiers do not need to be U.S. citizens (merely have U.S. tax liabilities they want to offset.)
          – 75% of the wages need to be spent in the U.S. (boots on the ground.)
          – Puerto Rico does not count as U.S. soil (the statute specifically excludes territories and possessions.)

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  • http://Www.dv3productions.com Larry olson

    Another question, if one is able to sell the movie in the year it is made, is having a section 181 qualification moot? Similarly would there be benefit to having 181 qualification if the film is sold the year after it is made?

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  • Jeff Steele

    That depends on your investor’s particular tax offset requirements, which they should discuss with their CPA.

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  • frank

    Can an investor write-off corporate taxes through 181 or does it have to be personal income?

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    • Jeff Steele

      Any taxpayer: corporate or individual.

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  • frank

    Thank you. One quick follow-up question: If it were possible for the investor to write off a 100% of his investment through 181, it would mean that the investor doesn’t risk a possible loss on the deal. However, could one promise the investor an automatic profit as well by also pledging a state tax rebate to him?

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    • Jeff Steele

      Unlike a tax credit, a $100,000 tax deduction not have the same value as $100,000 cash out the door.

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  • frank

    Jeff, I guess what I’m trying to say is this.
    Can an investor get a 100% Section 181 write-off, and also, a state tax credit rebate on top of it?
    I’m figuring that the tax credit rebate is what you meant by cash.

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    • Jeff Steele

      Generally speaking the production tax credit goes to the production entity/LLC, which can then assign or convey the proceed back to the investor. State tax credits and Section 181 are not mutually exclusive, though the investor should seek professional tax guidance.

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  • frank

    Got it. Thank you.

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  • http://www.tomnoise.com Tom Noise

    The statute reads that the deduction is off of ‘passive income’ such as investments or rental property income if the investor does not qualify as a ‘material participant’ such as a producer, etc.

    That means that the deduction is not available off of ‘ordinary income’ such as wages and tips to investors who just give you money.

    So if your investor is your best friend, mother or cousin who works a regular job and collects a pay check, but does not have income (for which they owe taxes) from some type of passive income, this deduction does not apply.

    Is this correct?

    Also, if I have started principal photography through my S-Corp, have not taken the election yet, and then next year form an LLC and take investors to finish the project, and the LLC buys the project and becomes the owner, can that LLC take the election next year?

    Thanks!!

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    • Jeff Steele

      You are correct: your family cannot take the Section-181 deduction against their wages, unless they are a material participant, which I understand requires 500 hours of active participation.

      Your S-Corp/LLC scheme sounds dubious, at best. I’d would assume that it won’t work unless your tax/legal professional say otherwise.

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  • http://www.turquoisetrailfilms.com Kenneth Knoll

    Our investors have taken 181 tax deduction for development investment with several audited and non have had deduction disallowed. I asked CPA to research the one day shoot requirement and could not find where this is a requirement. Can you clarify where you got your information?

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    • ari

      Your CPA is not going to find the one day requirement in the code b/c it’s not listed there. I just spoke with an author of Section 181 from the IRS.

      I didn’t ask him about TV but rather film, and he qualified his answer by commenting on what a leading entertainment lawyer is recommending to grandfather in Section 181…which included

      the one day of principal photography, preferably with dialogue, but not necessarily required, as in the case of a documentary.

      What you are looking to do is satisfy an auditor if ever audited for taking 181. He commented about making a bonafide good faith effort to begin principal photography before 12/31/11.

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  • Chris

    Jeff,

    We created an LLC three years ago and were in the middle of casting during the financial crash of 2008 when our German Film Fund and their three million dollar investment fell out. We had shot a day of production with sound. Last year, one investor claim the 181 tax credit, due to the fact we uses some of his funds to secure various rights that we needed. It was approx 100K. Lately, we have revived the project but our accountant has advised closing the LLC. It costs $800 in california fees and another $600 form him. (We have carried it for three years) Of course, we were prepared to close it and open another if we needed to until we noticed the 181 Grandfather hiccup. We really should close it…curious what’s your opinion?

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    • Jeff Steele

      Follow the advice of your tax and legal professional.

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  • Moe

    Hi Jeff,
    I am in the process of claiming the section 181 deduction. It is not clear on how to submit this to the IRS. I received a K1 for my investment, but my accountant says it shows no activity. Is there a clear process on how to claim the deduction for an individual investor?

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  • Darryl

    Is it possible to grandfather without having an LLC? We’ve been financing our movie ourselves. I lawyer I spoke to said yes…

    Also does the screenplay, and budget need to be registered or notarized in 2011?

    And how do you prove when the one day of footage was shot?

    Any info would be greatly appreciated.

    Thanks!

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    • Jeff Steele

      The S-181 ship has sailed. Elvis has left the building.

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  • Katarina Garcia

    Oh how I wish I read your blog last year. I will be following you from now on, Jeff. Thank you for the insightful posts!

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    • Jeff Steele

      You’re welcome. Thanks for the kudos.

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  • obin

    s 181 coming back anytime?

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    • Jeff Steele

      Yes! Section 181 was extended by the fiscal cliff bill through the end of 2013 and retroactive.

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  • Alex

    You mentioned that 75% of the film has to be spent in the US. Does that mean that the money has to be spent on US crew members (no foreigners), or that 75% of the film has to be shot on US soil?

    Also, I know for an investor to use their active income to write-off the deduction they have to be involved with the film. But do they have to be paid?

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  • Alex

    One other question… When investors take the deduction, does it lower both their federal and state tax liability, or just federal? It seem that if they lower their overall tax liability, their state taxes would drop as well.

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  • Pingback: How does Hollywood manage to keep a $430 million tax break? | ResidualRx.com

  • http://www.facebook.com/jon.raymond Jon Raymond

    If you fund your film through crowd funding as an LLC, can you consider those funds as a company investment that qualifies for section 181?

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