In the Words of the IRS:
When
a taxpayer produces or creates a product (video, film, recording,
etc.), the taxpayer will generally incur a great portion of the expenses
before the product is ready to produce income. When this happens, the
taxpayer is usually required to capitalize those expenses and recover
(deduct) them over the period of time that the product is producing
income. Several different provisions apply depending on whether the
taxpayer is already in the business and the specific business the taxpayer
is in.
Internal Revenue Code Section 195
Expenses for investigating, creating, or acquiring a new
business are nondeductible capital expenses. This applies to all expenses
before the day the active trade or business begins. These provisions apply
to someone starting out in the industry -- before offering a completed
product for sale, production, or distribution.
Start-up
expenses are expenditures, which would normally be deductible under IRC
section 162, if they were incurred in connection with an operating
business. These expenses, however, do not include amounts deductible under
other Code sections such as interest (IRC section 163), taxes (IRC section
164), and research expenses of a scientific nature (IRC section
174).
IRC
section 195 allows a taxpayer to elect to deduct these capitalized
expenses over a period of not less than 60 months. This is called
"amortization of startup costs" and is computed using a straight-line
computation. This election must be made by the due date of the return
(including extensions) for the year in which the business begins. If the
taxpayer does not make a timely election to amortize these expenses, they
are carried on the books as a capitalized item until the taxpayer disposes
of the business.
Internal Revenue Code Section 280
IRC
section 280 was repealed after 1986. Under this section, expenses incurred
in the production of a film, videotape, sound recording, book, or similar
property were required to be capitalized. These are expenses that would
otherwise have been deductible under IRC section 162. The capitalized
costs could then be recovered using the Income Forecast Method, beginning
in the year income is first received from the production or property.
Internal Revenue Code Section 263A
Beginning with 1987, uniform capitalization rules under IRC
section 263A apply to those taxpayers previously under IRC section 280.
These rules apply to people who are already in the trade or business. This
code section again requires the capitalization of expenses to produce a
creative work. This includes cost of researching, preparing, producing,
recording, etc. It also includes an allocation of indirect costs such as
utilities, tools, clerical, rental of equipment, etc.
Exemption From Internal Revenue Code Section
263A
Qualified creative expenses of writers, photographers, artists,
and composers are exempt from the Uniform Capitalization Rules (see IRC
section 263A(h)). Qualified creative expenses include ordinary and
necessary expenses incurred in the activity of being a writer, composer,
etc, other than as an employee. This does not mean that these people never
have to capitalize any expenses. Being a writer does not mean that a
taxpayer may not incur expenses that relate to publishing or production of
the finished (or unfinished) work. A composer may incur expenses that
relate to the production of a recording. Expenses that are not directly
tied to the creative activity of being a writer, composer, etc., may still
require capitalization.
Cost Recovery
Expenses which represent the basis of an asset used in or
produced in a trade or business may be recovered using one of several
possible methods. The appropriate recovery system or period may depend
upon the terms of sale or exploitation of the asset. If all rights to a
completed project (film, movie, etc.) are sold as a package, the recovery
of the capitalized costs will be allowed as part of adjusted basis
reducing the amount realized (or cost of goods reducing gross receipts).
If, as
is true in most productions, the project is exploited over a period of
years (released in theaters, TV, video, etc.). The most appropriate means
of recovering costs is through the income forecast method (RR 60-358, RR
64-273, and RR 71-29).
This
method requires an estimate of total income to be derived from the film
over its expected life. The term "income" as used here refers to the gross
receipts less the distribution expenses. This estimate will include not
only anticipated revenue from theatrical releases, but also TV, cable, and
video, if the arrangements are entered into prior to depreciating the film
down to its salvage value.
The
"cost of the film" includes the projected residuals and participations,
which will be received. (Transamerica Corp. v. United States, 999 F. 2d
1362 (9th Cir. 1993).)
A
forecast of income can be revised at the end of each taxable period, based
on additional information. For this computation, merchandising receipts
are not included. The basic computation for this method is: Revenue Received for Taxable Year Forecasted
------------------------------------- X Income Cost of the Film Anticipated
Abandonment
As
with any other business venture, if a project is abandoned, the taxpayer
can claim a deduction for the un-recovered basis. Abandonment requires
that the taxpayer show an intent to abandon and makes an affirmative act
of abandonment in such a manner that the asset is not retrievable. Putting
a script on the shelf for a while, with the possibility of selling it at a
later date, is not abandoning it. Merely not attempting to exhibit a film
is not abandoning it, since it may still be exploited in the future.
Notes
to Auditors:
1)
Include all expenses that would have been allowed if the taxpayer were in
a trade or business except for interest (IRC section 163) and taxes (IRC
section 164).
The
taxpayer may elect to recover these costs over a 60-month period beginning
in the first year in which the taxpayer is actually in the business. This
election must be made by the due date (including extensions) of the return
for the first year in the business.
2)
Qualified creative expenses include trade or business expenses (IRC
section 162) incurred in the activity of being a writer, artist,
photographer, or composer. These expenses do NOT include expenses incurred
to produce motion pictures, video tapes, sound recordings, or similar
items. Therefore, a "writer" may have some expenses allowable and others
capitalized if the writer is also involved in pre-production (budgeting,
casting, etc.), for the production of a movie from the screenplay being
written. A composer may have qualified creative expense and also incur
production expenses for preparing to record (or for recording) the music
as it is composed.
3) Do
Not Capitalize:
-
Marketing and selling expenses such as copying, distribution
contract negotiation, promotion expense, and advertising.
-
Bidding expenses for contracts not obtained (job search).
-
Administrative or general expenses not related to a
particular production activity.
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