In Actor Speak
It is not at all uncommon for performers to branch out and try their hand as a "hyphenate" (i.e. Actor-Director, or Actor-Producer) and create their own film.
Producing your own film seems to happen frequently enough to place this information on the website so that you can learn some of the special rules that apply when you spend money creating your own project.
Timing the production of your project can be very important. Unfortunately some of the possible problems in how you are allowed to use your expenses are too often learned only AFTER the money has been spent.
The information opposite has been left in its original IRS language, which can make it difficult to follow, but if you are considering producing your own project, read carefully.
The essential lesson is that there are two ways to write off any film making expenses:
1) You can amortize (depreciate) the expenses during the years they are created over a five year period. In other words you are supposed to take the entire year’s expenses and equally distribute the costs over five years. If you spent $10,000 then you can write off $2,000 a year over the next five years. If you incur additional expenses in the following year, then that amount must be written off in a similar manner.
Let’s say you spent $10,000 in the first year and then $5,000 in the second year to complete and market the film. The amount you can write off in each year is as follows.
· Year 1: $2,000 (20% of the original $10,000).
· Year 2: $3,000 (another 20% of the original $10,000 and $1,000 of the $5,000).
· Year 3: $3,000 (same as year two)
· Year 4: $3,000 (same as year two and three)
· Year 5: $3,000 (same as years 2,3 and 4)
· Year 6: $1,000 (The entire original expense is now gone and all that remains is the final amount from year 2 expenses.)
For most small filmmakers this is a fairly unusable manner to make use of the expenses because they need to re-coup their total costs as quickly as possible.
Therefore most small filmmakers use the following scenario:
2) You are allowed to write off the TOTAL of the film’s expenses in the year that the film is available for sale, assuming you have made attempts to get it distributed. Bear in mind, if you don’t make any attempt to actually sell the film then the IRS has the right to argue that the film was not a profit making expense and it is not acceptable as a business write-off. Understandably you may not actually sell the film, but you have to be able to prove you made the attempt. Showcasing the film at competitions and in other mediums would be justification of your attempts to sell the project.
Using a two year scenario, assuming you finished and marketed the film by the end of the second year, you could then write off the FULL $15,000 on your return in that year. In other words, by holding onto all the expenses until the film is completed, you will gain the full rewards of those deductions in a shorter period of time (versus a five year depreciation).
But if you spent the entire amount, finished a film and marketed the project all in the same year, then the entire costs of the film can be written off on your return for that year.
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.
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
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.