As we have noted in past reports, tax reform is impacting the media industry in a number of important ways. When making investment decisions, potential investors will look to the overall health of the industry. The entertainment and media sector is unique in its outsized dependence on the creative talent of those who work in the field, as employees or otherwise. Accordingly, this fifth installment discussing tax reform and the media will focus on ways in which tax reform may help or hurt these individuals and, as a consequence, the industry at large.
The change for individual taxpayers resulting from tax reform that has garnered the largest amount of attention in the entertainment and media industry is the elimination (currently, through 2025) of the deduction for itemized expenses above 2% of adjusted gross income (the so-called 2% floor). This had been the means for employees to deduct business related expenses and was particularly important to individuals in the creative professions who are employees for tax purposes. This provision could have applied to the most famous of performers (such as those under contract with a show or network, or a concert promoter, in the case of musicians) who spent a disproportionate amount of their income on items that would qualify for this deduction. These expenses included such industry-specific necessities as acting and other training classes, travel costs for auditions and interviews, head shots and agent and manager fees. It is estimated that, whereas an individual taxpayer taking this deduction only needed to spend approximately 2% of his or her income on the items that qualify under this provision, those in the creative professions spend between 20% and 35%.1 This high percentage of income so spent, coupled with the modest salary earned by many individuals working in the entertainment industry, could result in fewer people from lower and middle-income backgrounds – who may have greater talent but lack the financial safety net (or luck) of their wealthier peers – from pursuing a career in the industry. Moreover, those who work “day jobs” in other fields otherwise may be unable to deduct expenses relating to an acting or creative career to the extent they cannot show a history of profit.2 Indeed, this is possibly another illustration of how tax reform either has benefitted or spared high wage earners while harming the working class – the media and entertainment industry appears not to have escaped this wide spread effect, and criticism, of the new tax laws.
There are two options available to a taxpayer that wants to continue to deduct these expenses. First, an individual performing services in the entertainment industry instead could perform those services as an independent contractor. However, this would come at the price of certain employee benefits of particular importance to certain people in the entertainment industry, including the right to unionize. The other alternative is for the individual taxpayer to “incorporate” themselves and become a pass through entity, such as an LLC or an “S Corporation,” that generally is not itself subject to corporate level tax. Similarly, the individual could form a C corporation and take advantage of lower corporate rates; the effective federal tax rate for an individual shareholder on corporate earnings (now taxed at the new 21% corporate tax rate) and dividends (if any, taxed at 20%) is 36.8%; as we have noted [here], this rivals the new rates on pass through income. In each case, the taxpayer could then “loan out” their services to the media or production company and still take advantage of the deduction. However, these entities may prove unpractical, as incorporation comes with steep attorney fees, both for the high upfront costs for legal filings required for incorporation as well as continued reporting and tax compliance (which can be surprisingly complex, particularly in the case of an S corporation). Consequently, this solution may prove most practical for only the highest earners who ironically otherwise might be least likely to feel the deduction’s loss (though high earners operating as employees would not be indifferent, as their costs could have exceeded the 2% floor, even at high levels of compensation). The LLC could be an attractive, less expensive option (which we explore a bit more below), but may require a second member if the intent is to avoid a single member LLC, which generally is ignored for federal income tax purposes. Otherwise, if an actor forms a disregarded entity to perform services, it is no different than the actor herself being an independent contractor or, in certain circumstances, an employee (which is what this intended to avoid).
In addition to the realized concerns about losing the employee business deduction, there also had been concern that the trade and business expense deduction for performing artists would be revoked as a revenue raiser for the new legislation. Fortunately, this deduction was preserved, though the impact may be minimal after all. Code Section 62(a)(2)(B) allows a trade or business expense deduction for expenses of a qualified performing artist incurred in connection with his or her performances. The term “qualified performing artist” means (i) one which performed as an employee for two different employers during the taxable year, (ii) the amount of income eligible for deduction exceeds ten percent of the taxpayer’s income, or (iii) the taxpayer made less than $16,000 for the year. As a result of this provision not being repealed, performing artists may continue to take advantage of this valuable deduction while they chase the rise to fame – or settle comfortably in supporting or other roles that are more available. However, this deduction requires the individual to be an employee, which ought to prevent the individual from otherwise deducting job-related expenses (following the repeal of the deduction described above).
However, the new and much publicized strict limitations on deductions for state and local taxes also will negatively impact individuals in the entertainment and media industry, as it is overwhelmingly located in California and the greater New York area (comprised of New York, Connecticut and New Jersey). These jurisdictions all have some of the highest state taxes in the country, with New York City also leveling relatively high local taxes. Of particular concern is the non-deductibility of property taxes, which are particularly high in these states due to both the tax rates themselves and the high value of real property. The inability to deduct this hefty tax burden from their income may lead many in the entertainment and media industry to relocate. This potential dispersal of talent could lead to companies having difficulty filling positions and individuals finding it costly to attend auditions and interviews in other states. On the other hand, opportunities may abound for states and offshore locations that previously had trouble attracting talent away from NYC and LA. However, this is another reason that those not at the highest levels of the industry may be forced away from these epicenters, especially if the industry acclimates to the new higher costs and does not abandon historic locales for filming and production.
New Code Section 199A may be helpful for independent acts that consider themselves too small to warrant incorporation (or otherwise want to avoid corporations) and instead opt for passthrough status. These stand to benefit from the new so-called “qualified business income” (QBI) deduction (click here for more). New Code Section 199A generally permits a 20% deduction against taxable income for QBI, which, broadly-speaking, is taxable income earned from certain U.S. trades or businesses. Under prior law, an individual taxpayer’s QBI would have been subject to the ordinary federal income tax rates applicable to individuals, with a maximum rate of 39.6%. Under the TCJA, unless limitations apply, the QBI deduction could reduce the maximum effective rate imposed on an individual’s share of an entity’s QBI to 29.6% (or 80% of the new maximum ordinary rate of 37%). This will help offset the advantage that larger entertainment and media corporations received over these smaller acts as a result of the forty percent decrease in the federal corporate tax rate. Note that new Section 199A also applies to income earned directly, but the use of a passthrough entity such as an LLC may help a group of performers – such as a band, or a group of actors in a performance – share income, as well as invest income and provide for governance and decision-making powers as desired. Typically, these entities also provide liability protection, which is a prime non-tax consideration – this includes single member LLCs, which provide the benefit of the new 199A deduction, add little to no tax complexity (as they are disregarded for federal and most state income tax purposes), and provides a legal form of doing business separate from the individual.
Although the creation of new Code Section 199A may help individuals in the industry, the repeal of old Code Section 199, which provided a deduction for domestic production activities (the Domestic Production Activities Deduction or DPAD) and was relied upon heavily in the media and entertainment industry, most notably for film and TV production, may negatively impact opportunities for actors, producers and directors as well as other performers in the United States. This incentive brought film and TV production (and with it, jobs in this sector) back from Canada and other jurisdictions that initially had lured companies abroad with low cost and tax incentives. Futhermore, Code Section 181, which allowed the cost of qualified film, television or live theater productions (defined as those projects where 75% of the compensation for services occurs in the United States) to be treated as a deductible expense, does not apply to productions commencing after December 31, 2017. However, taxpayers wondering what to do about later projects should be pleased to see that going forward, these qualified projects also are eligible for the so-called “immediate expensing” provision contained in Code Section 168(k) (click here for more). This provision allows businesses to immediately deduct the full cost of new and used property placed into service between September 27, 2017 and (generally) January 1, 2023, at which point the percentage that may be expensed begins to be phased down through January 1, 2027. Although there is hope that the new deduction will result in an increase in the number of projects undertaken (and thus the number of jobs located) domestically, it has yet to be seen the extent to which it will counteract the DAPD’s repeal, particularly since it is not yet clear how it will operate in place of the old Section 181 deduction for qualified productions. Combined with the loss of most deductibility for federal tax purposes for state and local taxes, historically favored locations such as NYC and LA also must be considering state and local incentives to keep movie, TV and music production from relocating. If nothing else, the reactions of state and local governments may impact planning for those in media and entertainment on the talent side as much as investors and those on the business side of the industry. Of course, the talent’s reaction and tax planning can influence the industry as much as the industry can affect its actors (pun intended).
2 See Section 183(d) (presumes that an activity is for profit if profitable for three years in a five year period).