Los Angeles — The USC Gould School of Law hosted its 2021 Tax Institute online from Monday, Jan. 25 through Wednesday, Jan. 27. One of the evening discussions focused on Entertainment Industry Tax Updates.
Some of the topics discussed include the 2020 stimulus legislation and its support for the entertainment industry, corporate tax changes as well as President Biden’s campaign tax proposals and their prospects in the 117th U.S. Congress and music catalogue sales.
The Entertainment Industry Tax Update webinar featured three speakers: Michael H. Salama, lead tax counsel at The Walt Disney Company; and Paul Sczudlo, a tax counsel at Withersworldwide. Bradford S. Cohen, partner of Jeffer Mangels Butler & Mitchell LLP, served as the moderator of the discussion.
USC Gould’s Burton Forester provided the introduction for the panel. “This sessions covers what occurred in the industry during the year 2020 although the title is 2021. I’m pleased now to introduce the speakers for this subject matter.”
“We’re going to try to introduce several entertainment tax topics tonight,” said Moderator Brad Cohen. “It’s a really great time to be practicing tax law in the entertainment industry. Lots of changes that are happening, lots of unknowns, lots of opportunities where those unknowns exist. It makes it very interesting.”
The state of the entertainment industry and distribution from the corporate overview perspective
“What a difference a year makes, right?” said Michael H. Salama, lead tax counsel at The Walt Disney Company. “Last year, we were here talking about state law developments in California and California AB5 and when we hit the March time period this year, almost all physical production was shut down. There’s been a process of trying to determine and in what places production might be deemed essential and where work can be done and there’s been very few locations where that’s the case. The actual distribution hasn’t completely ground to a halt. We’ve seem limited theatrical releases, certainly no real theatrical releases in the U.S. other than a few drive-in movies that were shown back in like April. We’ve seen a change from theatrical films being released either held back or being released on streaming properties either as part of a subscription package or paid-to-view package. I don’t know if I would say that’s an acceleration of practice but it’s certainly a change that we’ve seen during the pandemic.
The way content is being produced during the pandemic has certainly changed as well. Some mediums have done better than others. Television has found a way to move forward. But episodic comedies and dramas not so much and it remains to be seen when production will actually come back in full force and when it does of course, we’ll need to the opportunity to test and have the opportunity for testing and safety. When it does, the world is going to look a whole lot different than it does now and it did a year ago. So it’s been very interesting.”
The 2020 stimulus legislation provides welcome industry support
“What we saw was a very broad stimulus package as well as provisions that were contained in military funding bill,” said Paul Sczudlo, a tax counsel at Withersworldwide. “The first thing that I think is the most significant impact was that we saw Section 181 allowing for the expensing of qualified production costs being extended. It was set to run out at the end of 2020 but it was extended for five more years through 2025. This provision provides a lot more certainly for planning and I think it was very well received by the industry. The next thing that we saw was a 100 percent deduction for business meals in 2021 and 2022. This is of general interest but I think it’s also of interest for many people in the entertainment industry. It is of importance for people getting together and planning their deals.
We have an employer retention tax credit for employer’s social security tax paid on wages. It’s basically a credit against the employer, it’s a refundable credit that’s available to employers whose business was fully or partially suspended due to COVID government orders. Think of movie theaters as well as many other companies involved in production, post-production, pre-production activities. It’s available for wages paid in the first half of 2021 through June 30. It’s limited to 70 percent of qualified wages, wages up to $10,000 paid per quarter. Of that, you get a credit equal to 70 percent of wages. That’s a maximum of $14,000 per employee for two quarters.”
Paul Sczudlo: “We also saw a credit for employee payroll taxes for sick or absent pay through the end of March 2021. We’ve seen that even though those [PPP] loans are being forgiven, compensation and other expenses that are paid through those PPP loans funds can still be deductible. Rules were also liberalized for distribution and loans from retirement plans. Basically, there’s no 10 percent early withdrawal penalty on those qualified plan distributions or 401k or IRA distributions even though you haven’t made the age of 55 1/2.
The SBA Loan Program was extended. Basically, it’s economic injury disaster loans. Small businesses can get up to $2 million if they show a 30 percent decline in revenues due to COVID. We’ve seen a drop in the medical expense deductibility from 10 percent of AGI (adjusted gross income) to 7.5 percent of AGI going forward and charitable deductions limitations have been liberalized.”
Biden’s campaign tax proposals and their prospects in the 117th U.S. Congress
Paul Sczudlo: “One thing that’s interesting about the tax proposals is everybody’s crystal ball is very cloudy. We really don’t know where these are going. They may be enacted but nobody fully expects them to be completely enacted. Right now, we have the House, Senate and White House all controlled by the Democrats. It’s a slim margin in the House and it’s a razor-thin margin in the Senate. A 50-50 split in the Senate itself and Vice President Harris casting the deciding vote in the event of a tie. There may be some more liberal Republican senators that side with the Democrats or some more conservative Democrat senators that side with the Republicans particularly when it comes to fiscal tax matters. The tax proposals are generally neutral with respect or even favorable for those with taxable income of $400,000 or less.
What is the projected amount for the full Biden tax proposals by some commentators is $2.8 trillion. We have more spending proposals that are being proposed by the Biden administration to rev up the economy even further from its very weak state including an ‘American Rescue Plan’ with $1.9 trillion in additional relief spending including the hallmark distribution of an additional $1,400 per qualifying recipient. This would bring the total COVID relief spending over the past year in excess of $5 trillion. One could wonder where the funding will come for all of this spending and part of it has to come from tax increases.
Taxable income which is slated to go up to 39.6 percent after 2025 on income over $400,000 and that would be accelerated before 2026. I think there’s a very interesting question as to whether or not these tax increases if legislated will be retroactive til January 1 of this year. I think there’s a lot of concern about that. Long-term capital gains and qualified dividends are going to be taxed at 39.6 percent no more 20 percent rates on those types of income if your taxable income exceeds $1 million. We’re going to see similarly the Social Security payroll tax of 12.4 percent being imposed on wages above $400,000. That is going to create a donut with the amount between $142,800 and $400,000 not being subject to Social Security taxes and the highly paid wages above $400,000 will be subject to that Social Security tax.
We’re going to have a limitation on itemized deductions as well as a partial phase out based on the Pease limitation based on 3 percent of AGI. The qualified business income deduction under Section 199A is going to be phased out for taxpayers having income greater than $400,000. That excludes income from the performing arts and athletic businesses. The state and local tax deduction is going to restored but will be limited. This was really the biggest complaint under the Tax Cuts and Job Act in 2017 because it really hit the high tax blue states on taxpayers much more highly than a lot of states that imposed a lower income tax rate.
We’re going to see an elimination of like-kind exchanges on real estate above $400,000 with limitations on real estate losses. There’s a number of relevant estate and gift tax changes. I think the key ones are reducing the exemption amount for estate gift purposes from $11.58 million to perhaps $3.5 million which is the rate in 2009. It would be indexed. We’d see a $1 million indexed exemption amount for lifetime gifts. We’d see no step-up in tax basis in death.”
Corporate income tax changes
Michael Salama: “The anticipated raise that the Biden team has floated is to go from the 21 percent headline rate to 28 percent which is slightly higher than you’d see in Western countries but comparable to what you’d see in Australia, Japan, and other modern states with robust economies and diverse economies like we see. That would be a revenue raise if it could be done. There’s some other things that have been floated out there that I don’t want to say are optimistic, they may be more of a campaign pitch than anything else.”
Michael Salama: “One of them is a 15 percent minimum tax on global book income. In theory, it’s easy to administer. The details would come out to what’s foreign tax credit eligible, are the taxes compulsory credits. We’ve never had anything in the U.S. income tax system that looks like a flat rate being applied to income. At the state and local level, we see it. In Ohio, for example, there’s a consumer activity tax which is a flat percentage applied to gross receipts and other states have gross receipts taxes. For federal purposes, we haven’t seen it.
There are a whole host of proposals on the international front. The common theme when you look at them together is to try and incentivize keeping manufacturing and production in the U.S. and to try and halt offshore production and moving tech and jobs that can be done elsewhere and prevent them from moving offshore. So it’s a set of penalty regimes, more penalties in terms of surtaxes or denial of reductions. The Section 250 provision was meant to do basically that, to keep jobs in the U.S. by creating a lower rate or a teaser rate for keeping your intellectual property and your assets in the U.S. In theory, why these additional provisions would be needed?”
Music catalogue sales
Michael Salama: “When we are talking about a sale or disposition or contribution of a music catalogue, there are a number of questions that are there. If I’ve got gain, is it ordinary or capital? The other big question is…what’s it worth? And valuation, as we know, is not a precise science. There are some fundamental things you have to consider in a transfer or disposition. First, what is the purpose of the valuation? Are you doing a valuation for tax purposes or are you a company or holder of IP (intellectual property)? That’s going to drive in part the valuation method that you use. If you have to do a valuation for GAAP (generally accepted accounting principles) purposes then also have to do a valuation for taxes, you’d like the standards to be identical but they’re not necessarily the same. So that needs to be navigated and considered.
Michael Salama: “In terms of the methods to valuate the IP, what you’re looking for is the most reliable measure of value. There’s generally three methods to use: a cost method, a market-based valuation method and there’s an income method. For tax, again you’re looking at what the most reliable measure of value. You may end up in a situation where you have more than one method to value the IP. The other challenge you run into is… how do you define the underlying assets? If you are valuing a music catalogue, are there separate identifiable trademarks within that portfolio of IP? Do they have an economic existence separate from the music catalogue? Is the composition a separate asset from the rendition? So maybe you have a musical composition, you have the score, the lyrics but then you have the actual recording of those elements. They’re separate IP. In music catalogues, we tend of think of things as songs. But the songs have different intellectual property components. You could license a particular recording, you could license the score, you could license the lyrics. All separately or exploit them in some combination.”
Bradford Cohen: “On the sale of musical assets, this is a real active area right now. I guess the first fundamental question…what is the transaction? Is it a sale or is it a license? Again, sales potentially capital gains; licenses generate ordinary income. When you do these copyright sales of musical assets, you really have to drill down as to what the heck is being sold. It’s very confusion and in that confusion creates potential opportunities. There’s musical compositions, master recordings, writer’s share, a thing called SoundExchange, and name/likeness rights. Depending on how those assets break down, it will potentially determine what the tax is going to be on those sales. The seller cares a lot about how that allocation takes place. Maybe the buyer is a bit agnostic about it. You want to actively push the assets into the categories that are going to generate the best chance of capital gains.”
The panelists briefly discussed the 2016 Star Wars film “Rogue One: A Star Wars Story” which featured a posthumous performance by Peter Cushing using a cutting-edge special effects studio. They also highlighted case studies about the estates of musicians Michael Jackson and Prince.
Special thanks to the great folks at the USC Gould School of Law for allowing me to attend their 2021 Tax Institute webinar.