Film Financing With State Tax Credits

The most important development in film financing over the last decade is the drastic expansion of state tax credits for film production. These state tax credits come in two basic flavors: those that are assignable and those that are not. The assignable tax credits can be sold to third parties, and an entire industry has evolved around brokering these tax credits. For the non-assignable tax credits, the state typically refunds the production company the amount of the credit that is not offset against the production company's state tax liability. The non-assignable tax credits are much more difficult to monetize; generally the production company has to seek a loan from a third party secured by the potential tax refund. It is difficult, although not impossible, for lenders to obtain direct payment of the tax refunds, so assignable tax credits are far preferable to non-assignable ones.

While all state laws are different, the basic premise is to permit a tax credit for costs incurred in the state. Not surprisingly, producers attempt to classify as much costs as possible as being incurred in the state, including many costs that are difficult to source to any particular location, such as completion bond fees, financing costs, and overhead. The real benefit occurs when the state permits payments to actors, the director, and producers to qualify.

Some states limit the amount of annual tax credits they permit, which drastically reduces the attractiveness of shooting in those states, since the producer may not be assured of if and when it will obtain the benefit of the tax credit.

In the nascent days of these tax credits, production companies were able to sell or borrow against the tax credits for approximately 70 to 75 percent of the tax credits. Through increased competition, this percentage has gradually crept up to over 85 percent for credits that are payable within one year.

California has joined the state tax credit fray with a film production tax credit of its own, but it does not quite live up to its billing and has a number of limits that make it generally unworkable for independent producers. For "independent films," the credit is 25 percent of "qualified costs." The production company for an independent film may make only one sale of the credit, so brokers acting as financiers must be careful to structure the transaction as a "loan," not a "purchase" and "resale," of the credit. The credit is not refundable, so the sale of credits for independent films is thus the only way to raise actual financing for the production of a film.

The IRS has put a damper on the state tax credit party by issuing a Chief Counsel Advice that holds that the receipt of the proceeds from the sale of state tax credits is immediately taxable (IRS Chief Counsel Advice 201147024), but so far producers do not seem aware of it.

So enjoy this party while it lasts, since it defies gravity and economic sense (see a prior blog I wrote titled The Lunacy of State Tax Credits).