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For many years, owners of motion pictures and television films have optimized the tax benefits of depreciation deductions by employing a broad concept of basis. In addition to their cash investment, these taxpayers have increased their basis to reflect both fixed and contingent liabilities incurred in creating or acquiring these assets. Some of these liabilities represent royalties for the use of intellectual property such as music and literary works incorporated in the film. Others constitute deferred compensation for the services performed by producers, directors, actors, musicians, and others during the production process. The fixed liabilities do not depend on the financial success of the production, but the contingent liabilities, including payments commonly known as “participations” and “residuals,” are dependent on, and often measured by, the revenues that the film generates.

This article examines the propriety of including these types of fixed and contingent liabilities in the depreciable basis of motion pictures and television films. Although the federal government has challenged the entertainment industry's practice of including participations and residuals in basis, this effort was thwarted by the Ninth Circuit's 1993 decision in Transamerica Corp. v. United States. This article, however, contends that most of this contingent debt, as well as any fixed debt that represents compensation for personal services, should be excluded entirely from the depreciable basis of these and similar entertainment products. By including these amounts in basis, entertainment industry taxpayers have consistently overstated the basis of their motion pictures, television films, and videocassette releases, thus generating inflated depreciation deductions.

Publication Citation

15 Va. Tax Rev. 685 (1996).