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Federal Register / Vol. 72, No. 27 / Friday, February 9, 2007 / Rules and Regulations
installer, as specified in paragraph (c) of
this section. In making such repairs or
replacements, conformity with the
current requirements must be met before
the vessel may lawfully operate under
the Treaty.
(i) Access to data. As a condition to
obtaining a license, holders of vessel
licenses issued under § 300.32 must
allow the Regional Administrator, an
authorized officer, the Administrator or
an authorized party officer or designees
access to the vessel’s position data
obtained from the VMS unit at the time
of, or after, its transmission to the
vendor or receiver.
■ 11. A new § 300.46 is added to read
as follows:

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§ 300.46

(a) Applicability. This section applies
to vessels licensed under § 300.32.
(b) Transshipping may only be done
at the time and place authorized for
transshipment by the Pacific Island
Parties, following the notification and
request requirements of § 300.34(c)(5).
(c) The operator and each member of
the crew of a vessel from which any fish
taken in the Licensing Area is
transshipped must:
(1) Allow and assist any person
identified as an officer of the Pacific
Island Party to:
(i) Have full access to the vessel and
any place where such fish is being
transshipped and the use of facilities
and equipment that the officer may
determine is necessary to carry out his
or her duties;
(ii) Have full access to the bridge, fish
on board and areas which may be used
to hold, process, weigh and store fish;
(iii) Remove samples;
(iv) Have full access to the vessel’s
records, including its log and
documentation, for the purpose of
inspection and copying; and
(v) Gather any other information
required to fully monitor the activity
without interfering unduly with the
lawful operation of the vessel; and
(2) Not assault, obstruct, resist, delay,
refuse boarding to, intimidate, or
interfere with any person identified as
an officer of the Pacific Island Party in
the performance of his or her duties.
(d) Transshipping at sea may only be
done:
(1) In a designated area in accordance
with such terms and conditions as may
be agreed between the operator of the
vessel and the Pacific Island Party in
whose jurisdiction the transshipment is
to take place;
(2) In accordance with the
requirements of § 300.34; and

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[FR Doc. 07–593 Filed 2–8–07; 8:45 am]
BILLING CODE 3510–22–P

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 9312]
RIN 1545–BF95

Section 181—Deduction for Film and
Television Production Costs
Internal Revenue Service (IRS),
Treasury.
ACTION: Temporary regulation.
AGENCY:

Transshipping requirements.

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(3) If the catch is transshipped to a
carrier vessel duly authorized in
accordance with national laws.

This document contains
temporary regulations relating to
deductions for the cost of producing
film and television productions under
section 181. These temporary
regulations reflect changes to the law
made by the American Jobs Creation Act
of 2004 and the Gulf Opportunity Zone
Act of 2005, and affect taxpayers that
produce films and television
productions within the United States.
The text of these temporary regulations
also serves as the text of the proposed
regulations set forth in the notice of
proposed rulemaking on this subject in
the Proposed Rules section in this issue
of the Federal Register.
DATES: Effective Date: These regulations
are effective February 9, 2007.
Applicability Dates: For dates of
applicability, see § 1.181–6T.
FOR FURTHER INFORMATION CONTACT:
Bernard P. Harvey, (202) 622–3110 (not
a toll-free number).
SUPPLEMENTARY INFORMATION:
SUMMARY:

Paperwork Reduction Act
These temporary regulations are being
issued without prior notice and public
procedure pursuant to the
Administrative Procedure Act (5 U.S.C.
553). For this reason, the collections of
information contained in these
regulations have been reviewed and,
pending receipt and evaluation of
public comments, approved by the
Office of Management and Budget under
control number 1545–2059. Responses
to these collections of information are
required to obtain a tax benefit.
An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless the collection of information
displays a valid OMB control number.

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For further information concerning
this collection of information, and
where to submit comments on the
collection of information and the
accuracy of the estimated burden, and
suggestions for reducing this burden,
please refer to the preamble of the crossreferencing notice of proposed
rulemaking published in the Proposed
Rules section in this issue of the Federal
Register.
Books or records relating to a
collection of information must be
retained as long as their contents may
become material in the administration
of any internal revenue law. Generally,
tax returns and tax return information
are confidential, as required by 26
U.S.C. 6103.
Background
This document contains amendments
to 26 CFR part 1 to provide regulations
under section 181 of the Internal
Revenue Code of 1986 (Code). Section
181 was added to the Code by section
244 of the American Jobs Creation Act
of 2004, Public Law 108–357 (118 Stat.
1418) (Oct. 22, 2004), and was modified
by section 403(e) of the Gulf
Opportunity Zone Act of 2005, Public
Law 109–135 (119 Stat. 2577) (Dec. 21,
2005).
Explanation of Provisions
For several years, independent
filmmakers and television producers
have moved production activities from
the United States to other countries.
Frequently, this has been motivated by
credits and other incentives offered by
foreign governments to attract the
economic benefits gained by hosting
these productions. Congress enacted
section 181 to make domestic
production more attractive to these
taxpayers.
Section 181 permits the owner of a
qualified film or television production
to elect to deduct production costs in
the year the costs are paid or incurred
in lieu of capitalizing the costs and
recovering them through depreciation
allowances if the aggregate costs do not
exceed $15 million for each qualifying
production ($20 million if a significant
amount of the production costs are
incurred in certain designated areas)
(the ‘‘production cost limit’’). A film or
television production is a qualified film
or television production if 75 percent of
the total compensation of the
production is compensation for services
performed in the United States by
actors, directors, producers, and other
relevant production personnel (the ‘‘75
percent test’’).

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Allowance of Deduction
The deduction under section 181 is
allowed for the cost of producing
qualified film and television
productions for which principal
photography begins after October 22,
2004, and before January 1, 2009.
Production costs incurred before or after
this period may be deducted so long as
principal photography commences
during the period.
Section 181 refers to ‘‘the taxpayer’’
who makes the election and takes the
deduction. The temporary regulations
provide that only the owner of the film
or television production may elect to
deduct production costs under section
181. Under the regulations, the owner of
the production is deemed to be the
person or persons otherwise required to
capitalize production costs into the
basis of the film or television
production under section 263A (or the
person or persons that would be
required to capitalize production costs if
subject to section 263A).
The production costs that must be
taken into account (for both the amount
of the deduction and for the production
cost limit) are the amounts that, absent
section 181, are required to be
capitalized under section 263A (or the
amounts that would be required to be
capitalized if the taxpayer was subject to
section 263A). Although a film’s budget
might be evidence that the production
costs will not exceed the production
cost limit, the budget is not the same as
production costs for purposes of section
181. All production costs eligible to be
deducted under section 181 are subject
to the production cost limit. Under the
temporary regulations, distribution costs
are specifically excluded from the
definition of production costs under
section 181, consistent with the
exclusion of distribution costs under
section 263A.
Section 181 does not require the
production to be placed in service in
order for the producer to begin
deducting production costs, and there is
no requirement that the production ever
be placed in service or completed.
However, the temporary regulations
require that, at the time the election is
made and in any year that a deduction
is claimed, a taxpayer must have a
reasonable basis for believing that the
production will be set for production (as
defined in American Institute of
Certified Public Accountants Statement
of Position 00–2), will be a qualified
film or television production upon
completion, and will not exceed the
production cost limit. For example, a
taxpayer that has developed a shooting
script, has a well-documented budget,

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and has obtained financing on the basis
of these facts is in a good position to
determine whether it has a reasonable
basis to claim the deduction.
The temporary regulations treat the
cost of acquiring a production as a
production cost. This rule is premised
upon the understanding that under
section 1245, the seller would recapture
upon the sale of the production any
section 181 deduction that the seller
had claimed. In the case of a sale
between related parties, the purchaser
must treat the greater of the acquisition
cost or the seller’s production cost as
the purchaser’s production cost for
purposes of the production cost limit,
notwithstanding that the purchaser’s
deduction under section 181 is based on
the purchaser’s actual acquisition cost.
In the film industry, once a
prospective producer has determined
the estimated budget for a production, it
usually must obtain financing from a
bank or other lender to cover at least
part of the production cost. The
producer may incur up-front costs in
obtaining such financing. The
producer’s pre-sale agreements with
distributors may be used as collateral for
this financing. Generally, the financier
will be repaid directly by these
distributors upon delivery of the
finished production. In addition, the
financier will usually require that the
producer obtain a completion guarantee
(often referred to as a completion bond)
as a condition of the loan. The
completion guarantee is a guarantee
that, if the production costs exceed the
budgeted costs or the loan proceeds are
mishandled, the film will still be
completed and/or the financier will be
made whole. A completion guarantee
can be satisfied in a number of ways.
For example, the guarantor may loan
funds to the producer to finish the
production, may finish the production
itself (although this is rare), or may
reimburse the financier for the amount
loaned to the producer (plus interest
and other charges). Generally, the
producer must pay an up-front amount
in order to obtain a completion
guarantee.
The temporary regulations provide
that the costs of obtaining financing,
including premium costs for completion
guarantees, are production costs that are
subject to the production cost limit and
are deductible under section 181. In
addition, if the completion guarantor
loans additional funds to the producer
and the funds are expended by the
producer to complete the production, or
if the completion guarantor incurs
additional production costs on its own
behalf, the additional funds are
production costs under section 181.

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Participations and residuals (P&R) are
defined in section 167(g)(7)(B), as costs
with respect to an item of property
described in section 167(g)(6), the
amount of which by contract varies with
the amount of income earned in
connection with the property. In the
context of film and television
production, participations are payments
to actors, directors, and other talent
based on a contractually-defined
measure of future income from the
production. Residuals are payments
made pursuant to collective-bargaining
agreements, such as those of the
directors’ and actors’ guilds, based upon
non-theatrical sales, under terms that
differ between video, free television,
and pay television sales. Participations
are generally paid by the producer but
may be assumed by a third-party
distributor. On the other hand, residuals
are generally paid by a distributor out of
its gross receipts from the production.
Industry accounting generally treats
participation payments made by
distributors as a reduction in the
producer’s profit rather than a
production cost, and generally treats
residual payments made by distributors
as a distribution cost.
Various comments were received with
respect to the treatment of P&R under
section 181. Some comments suggested
that taxpayers be permitted to elect to
deduct participation payments (rather
than capitalizing those payments into
the basis of the production) under the
income forecast method rather than
section 181. Other comments suggested
that Congress, by specifically excluding
P&R costs paid or incurred by the
taxpayer from the definition of
‘‘qualified compensation’’ in section
181(d)(3), intended these costs to be
excluded from the production cost limit
in section 181(a)(2). Comments received
also suggested that P&R costs should be
excluded for purposes of determining
whether the production cost limit is
exceeded, but nonetheless should be
deductible production costs under
section 181.
In addition, various comments
expressed concerns about productions
being subsequently disqualified if P&R
costs are included in determining if the
production cost limit is exceeded. For
example, a taxpayer forecasts its
production costs (including a reasonable
amount of P&R costs based upon
projected income from the production)
and based upon this forecast the
taxpayer determines it has a reasonable
basis for making an election under
section 181. However, if an
unexpectedly large amount of P&R is
later paid as a result of production
earnings being much greater than was

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initially expected, with the result that
the total production cost exceeds the
production cost limit, the production
would become disqualified from
treatment under section 181.
The temporary regulations provide
that P&R costs are considered
production costs for purposes of the
production cost limit. The IRS and
Treasury Department recognize that P&R
costs are costs that are generally subject
to capitalization under section 263A
(see § 1.263A–1(e)(2) and § 1.263A–
1(e)(3)). Nonetheless, an explicit
reference to P&R costs is provided in the
temporary regulations in order to avoid
any uncertainty with respect to these
costs.
The IRS and Treasury Department
believe that the statute requires P&R
costs to be included in the production
cost limit. For example, the statute
specifically provides that participations
and residuals are excluded from the
definition of compensation for purposes
of determining whether the production
was a qualified film or television
production, as defined in section
181(d)(1). This explicit exclusion is not
found in the production cost limit of
section 181(a)(2) or elsewhere in section
181.
In addition, the IRS and Treasury
Department are concerned that if P&R
costs were excluded from the definition
of production costs under section 181,
section 181(b) could cause them to be
nondeductible under any provision of
the Internal Revenue Code. Specifically,
section 181(b) states that no
depreciation or amortization deduction
other than the deduction provided
under section 181 is allowed for the
basis of a qualified film or television
production for which an election has
been made. Therefore, if P&R costs were
excluded from the definition of
production costs under section 181, a
taxpayer wishing to expense P&R costs
under the holding of Associated
Patentees, 4 T.C. 979 (1945), may be
barred from doing so under section
181(b), as the holding in that case is
explicit that a deduction under
Associated Patentees is a depreciation
deduction of basis.
Additionally, the IRS and Treasury
Department are concerned that a blanket
exclusion of participations from the
definition of production costs would
allow taxpayers to manipulate the total
production cost (and avoid the
production cost limit) by structuring
compensation as participation
payments. Commentators argued that
this potential abuse could be mitigated
with an anti-abuse rule that treats only
those participations that are disguised
non-contingent or guaranteed payments,

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where the talent incurs minimal risk of
non-payment (for example,
participations with a payment priority
over distribution cost repayment and/or
production financing cost repayment) as
production costs subject to the
production cost limit, but does not treat
other participation costs as production
costs.
The IRS and Treasury Department
considered excluding from the amount
to be taken into consideration as
production costs any residuals
(payments to actors’ or directors’ guilds
based on gross income from exploitation
in secondary markets) that are paid by
the distributor or other third party,
under the theory that these payments
are costs of exploiting the finished
production. However, the same
argument could be advanced for
participations contingent on income,
notwithstanding that most
participations are taken in lieu of
compensation for services (normally a
production cost). In addition, a payment
of residuals by a third party is still made
on the producer’s behalf, and the
producer remains the party with
ultimate liability for the payment. Thus,
the temporary regulations provide that
P&R costs are production costs that are
deductible under section 181 and are
included in the production cost limit.
Section 181(a)(2)(B) provides a higher
production cost limit for a qualified film
or television production ‘‘the aggregate
cost of which is significantly incurred’’
in a designated area. Designated areas
include areas eligible for designation as
low-income communities or certain
distressed counties and isolated areas.
However, neither the statute nor its
legislative history provides a definition
for ‘‘significantly incurred,’’ nor do they
explain how the standard should be
applied. However, Congress’ stated
intent in enacting section 181 was to
encourage economic activity in these
designated areas. Accordingly, the
temporary regulations provide two
different tests for establishing when
production costs have been significantly
incurred in a designated area. One test
is based upon production costs while
the other is based upon days of
production. Under the first of these
tests, the temporary regulations
establish a 20 percent threshold for the
‘‘significantly incurred’’ standard
(similar to the rules of § 1.199–3(g)(3)).
This test compares production costs
incurred in first-unit principal
photography that takes place in a
designated area to all production costs
incurred for first-unit principal
photography. First-unit principal
photography typically films the primary
actors, whereas second-unit principal

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photography typically films shots that
establish location or context (exteriors
of buildings, crowds, cars passing).
Production costs of principal
photography include, for example,
compensation to actors, directors and
other production personnel, location
costs, camera rental and insurance, and
catering. This 20 percent test is based
upon production costs incurred in firstunit principal photography and ignores
all other production costs such as
preproduction, editing, and
postproduction costs for purposes of the
‘‘significantly incurred’’ requirement.
These other production costs often
greatly exceed principal photography
costs, and must be incurred where
adequate production facilities exist (and
it is likely that few such facilities are
available in the designated areas). The
IRS and Treasury Department believe
that if all production costs were taken
into consideration in determining
whether the 20 percent ‘‘significantly
incurred’’ threshold had been met, very
few films would qualify for the higher
production cost limit, even if a
substantial amount of principal
photography occurred in a designated
area. However, we request comments
regarding whether the exclusion of
preproduction, editing, and
postproduction costs will unfairly
impact taxpayers.
Comments were received requesting
that consideration be given to
developing a ‘‘significantly incurred’’
test based upon the number of days of
principal photography. The temporary
regulations adopt this suggestion and
provide, as an alternative to the 20
percent cost-based test, a ‘‘significantly
incurred’’ test based upon the total
number of days of principal
photography. Under this test, if at least
50 percent of the total days of principal
photography take place in a designated
area, the production will be deemed to
have satisfied the ‘‘significantly
incurred’’ requirement of section
181(a)(2)(B). This 50 percent test may
provide a simpler computation than the
20 percent cost-based test and avoids
issues such as the allocation of salaries
to specific days of principal
photography.
A taxpayer intending to utilize the
$20 million production cost limit under
section 181(a)(2)(B) must maintain
records adequate to demonstrate that it
has a reasonable basis under the
‘‘significantly incurred’’ standard to
support reliance on the higher dollar
limitation.
Election
The Conference report underlying
section 181 provides that, until the

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Secretary publishes specific guidance,
taxpayers may make a valid election
under section 181 by claiming the
deduction on the taxpayer’s return for
the year that production costs are first
incurred. H. R. Conf. Rep. 108–755. The
IRS published the section 181 election
requirements in Notice 2006–47 (2006–
20 IRB 892, May 15, 2006). See
§ 601.601(d)(2)(ii)(b). The Notice also
includes transition rules for taxpayers
that incurred costs during the period
prior to October 22, 2004 (the enactment
of section 181) for productions that
qualify under section 181 (that is,
productions for which principal
photography began on or after October
22, 2004). The temporary regulations
provide the same election requirements
and transition rules, along with a
requirement that the taxpayer have a
reasonable basis for claiming the
deduction.
Many films are owned by a
passthrough entity with more than one
owner. The temporary regulations
provide that if the production is owned
by a partnership, the election is made at
the partnership level.
Section 181(c)(2) provides that an
election under section 181 may not be
revoked without the consent of the
Secretary. However, the election is
effectively revoked if the production
costs exceed the production cost limit or
if the production fails to be a qualified
film or television production. In
recognition of the concerns expressed
by commentators over the inclusion of
P&R costs in the definition of
production costs under section 181, and
the fact that the requirements of section
181 may ultimately not be met
notwithstanding a prior reasonable basis
for believing otherwise, the temporary
regulations permit taxpayers to revoke a
section 181 election by filing a
statement with the return for the taxable
year in which the revocation is effective
identifying the production for which the
election is revoked. The return for that
taxable year must also report
compliance with the recapture
provisions discussed in ‘‘Special Rules’’
in this preamble.
Qualified Film or Television Production
(Definitions)
Both the Senate report and the
Conference report underlying section
181 state that ‘‘the provision defines a
qualified film or television production
as any production of a motion picture
(whether released theatrically or
directly to video cassette or any other
format); miniseries; scripted, dramatic
television episode; or movie of the
week’’ that satisfies the 75 percent test.
The definition provided in the Senate

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report and the Conference report
arguably would exclude productions
that do not fall within these delineated
categories, such as reality programming,
documentaries, sports programs, news
programs, variety shows, game shows,
live performances, interview and talk
shows, commercials and ‘‘infomercials,’’
religious/inspirational programming,
educational programming, exercise
shows, training videos, and others.
Comments were received noting that it
appeared from the legislative history
that Congress intended for the provision
to apply only to a motion picture,
miniseries, scripted dramatic television
episode, or movie of the week.
Notwithstanding the legislative history,
section 181(d)(2) itself defines a
production as ‘‘property described in
section 168(f)(3).’’ Section 168(f)(3)
property is ‘‘any film or video tape.’’
Accordingly, the temporary regulations
adopt the broader statutory definition
provided in section 168(f)(3) and
specifically define a production under
section 181 to include any film or video
tape production the production cost of
which is subject to capitalization under
section 263A.
Once a film or television production
is released or broadcast, the taxpayer
may face additional costs to prepare the
production for foreign distribution,
rebroadcast (for example, editing a
theatrical film for television), or release
to the home video market. Consistent
with the approach taken under the
income forecast method (see section
167(g)(5)(A)(ii)), these costs are not
treated as production costs of the film
or television production for purposes of
the production cost limit under section
181(a)(2), and no deduction may be
taken under section 181 for such costs.
Section 181(d)(1) compares qualified
compensation to total compensation in
applying the 75 percent test. Although
qualified compensation is defined by
section 181(d)(3)(A) as compensation for
services performed in the United States
by actors, directors, producers, and
other relevant production personnel, the
75 percent test compares this amount to
the ‘‘total compensation of the
production.’’ In order to be consistent
with the definition provided for in
section 181(d)(3)(A), the temporary
regulations define ‘‘total compensation
of the production’’ as the total amount
of compensation paid for services
performed anywhere by actors,
directors, producers, and other relevant
production personnel in the production
of the film or television production. In
addition, the temporary regulations
specifically provide that the terms
compensation and qualified
compensation include compensation

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paid to persons who are not directly
employed by the producer.
The term qualified compensation is
defined as compensation for services by
various participants performed ‘‘in the
United States.’’ The definition of
‘‘United States’’ in section 7701(a)(9)
includes the 50 states and the District of
Columbia. Although the goal of section
181 is to encourage economic activity
within the United States as defined in
section 7701(a)(9), the use of a standard
based upon principal photography
requires the use of a slightly broader
definition that takes into account that
the physical act of principal
photography may take place on land, at
sea, or in the air. Consequently, the
temporary regulations provide that a
service is performed in the United
States for purposes of the 75 percent test
if the principal photography to which
the service relates occurs within the
fifty states, the District of Columbia, the
territorial waters of the continental
United States, or the airspace or space
above the continental United States and
its territorial waters.
There are some services related to a
production that may physically take
place at a variety of places outside the
control and knowledge of the producer
(for example, training, rehearsal, and
pre- and post-production). However, the
producer has direct or indirect control
and knowledge of the shooting location
of principal photography with which
these other services are associated.
Therefore, the IRS and Treasury
Department believe that as a general
rule the 75 percent test should be based
upon the locations where principal
photography occurs.
In this regard, the temporary
regulations provide a special rule for
animated productions. Although these
productions may have a ‘‘principal
photography’’ analogue, the production
process is completely different and the
majority of the work of the ‘‘talent’’ is
performed independent of the actual
frame photography. Computer-generated
animation is not photographed at all.
Hand-drawn animated films involve the
creation of a storyboard (sketches of the
story action) by the principal artists.
Once the storyboards are approved,
individual frames showing important
moments in the action called
‘‘keyframes’’ are created by the principal
artists, after which the frames in
between these frames (the ‘‘inbetweens’’) are produced by assistant
animators. These in-betweens are
frequently outsourced overseas.
Background art is created separately.
The animation frames are transferred to
plastic cels with a copier or, in some
cases, are hand painted on the cels (or

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both). The cels are then photographed
against the background art. Voice acting,
music, and Foley (sound effects) are
recorded independently. All of these
elements are then combined into the
finished film.
The production process for computer
animation is similar, except that the
principal artists work directly with
computer programmers to create
keyframe images in the animation
software. In-between work is less likely
to be outsourced, as the computer can
generate most in-between frames from
the keyframes themselves. Background
art can be created within the computer
program or scanned in from physical
artwork. Post-production is generally
done completely in the digital realm,
and the final product is output to disc.
The temporary regulations apply the
75 percent test to animated productions
based upon the production locations for
(at least) the keyframe animation, the inbetween animation, the animation
photography, and the recording of the
voice acting performances instead of the
location where principal photography
takes place. A separate rule is provided
for productions that combine animation
and live action, taking into account the
production locations for the animation
functions in addition to the location of
principal photography.
Special Rules
The version of the legislation that
became section 181 (as originally passed
by the Senate) provided a deduction for
production costs up to $15 million, and
allowed production costs in excess of
$15 million to be depreciated using the
straight-line method over a 36-month
period. Jumpstart Our Business Strength
(JOBS) Act, S. 1637, 108th Cong. § 321
(2003). The depreciation provision was
removed in conference, with the result
that the deduction does not apply to
qualified film or television productions
with an aggregate production cost in
excess of $15 million ($20 million if a
significant amount of the production
costs are incurred in designated areas.)
Section 181 is silent as to what should
happen when a production appears to
meet the requirements of section 181 in
the year the election is first made, but
fails to meet those requirements
thereafter (for example, when the
production cost exceeds $15 million, or
when the production no longer meets
the 75 percent test).
The temporary regulations provide a
recapture provision that requires the
recapture of any production costs
previously deducted under section 181
in the year the election is voluntarily
revoked or the production fails to meet
the requirements of section 181. For

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property already placed in service, the
taxpayer must include in income the
difference between the aggregate
amount claimed under section 181 and
the depreciation that would have been
otherwise allowable with respect to the
production in the same years. For a
production not yet placed in service, the
taxpayer must include in income the
aggregate amount claimed under section
181. The structure of the recapture
provision is intended in part to alleviate
concerns that including P&R in the
definition of production costs under
section 181 would cause taxpayers to
completely forgo the benefits of section
181. Under the temporary regulations, a
taxpayer with a reasonable belief that it
is producing a qualified film or
television production, and that the
production cost will not exceed the
production cost limit, will be permitted
to elect to currently deduct production
costs under section 181 with the
understanding that a recapture may be
required in a later year if circumstances
or expectations change. A taxpayer that
is required to recapture previously
deducted production costs under
section 181 will nonetheless be
permitted to deduct otherwise allowable
depreciation expenses in future years.
Prior to the technical correction
enacted in the Gulf Opportunity Zone
Act of 2005, a taxpayer could
potentially incur production costs,
deduct the production costs under
section 181 against ordinary income,
then sell the film after holding it for one
year and report the proceeds (including
the gain attributable to the basis
reduction from the section 181
deduction) as a long-term capital gain,
effectively converting ordinary income
to capital gain. This potential ‘‘tax flip,’’
existed because, as originally enacted,
the statute did not specify that the
deduction under section 181 is a
deduction for depreciation or
amortization, or state that it is subject to
recapture under section 1245. The
technical correction specifically treats a
deduction under section 181 as a
deduction for depreciation or
amortization that is subject to recapture
under section 1245, and the temporary
regulations follow this rule.
Effective Date
The temporary regulations apply to
qualified film and television
productions with respect to which
principal photography or, in the case of
an animated production, in-between
animation, commenced on or after
February 9, 2007 and before January 1,
2009.

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Effect on Other Documents
The following publications are
modified as of February 9, 2007:
Notice 2006–47 (2006–20 IRB 892) is
modified by removing section B.2. in
the INTERIM PROVISIONS of Notice
2006–20.
Rev. Proc. 2002–9 (2002–1 CB 327) is
modified and amplified to include the
automatic changes in methods of
accounting in § 1.181–2T(d)(2) and
(e)(1) in the Appendix of Rev. Proc.
2002–9.
Special Analyses
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in
Executive Order 12866. Therefore, a
regulatory assessment is not required. It
also has been determined that section
553(b) and (d) of the Administrative
Procedure Act (5 U.S.C. chapter 5) does
not apply to these regulations. For
applicability of the Regulatory
Flexibility Act (5 U.S.C. chapter 6),
please refer to the Special Analyses
section of the preamble to the crossreference notice of proposed rulemaking
published in the Proposed Rules section
in this issue of the Federal Register.
Pursuant to section 7805(f) of the Code,
these regulations have been submitted
to the Chief Counsel for Advocacy of the
Small Business Administration for
comment on its impact on small
business.
Drafting Information
The principal author of these
regulations is Bernard P. Harvey, Office
of Associate Chief Counsel
(Passthroughs and Special Industries).
However, other personnel from the IRS
and Treasury Department participated
in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping
requirements.
Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:

■

PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 continues to read, in part, as
follows:

■

Authority: 26 U.S.C. 7805 * * *
■ Par. 2. Sections 1.181–0T through
1.181–6T are added to read as follows:

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§ 1.181–0T

Federal Register / Vol. 72, No. 27 / Friday, February 9, 2007 / Rules and Regulations
Table of contents (temporary).

§ 1.181–5T

Examples (temporary).

This section lists the table of contents
for §§ 1.181–1T through 1.181–6T.

§ 1.181–6T

Effective date (temporary).

§ 1.181–1T Deduction for qualified film and
television production costs (temporary).

(a) Deduction.
(1) In general.
(2) Owner.
(3) Production costs.
(b) Limit on amount of production
costs and amount of deduction.
(1) In general.
(2) Higher limit for productions in
certain areas.
(i) In general.
(ii) Significantly incurred.
(iii) Animated film and television
productions.
(iv) Productions incorporating both
live action and animation.
(v) Records required.
(c) No other depreciation or
amortization deduction allowed.
§ 1.181–2T

§ 1.181–1T Deduction for qualified film and
television production costs (temporary).

Election (temporary).

(a) Time and manner of making
election.
(b) Election by entity.
(c) Information required.
(1) Initial election.
(2) Subsequent taxable years.
(3) Deductions by more than one
owner.
(d) Revocation of election.
(1) In general.
(2) Consent granted.
(e) Transition rules.
(1) Costs first paid or incurred prior
to October 23, 2004.
(2) Returns filed after June 14, 2006,
and before March 12, 2007.
(3) Information required.
§ 1.181–3T Qualified film or television
production (temporary).

(a) In general.
(b) Production.
(1) In general.
(2) Special rules for television
productions.
(3) Exception for certain sexually
explicit productions.
(c) Compensation.
(d) Qualified compensation.
(e) Special rule for acquired
productions.
(f) Other definitions.
(1) Actors.
(2) Production personnel.
(3) United States.
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§ 1.181–4T

Special rules (temporary).

(a) Recapture.
(1) Applicability.
(2) Principal photography not
commencing prior to January 1, 2009.
(3) Amount of recapture.
(b) Recapture under section 1245.

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(a) In general.
(b) Application of regulation project
REG–115403–05 to pre-effective date
productions.
(c) Special rules for returns filed for
prior taxable years.

(a) Deduction—(1) In general. The
owner (as defined in paragraph (a)(2) of
this section) of any film or television
production (as defined in § 1.181–3T(b))
that the owner reasonably expects will
be, upon completion, a qualified film or
television production (as defined in
§ 1.181–3T(a)) for which the production
costs (as defined in paragraph (a)(3) of
this section) will not be in excess of the
production cost limit of paragraph (b) of
this section may elect to treat all
production costs incurred by the owner
as an expense that is deductible in the
taxable year in which the costs are paid
(in the case of a taxpayer who uses the
cash method of accounting) or incurred
(in the case of a taxpayer who uses the
accrual method of accounting). This
deduction is subject to recapture if the
owner’s expectations prove to be
inaccurate. This section provides rules
for determining who is the owner of a
production, what is a production cost,
and the maximum production cost that
may be incurred for a production for
which an election is made under section
181 of the Internal Revenue Code
(Code). Section 1.181–2T provides rules
for making the election under section
181. Section 1.181–3T provides
definitions and rules concerning
qualified film and television
productions. Section 1.181–4T provides
special rules, including rules for
recapture of the deduction. Section
1.181–5T provides examples of the
application of §§ 1.181–1T through
1.181–4T, while § 1.181–6T provides
the effective date of §§ 1.181–1T
through 1.181–5T.
(2) Owner. For purposes of this
section and §§ 1.181–2T through 1.181–
6T, the owner of a production is any
taxpayer that is required under section
263A to capitalize costs paid or incurred
in producing the production into the
cost basis of the production, or that
would be required to do so if section
263A applied to that taxpayer. A
taxpayer that obtains only a limited
license or right to exploit a production,
or receives an interest or profit
participation in a production as
compensation for services, generally is
not an owner of the production for

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purposes of this section and §§ 1.181–
2T through 1.181–6T.
(3) Production costs. (i) The term
production costs means all costs paid or
incurred by the owner in producing or
acquiring a production that are required,
absent the provisions of section 181, to
be capitalized under section 263A, or
that would be required to be capitalized
if section 263A applied to the owner.
These production costs specifically
include, but are not limited to,
participations and residuals,
compensation paid for services,
compensation paid for property rights,
non-compensation costs, and costs paid
or incurred in connection with
obtaining financing for the production
(for example, premiums paid or
incurred to obtain a completion bond
for the production).
(ii) Production costs do not include
costs paid or incurred to distribute or
exploit a production (including
advertising and print costs).
(iii) Production costs do not include
the costs to prepare a new release or
new broadcast of an existing film or
video after the initial release or initial
broadcast of the film or video (for
instance, the preparation of a DVD
release of a theatrically-released film, or
the preparation of an edited version of
a theatrically-released film for television
broadcast). Costs paid or incurred to
prepare a new release or a new
broadcast of a film or video that has
previously been released or broadcast,
therefore, are not taken into account for
purposes of paragraph (b) of this
section, and may not be deducted under
this paragraph (a).
(iv) If a production (or any right or
interest in a production) is acquired
from any person bearing a relationship
to the taxpayer described in section
267(b) or section 707(b)(1), and the costs
paid or incurred to acquire the
production are less than the seller’s
production cost, the purchaser must
treat the seller’s production cost as a
production cost of the acquired
production for purposes of determining
whether the aggregate production cost
paid or incurred with respect to the
production exceeds the applicable
production cost limit imposed under
paragraphs (b)(1) and (b)(2) of this
section. Notwithstanding this paragraph
(a)(3)(iv), the taxpayer’s deduction
under section 181 is limited to the
taxpayer’s acquisition cost of the
production plus any further production
costs incurred by the taxpayer.
(v) The provisions of this paragraph
(a) apply notwithstanding the
provisions of section 167(g)(7)(D).
(b) Limit on amount of production
cost and amount of deduction—(1) In

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Federal Register / Vol. 72, No. 27 / Friday, February 9, 2007 / Rules and Regulations
general. Except as provided under
paragraph (b)(2) of this section, the
deduction permitted under section 181
does not apply in the case of any
production, the production cost of
which exceeds $15,000,000.
(2) Higher limit for productions in
certain areas—(i) In general. This
section is applied by substituting
$20,000,000 for $15,000,000 in the case
of any production the aggregate
production cost of which is significantly
incurred in an area eligible for
designation as—
(A) A low income community under
section 45D; or
(B) A distressed county or isolated
area of distress by the Delta Regional
Authority established under 7 U.S.C
section 2009aa–1.
(ii) Significantly incurred. The
aggregate production cost of a
production is significantly incurred
within one or more areas specified in
paragraph (b)(2)(i) of this section if—
(A) At least 20 percent of the total
production cost incurred in connection
with first-unit principal photography for
the production is incurred in
connection with first-unit principal
photography that takes place in such
areas; or
(B) At least 50 percent of the total
number of days of first-unit principal
photography for the production consists
of days during which first-unit principal
photography takes place in such areas.
(iii) Animated film and television
productions. For purposes of an
animated film or television production,
the aggregate production cost of the
production is significantly incurred
within one or more areas specified in
paragraph (b)(2)(i) of this section if—
(A) At least 20 percent of the total
production cost incurred in connection
with keyframe animation, in-between
animation, animation photography, and
the recording of voice acting
performances for the production is
incurred in connection with such
activities that take place in such areas;
or
(B) At least 50 percent of the total
number of days of keyframe animation,
in-between animation, animation
photography, and the recording of voice
acting performances for the production
consists of days during which such
activities take place in such areas.
(iv) Productions incorporating both
live action and animation. For purposes
of a production incorporating both live
action and animation, the aggregate
production cost of the production is
significantly incurred within one or
more areas specified in paragraph
(b)(2)(i) of this section if—

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(A) At least 20 percent of the total
production cost incurred in connection
with first-unit principal photography,
keyframe animation, in-between
animation, animation photography, and
the recording of voice acting
performances for the production is
incurred in connection with such
activities that take place in such areas;
or
(B) At least 50 percent of the total
number of days of first unit principal
photography, keyframe animation, inbetween animation, animation
photography, and the recording of voice
acting performances for the production
consists of days during which such
activities take place in such areas.
(v) Records required. A taxpayer
intending to utilize the higher
production cost limit under paragraph
(b)(2)(i) of this section must maintain
records adequate to demonstrate
qualification under this paragraph
(b)(2).
(c) No other depreciation or
amortization deduction allowed. (1)
Except as provided in paragraph (c)(2)
of this section, an owner that elects to
deduct production costs under section
181 with respect to a production may
not deduct production costs for that
production under any provision of the
Code other than section 181 unless
§ 1.181–4T(a) applies to the production.
In addition, except as provided in
paragraph (c)(2) of this section, an
owner that has, in a previous taxable
year, deducted any production cost of a
production under a provision of the
Code other than section 181 is ineligible
to make an election with respect to that
production under section 181.
(2) An owner may make an election
under section 181 despite prior
deductions claimed for amortization of
the cost of acquiring or developing
screenplays, scripts, story outlines,
motion picture production rights to
books and plays, and other similar
properties for purposes of potential
future development or production of a
production under any provision of the
Code if such costs were incurred before
the first taxable year in which an
election could be made under § 1.181–
2T(a). However, the production cost of
the production does not include costs
that a taxpayer has begun to amortize
prior to the time that the production is
set for production (for further guidance,
see Rev. Proc. 2004–36 (2004–1 CB
1063) and § 601.601(d)(2)(ii)(b) of this
chapter).
§ 1.181–2T

Election (temporary).

(a) Time and manner of making
election. (1) Except as provided in
paragraph (e) of this section, a taxpayer

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6161

electing to deduct the production cost of
a production under section 181 must do
so in the time and manner described in
this paragraph (a). Except as provided in
paragraphs (a)(2) and (e) of this section,
the election must be made by the due
date (including extensions) for filing the
taxpayer’s Federal income tax return for
the first taxable year in which
production costs (as defined in § 1.181–
1T(a)(3)) have been paid or incurred.
See § 301.9100–2 of this chapter for a
six-month extension of this period in
certain circumstances. The election
under section 181 is made separately for
each production produced by the
owner.
(2) An owner may not make an
election under paragraph (a)(1) of this
section until the first taxable year in
which the owner reasonably expects
(based on all of the facts and
circumstances) that—
(i) The production will be set for
production and will, upon completion,
be a qualified film or television
production; and
(ii) The aggregate production cost
paid or incurred with respect to the
production will, at no time, exceed the
applicable production cost limit set
forth under § 1.181–1T(b) of the
regulations.
(3) If the election under this
paragraph (a) is made in a taxable year
subsequent to the taxable year in which
production costs were first paid or
incurred because paragraph (a)(2) of this
section was not satisfied until such
subsequent taxable year, the election
must be made in the first such taxable
year, and any production costs incurred
prior to the taxable year in which the
taxpayer makes the election are treated
as production costs (except as provided
in § 1.181–1T(c)(2)) that are deductible
under § 1.181–1T(a) in the taxable year
paragraph (a)(2) of this section is first
satisfied and the election is made.
(b) Election by entity. In the case of a
production owned by an entity, the
election is made by the entity. For
example, the election is made for each
member of a consolidated group by the
common parent of the group, for each
partner by the partnership, or for each
shareholder by the S corporation. The
election must be made by the due date
(including extensions) for filing the
return for the later of the taxable year of
the entity in which production costs are
first paid or incurred or the first taxable
year in which § 1.181–2T(a)(2) is
satisfied.
(c) Information required—(1) Initial
election. For each production to which
the election applies, the taxpayer must
attach a statement to the return stating

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Federal Register / Vol. 72, No. 27 / Friday, February 9, 2007 / Rules and Regulations

that the taxpayer is making an election
under section 181 and providing—
(i) The name (or other unique
identifying designation) of the
production;
(ii) The date production costs were
first paid or incurred with respect to the
production;
(iii) The amount of production costs
(as defined in § 1.181–1T(a)(3)) paid or
incurred with respect to the production
during the taxable year (including costs
described in § 1.181–2T(a)(3));
(iv) The aggregate amount of qualified
compensation (as defined in § 1.181–
3T(d)) paid or incurred with respect to
the production during the taxable year
(including costs described in § 1.181–
2T(a)(3));
(v) The aggregate amount of
compensation (as defined in § 1.181–
3T(c)) paid or incurred with respect to
the production during the taxable year
(including costs described in § 1.181–
2T(a)(3));
(vi) If the owner expects that the total
production cost of the production will
be significantly paid or incurred in (or,
if applicable, if a significant portion of
the total number of days of principal
photography will occur in) one or more
of the areas specified in § 1.181–
1T(b)(2)(i), the identity of the area or
areas, the amount of production costs
paid or incurred (or the number of days
of principal photography engaged in) for
the applicable activities described in
§ 1.181–1T(b)(2)(ii), (iii), or (iv), as
applicable, that take place within such
areas (including costs described in
§ 1.181–2T(a)(3)), and the total
production cost paid or incurred (or the
total number of days of principal
photography engaged in) for such
activities (whether or not they take
place in such areas), for the taxable year
(including costs described in § 1.181–
2T(a)(3)); and
(vii) A declaration that the owner
reasonably expects (based on all of the
facts and circumstances at the time the
election was filed) both that the
production will be set for production (or
has been set for production) and will be
a qualified film or television
production, and that the aggregate
production cost of the production paid
or incurred will not, at any time, exceed
the applicable dollar amount set forth
under § 1.181–1T(b).
(2) Subsequent taxable years. If the
owner pays or incurs additional
production costs in any taxable year
subsequent to the taxable year in which
production costs are first deducted
under section 181, the owner must
attach a statement to its Federal income
tax return for that subsequent taxable
year providing—

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(i) The name (or other unique
identifying designation) of the
production;
(ii) The date the production costs
were first paid or incurred;
(iii) The amount of production costs
paid or incurred by the owner with
respect to the production during the
taxable year;
(iv) The amount of qualified
compensation paid or incurred with
respect to the production during the
taxable year;
(v) The aggregate amount of
compensation paid or incurred with
respect to the production during the
taxable year, and the aggregate amount
of compensation paid or incurred with
respect to the production in all prior
taxable years;
(vi) If the owner expects that the total
production cost of the production will
be significantly paid or incurred in (or,
if applicable, if a significant portion of
the total number of days of principal
photography will occur in) one or more
of the areas specified in § 1.181–
1T(b)(2)(i), the identity of the area or
areas, the amount of production costs
paid or incurred (or the number of days
of principal photography engaged in) for
the applicable activities described in
§ 1.181–1T(b)(2)(ii), (iii), or (iv), as
applicable, that take place within such
areas, and the total production cost paid
or incurred (or the number of days of
principal photography engaged in) for
such activities (whether or not they take
place in such areas), for the taxable year;
and
(vii) A declaration that the owner
continues to reasonably expect (based
on all of the facts and circumstances at
the time the election was filed) both that
the production will be set for
production (or has been set for
production) and will be a qualified film
or television production, and that the
aggregate production cost of the
production paid or incurred will not, at
any time, exceed the applicable dollar
amount set forth under § 1.181–1T(b).
(3) Deductions by more than one
owner. If more than one taxpayer will
claim deductions under section 181
with respect to the production for the
taxable year, each owner (but not the
members of an entity who are issued a
Schedule K–1 by the entity with respect
to their interest in the production) must
provide a list of the names and taxpayer
identification numbers of all such
taxpayers, the dollar amount that each
such taxpayer is entitled to deduct
under section 181, and the information
required by paragraphs (c)(1)(iii)
through (vi) and (c)(2)(iii) through (vi) of
this section for all owners.

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(d) Revocation of election—(1) In
general. An election made under this
section may not be revoked without the
consent of the Secretary.
(2) Consent granted. The Secretary’s
consent to revoke an election under this
section with respect to a particular
production will be granted if the
owner—
(i) Files a Federal income tax return
in which the owner complies with the
recapture provisions of § 1.181–4T(a) to
recapture the amount described in
§ 1.181–4T(a)(3); and
(ii) Attaches a statement to the
owner’s return clearly indicating the
name (or other unique identifying
designation) of the production, and
stating that the election under section
181 with respect to that production is
being revoked pursuant to § 1.181–
2T(d)(2).
(e) Transition rules—(1) Costs first
paid or incurred prior to October 23,
2004. If a taxpayer begins principal
photography of a production after
October 22, 2004, but first paid or
incurred production costs before
October 23, 2004, the taxpayer is
entitled to make an election under this
section with respect to those costs. If,
before June 15, 2006, the taxpayer filed
its Federal tax return for the taxable year
in which production costs were first
paid or incurred, and if the taxpayer
wants to make a section 181 election for
that taxable year, the taxpayer may
make the election either by—
(i) Filing an amended Federal tax
return for the taxable year in which
production costs were first paid or
incurred, and for all subsequent affected
taxable year(s), on or before November
15, 2006, provided that all of these years
are open under the period of limitations
for assessment under section 6501(a); or
(ii) Filing a Form 3115, ‘‘Application
For Change in Accounting Method,’’ for
the first or second taxable year ending
on or after December 31, 2005, in
accordance with the administrative
procedures issued under § 1.446–
1(e)(3)(ii) for obtaining the
Commissioner’s automatic consent to a
change in accounting method (for
further guidance, for example, see Rev.
Proc. 2002–9, 2002–1 CB 327, and
§ 601.601(d)(2)(ii)(b) of this chapter).
This change in method of accounting
results in a section 481 adjustment.
Further, any limitations on obtaining
the automatic consent of the
Commissioner do not apply to a
taxpayer seeking to change its method of
accounting under this paragraph (e)(1).
Moreover, the taxpayer must include on
line 1a of the Form 3115 the designated
automatic accounting method change
number ‘‘100’’.

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(2) Returns filed after June 14, 2006,
and before March 12, 2007. If, after June
14, 2006, and before March 12, 2007, the
owner of a film or television production
filed its original Federal income tax
return for a taxable year ending after
October 22, 2004, without making an
election under section 181 for
production costs first paid or incurred
after October 22, 2004, and if the
taxpayer wants to make an election
under section 181 for production costs
first paid or incurred during that taxable
year, the taxpayer must make the
election within the time provided by
paragraph (a) of this section and in the
manner provided in paragraph (c)(1) of
this section, except that the election
statement attached to the return must
include the information required in
paragraphs (c)(1)(i) through (vi) of this
section.
(3) Information required. If, in
accordance with paragraph (e)(1) of this
section, the taxpayer is making an
election for a prior taxable year by filing
amended Federal tax return(s), the
statement and information required by
paragraphs (c)(1) and (c)(2) of this
section must be attached to each
amended return. If, in accordance with
paragraph (e)(1) of this section, the
taxpayer is making a section 181
election for a prior taxable year by filing
a Form 3115 for the first or second
taxable year ending on or after
December 31, 2005, the statement and
information required by paragraphs
(c)(1) and (c)(2) of this section must be
attached to the Form 3115. For purposes
of the preceding sentence, the amount of
the cost or compensation paid or
incurred for the production must only
include the amount paid or incurred in
taxable years prior to the year of change
(for further guidance on year of change,
see section 5.02 of Rev. Proc. 2002–9
and § 601.601(d)(2)(ii)(b) of this
chapter).

hsrobinson on PROD1PC76 with RULES

§ 1.181–3T Qualified film or television
production (temporary).

(a) In general. The term qualified film
or television production means any
production (as defined in paragraph (b)
of this section) if not less than 75
percent of the total amount of
compensation (as defined in paragraph
(c) of this section) paid with respect to
the production is qualified
compensation (as defined in paragraph
(d) of this section).
(b) Production—(1) In general. Except
as provided in paragraph (b)(3) of this
section, for purposes of this section and
§§ 1.181–1T, 1.181–2T, 1.181–4T,
1.181–5T, and 1.181–6T, a film or
television production (or production)
means any film or video (including

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digital video) production the production
cost of which is subject to capitalization
under section 263A, or that would be
would be subject to capitalization if
section 263A applied to the owner of
the production.
(2) Special rules for television
productions. Each episode of a
television series is a separate production
to which the rules, limitations, and
election requirements of this section
and §§ 1.181–1T, 1.181–2T, 1.181–4T,
1.181–5T, and 1.181–6T apply. A
taxpayer may elect to deduct production
costs under section 181 only for the first
44 episodes of a television series
(including pilot episodes). A television
series may include more than one
season of programming.
(3) Exception for certain sexually
explicit productions. A production does
not include property with respect to
which records are required to be
maintained under 18 U.S.C. 2257.
Section 2257 of Title 18 requires
maintenance of certain records with
respect to any book, magazine,
periodical, film, videotape, or other
matter that—
(i) Contains one or more visual
depictions made after November 1,
1990, of active sexually explicit
conduct; and
(ii) is produced in whole or in part
with materials that have been mailed or
shipped in interstate or foreign
commerce, or is shipped or transported
or is intended for shipment or
transportation in interstate or foreign
commerce.
(c) Compensation. The term
compensation means, for purposes of
this section and § 1.181–2T(c), all
payments made by the owner (whether
paid directly by the owner or paid
indirectly on the owner’s behalf) for
services performed by actors (as defined
in paragraph (f)(1) of this section),
directors, producers, and other relevant
production personnel (as defined in
paragraph (f)(2) of this section) with
respect to the production. Indirect
payments on the owner’s behalf include,
for example, payments by a partner on
behalf of an owner that is a partnership,
payments by a shareholder on behalf of
an owner that is a corporation, and
payments by a contract producer on
behalf of an owner. Payments for
services include all elements of
compensation as provided for in
§ 1.263A–1(e)(2)(i)(B) and (3)(ii)(D).
Compensation is not limited to wages
reported on Form W–2, ‘‘Wage and Tax
Statement,’’ and includes compensation
paid to independent contractors.
However, solely for purposes of
paragraph (a) of this section, the term
‘‘compensation’’ does not include

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participations and residuals (as defined
in section 167(g)(7)(B)). See § 1.181–
1T(a)(3) for additional rules concerning
participations and residuals.
(d) Qualified compensation. The term
qualified compensation means, for
purposes of this section and § 1.181–
2T(c), all payments made by the owner
(whether paid directly by the owner or
paid indirectly on the owner’s behalf)
paid for services performed in the
United States (as defined in paragraph
(f)(3) of this section) by actors, directors,
producers, and other relevant
production personnel with respect to
the production. A service is performed
in the United States for purposes of this
paragraph (d) if the principal
photography to which the compensated
service relates occurs within the United
States and the person performing the
service is physically present in the
United States. For purposes of an
animated film or animated television
production, the location where
production activities such as keyframe
animation, in-between animation,
animation photography, and the
recording of voice acting performances
are performed is considered in lieu of
the location of principal photography.
For purposes of a production
incorporating both live action and
animation, the location where
production activities such as keyframe
animation, in-between animation,
animation photography, and the
recording of voice acting performances
for the production is considered in
addition to the location of principal
photography.
(e) Special rule for acquired
productions. A taxpayer who acquires
an unfinished production from a prior
owner must take into account all
compensation paid by or on behalf of
the seller and any previous owners in
determining if the production is a
qualified film or television production
as defined in paragraph (a) of this
section. Any owner seeking to deduct as
a production cost either the cost of
acquiring a production or any
subsequent production costs should
obtain from the seller detailed records
concerning the compensation paid with
respect to the production in order to
demonstrate the eligibility of the
production under section 181.
(f) Other definitions. The following
definitions apply for purposes of this
section and §§ 1.181–1T, 1.181–2T,
1.181–4T, 1.181–5T, and 1.181–6T:
(1) Actors. The term actors includes
players, newscasters, or any other
persons who are compensated for their
performance or appearance in a
production.

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Federal Register / Vol. 72, No. 27 / Friday, February 9, 2007 / Rules and Regulations

(2) Production personnel. The term
production personnel includes, for
example, writers, choreographers, and
composers providing services during
production, casting agents, camera
operators, set designers, lighting
technicians, make-up artists, and others
who are compensated for providing
services directly related to producing
the production.
(3) United States. The term United
States includes the 50 states, the District
of Columbia, the territorial waters of the
continental United States, the airspace
or space over the continental United
States and its territorial waters, and the
seabed and subsoil of those submarine
areas that are adjacent to the territorial
waters of the continental United States
and over which the United States has
exclusive rights, in accordance with
international law, with respect to the
exploration and exploitation of natural
resources. The term United States does
not include possessions and territories
of the United States (or the airspace or
space over these areas).

hsrobinson on PROD1PC76 with RULES

§ 1.181–4T

Special rules (temporary).

(a) Recapture—(1) Applicability. The
rules of this paragraph (a) apply
notwithstanding whether a taxpayer has
satisfied the requirements of § 1.181–
2T(d). A taxpayer that, with respect to
a production, claimed a deduction
under section 181 in any taxable year in
an amount in excess of the amount that
would be allowable as a deduction for
that year in the absence of section 181
must recapture deductions as provided
for in paragraph (a)(3) of this section for
the production in the first taxable year
in which—
(i) The aggregate production cost of
the production exceeds the applicable
production cost limit under § 1.181–
1T(b);
(ii) The owner no longer reasonably
expects (based on all of the facts and
circumstances at the time the election
was filed) both that the production will
be set for production (or has been set for
production) and will be a qualified film
or television production, and that the
aggregate production cost of the
production paid or incurred will not, at
any time, exceed the applicable dollar
amount set forth under § 1.181–1T(b); or
(iii) the taxpayer revokes the election
pursuant to § 1.181–2T(d).
(2) Principal photography not
commencing prior to January 1, 2009. If
a taxpayer claims a deduction under
section 181 with respect to a production
for which principal photography does
not commence prior to January 1, 2009,
the taxpayer must recapture deductions
as provided for in paragraph (a)(3) of

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this section in the taxpayer’s taxable
year that includes December 31, 2008.
(3) Amount of recapture. A taxpayer
subject to recapture under this § 1.181–
4T must, in the taxable year in which
recapture is triggered, include in the
taxpayer’s gross income and add to the
taxpayer’s adjusted basis in the
property—
(i) For a production that is placed in
service in a taxable year prior to the
taxable year in which recapture is
triggered, the difference between the
aggregate amount claimed as a
deduction under section 181 with
respect to the production in all such
prior taxable years and the aggregate
depreciation deductions that would
have been allowable with respect to the
property for such prior taxable years (or
that the taxpayer could have elected to
deduct in the taxable year that the
property was placed in service) with
respect to the production under the
taxpayer’s method of accounting; or
(ii) For a production that has not been
placed in service, the aggregate amount
claimed as a deduction under section
181 with respect to the production in all
such prior taxable years.
(b) Recapture under section 1245. For
purposes of recapture under section
1245, any deduction allowed under
section 181 is treated as a deduction
allowable for amortization.
§ 1.181–5T

Examples (temporary).

The following examples illustrate the
application of §§ 1.181–1T through
1.181–4T:
Example 1. X, a corporation using a
calendar taxable year, is a producer of films.
X is the owner (within the meaning of
§ 1.181–1T(a)(2)) of film ABC. X incurs
production costs in year 1, but does not
commence principal photography for film
ABC until year 2. In year 1, X reasonably
expects, based on all of the facts and
circumstances, that film ABC will be set for
production and will be a qualified film or
television production, and that at no time
will the production cost of film ABC exceed
the applicable production cost limit of
§ 1.181–1T(b). Provided that X satisfies all
other requirements of §§ 1.181–1T through
1.181–4T and § 1.181–6T, X may deduct in
year 1 the production costs for film ABC that
X incurred in year 1.
Example 2. The facts are the same as in
Example 1. In year 2, X begins, but does not
complete, principal photography for film
ABC. Most of the scenes that X films in year
2 are shot outside the United States and, as
of December 31, year 2, less than 75 percent
of the total compensation paid with respect
to film ABC is qualified compensation.
Nevertheless, X still reasonably expects,
based on all of the facts and circumstances,
that film ABC will be a qualified film or
television production, and that at no time
will the production cost of film ABC exceed
the applicable production cost limit of

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§ 1.181–1T(b). Provided that X satisfies all
other requirements of §§ 1.181–1T through
1.181–4T and § 1.181–6T, X may deduct in
year 2 the production costs for film ABC that
X incurred in year 2.
Example 3. The facts are the same as in
Example 2. In year 3, X continues, but does
not complete, production of film ABC. Due
to changes in the expected production cost of
film ABC, X no longer expects film ABC to
qualify under section 181. X files a statement
with its return for year 3 identifying the film
and stating that X revokes its election under
section 181. X includes in income in year 3
the deductions claimed in year 1 and in year
2 as provided for in § 1.181–4T. X has
successfully revoked its election pursuant to
§ 1.181–2T(d).
Example 4. The facts are the same as in
Example 2. In year 3, X completes
production of film ABC at a cost of $14.5
million and places it into service. ABC is an
unexpected success in year 4, causing
participation payments to drive the total
production cost of film ABC above $15
million in year 4. X includes in income in
year 4 as recapture under § 1.181–4T(a) the
difference between the deductions claimed in
year 1, year 2, and year 3, and the deductions
that it would have claimed under the income
forecast method described in section 167(g)
of the Internal Revenue Code, a method that
was allowable for the film in year 3 (the year
the film was placed in service). Because X
calculated the recapture amount by
comparing actual deductions to deductions
under the income forecast method, X must
use this method to calculate deductions for
film ABC for year 4 and in subsequent
taxable years.
§ 1.181–6T

Effective date (temporary).

(a) In general. (1) Section 181 applies
to productions commencing after
October 22, 2004, and shall not apply to
productions commencing after
December 31, 2008. Except as provided
in paragraphs (b) and (c) of this section,
§§ 1.181–1T through 1.181–5T apply to
productions, the first day of principal
photography for which occurs on or
after February 9, 2007, and before
January 1, 2009. In the case of an
animated production, this paragraph (a)
should be applied by substituting ‘‘inbetween animation’’ in place of
‘‘principal photography’’. Productions
involving both animation and liveaction photography may use either
standard.
(2) The applicability of §§ 1.181–1T
through 1.181–5T expires on February
8, 2010.
(b) Application of regulation project
REG–115403–05 to pre-effective date
productions. A taxpayer may apply
§§ 1.181–1T through 1.181–5T to
productions, the first day of principal
photography (or ‘‘in-between’’
animation) for which occurs after
October 22, 2004, and before February 9,
2007, provided that the taxpayer applies

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Federal Register / Vol. 72, No. 27 / Friday, February 9, 2007 / Rules and Regulations
all provisions in §§ 1.181–1T through
1.181–5T to the productions.
(c) Special rules for returns filed for
prior taxable years. If before March 12,
2007, an owner of a film or television
production began principal photography
(or ‘‘in-between’’ animation) for the
production after October 22, 2004, and
filed its original Federal income tax
return for the year such costs were first
paid or incurred without making an
election under section 181 for the costs
of the production, and if the taxpayer
wants to make an election under section
181 for such taxable year, see § 1.181–
2T(e) for the time and manner of making
the election.
PART 602—OMB CONTROL NUMBERS
UNDER THE PAPERWORK
REDUCTION ACT
■ Par. 3. The authority citation for part
602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 4. In § 602.101, paragraph (b) is
amended by adding the following entry
in numerical order to the table to read
as follows:

■

§ 602.101

*

OMB Control numbers.

*
*
(b) * * *

*

*

CFR part or section where
identified and described
*
*
*
1.181–1T and 1.181–2T .......
*

*

*

Current OMB
control No.
*

*
1545–2059

*

*

Kevin M. Brown,
Deputy Commissioner for Services and
Enforcement.
Approved: February 1, 2007.
Eric Solomon,
Assistant Secretary of the Treasury (Tax
Policy).
[FR Doc. E7–2154 Filed 2–8–07; 8:45 am]
BILLING CODE 4830–01–P

DEPARTMENT OF THE TREASURY
Alcohol and Tobacco Tax and Trade
Bureau
27 CFR Part 9
[T.D. TTB–58; Re: Notice No. 59]

hsrobinson on PROD1PC76 with RULES

RIN 1513–AB13

Establishment of the Outer Coastal
Plain Viticultural Area (2003R–166P)
Alcohol and Tobacco Tax and
Trade Bureau (TTB), Treasury.
ACTION: Final rule; Treasury decision.
AGENCY:

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SUMMARY: This Treasury decision
establishes the Outer Coastal Plain
viticultural area in southeastern New
Jersey. The viticultural area consists of
approximately 2,255,400 acres and
includes all of Cumberland, Cape May,
Atlantic, and Ocean Counties and
portions of Salem, Gloucester, Camden,
Burlington, and Monmouth Counties.
We designate viticultural areas to allow
bottlers to better describe the origin of
their wines and to allow consumers to
better identify the wines they may
purchase.
DATES: Effective Date: March 12, 2007.
FOR FURTHER INFORMATION CONTACT:
Jennifer Berry, Alcohol and Tobacco
Tax and Trade Bureau, Regulations and
Rulings Division, P.O. Box 18152,
Roanoke, VA 24014; telephone 540–
344–9333.
SUPPLEMENTARY INFORMATION:

Background on Viticultural Areas
TTB Authority
Section 105(e) of the Federal Alcohol
Administration Act (FAA Act), 27
U.S.C. 205(e), authorizes the Secretary
of the Treasury to prescribe regulations
for the labeling of wine, distilled spirits,
and malt beverages. The FAA Act
provides that these regulations should,
among other things, prohibit consumer
deception and the use of misleading
statements on labels, and ensure that
labels provide the consumer with
adequate information as to the identity
and quality of the product. The Alcohol
and Tobacco Tax and Trade Bureau
(TTB) administers the regulations
promulgated under the FAA Act.
Part 4 of the TTB regulations (27 CFR
part 4) allows the establishment of
definitive viticultural areas and the use
of their names as appellations of origin
on wine labels and in wine
advertisements. Part 9 of the TTB
regulations (27 CFR part 9) contains the
list of approved viticultural areas.
Definition
Section 4.25(e)(1)(i) of the TTB
regulations (27 CFR 4.25(e)(1)(i)) defines
a viticultural area for American wine as
a delimited grape-growing region
distinguishable by geographical
features, the boundaries of which have
been recognized and defined in part 9
of the regulations. These designations
allow vintners and consumers to
attribute a given quality, reputation, or
other characteristic of a wine made from
grapes grown in an area to its
geographical origin. The establishment
of viticultural areas allows vintners to
describe more accurately the origin of
their wines to consumers and helps
consumers to identify wines they may

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purchase. Establishment of a viticultural
area is neither an approval nor an
endorsement by TTB of the wine
produced in that area.
Requirements
Section 4.25(e)(2) of the TTB
regulations outlines the procedure for
proposing an American viticultural area
and provides that any interested party
may petition TTB to establish a grapegrowing region as a viticultural area.
Section 9.3(b) of the TTB regulations
requires the petition to include—
• Evidence that the proposed
viticultural area is locally and/or
nationally known by the name specified
in the petition;
• Historical or current evidence that
supports setting the boundary of the
proposed viticultural area as the
petition specifies;
• Evidence relating to the
geographical features, such as climate,
soils, elevation, and physical features,
that distinguish the proposed
viticultural area from surrounding areas;
• A description of the specific
boundary of the proposed viticultural
area, based on features found on United
States Geological Survey (USGS) maps;
and
• A copy of the appropriate USGS
map(s) with the proposed viticultural
area’s boundary prominently marked.
Rulemaking Proceedings
Outer Coastal Plain Petition
James Quarella of Bellview Winery,
Landisville, New Jersey, petitioned TTB
to establish the ‘‘Outer Coastal Plain’’ as
an American viticultural area in
southeastern New Jersey. The proposed
viticultural area covers approximately
2,255,400 acres and includes all of
Cumberland, Cape May, Atlantic, and
Ocean Counties and portions of Salem,
Gloucester, Camden, Burlington, and
Monmouth Counties. According to the
petitioner, the area currently includes
thirteen wineries, several vineyards, and
approximately 750 acres planted to
vines. We summarize below the
evidence submitted in support of the
petition.
Name Evidence
The Outer Coastal Plain is one of five
defined physiographic regions of New
Jersey. The other regions are the Inner
Coastal Plain, the Newark Basin
Piedmont, the Highlands, and the
Appalachian Valley and Ridge.
The Outer Coastal Plain includes most
of the State’s Atlantic coastline and the
area known as the ‘‘Pinelands’’ or ‘‘Pine
Barrens.’’ The petitioner states that most
geology reference sources and such

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