Pitching Section 181 – Rough Outline of How It Works:
January 6, 2011 3 Comments
There’s a lot of excitement associated with the news about the extension of Section 181. Some if it is over-hype. It’s definitely a good thing, but you need to understand what an investor will get out of it in order to make a proper pitch. I wrote this as an entry level blog for someone who is just beginning to review how the US Federal Tax Incentive works (known by everyone as Section 181).
Here is a 15 point workflow of what I see as a way to pitch “Mr. Bucks”:
1. The person you need to pitch, let’s call this person Mr. Bucks, is someone with a lot of “Passive Income” (Passive Income is primarily rental income, not income earned from bonds, stocks, etc. – make sure that he has a good understanding of what passive income is and how it is defined under IRS rules). Worth pointing out, but necessary to our pitch, is that Mr. Bucks also has access to cash.
2. Mr. Bucks, let’s assume for now, is NOT actively involved in the development of the script and in the shooting of the film or television project.
3. You get Mr. Bucks to agree to wire $500,000 to the production bank account at key stages (say, $50,000 on the first day of prep, $300,000 on the first day of shooting, $100,000 when a rough cut is delivered and the final $50,000 when the final cut is ready for delivery to the film festival circuit).
4. During the Pitch you’ve pointed out to Mr. Bucks that you’re going to shoot the film in a defined low-income location, say Michigan, and that the production will take place entirely with in the USA (Note: to qualify under Section 181 at least 75% of the production must be in the USA).
5. The production will take place during the calendar year of 2011.
6. Mr. Bucks can now deduct the $500,000 from his “Passive Income”.
7. What does that mean for Mr. Bucks? Well, say he was taxed at 35%. So, he would have had to pay 35% of $500,000 = $175,000 to the IRS. Now he doesn’t. So, he spent $500,000 to save $175,000.
8. That means that Mr. Bucks is still out $325,000 that he’ll want back, with some kind of profit as well. For example, Mr. Bucks knows that if he just left his money in a safe interest earning investment he could make 2% without a worry. He’ll expect much more of a return for a higher risk investment like film.
9. So, how else can you sweeten your pitch to Mr. Bucks? Well, if you haven’t already factored into the budgeted costs the Michigan tax credit of 40% to 42%, you can promise that back to Mr. Bucks. For our purposes, let’s assume the total budget is $500,000 and that the Michigan tax credit is up for grabs. After going through the budget and carefully estimating the Michigan tax credit you come up with 40% of $400,000 = $160,000 that you can get back to Mr. Bucks.
10. Okay. Now you have saved Mr. Bucks $175,000 + $160,000 = $335,000. From Mr. Bucks point of view he is now spending $500,000 to get back $335,000.
11. Bottom line of your pitch is that you’re asking for $500,000 with a guaranteed reimbursement of $335,000 within a year or so, and a risk of $165,000.
12. Now comes the gi-normous pitch – why your film or television project will sell for more than a net return of $165,000.
13. Of course, in terms of the pitch you could throw out percentages like, “Mr. Bucks I can guarantee you a 67% recapture”.(Note: you don’t say “return” as that word means the amount he gets over and above the investment). This is huge in the film industry where the risk is usually so very high.
14. A major point I want to make is that you really need to tell Mr. Bucks that he needs to confirm all of this with his accountant or lawyer. If you get well into this only to find out that his income does NOT qualify as “Passive Income” there will be a lot of heartbreak.
15. A final point in the pitch is that if the investor can prove that he is ACTIVELY involved in the project, the investor can deduct the investment (i.e. the $500,000 in our example) from ALL income – not just from “Passive” income. Take care with this, because the definition of “ACTIVE” means that our Mr. Bucks must really be active in the development and production of the film or television production. I have heard some horror stories about this and unless Mr. Bucks is really part of the creative, production and delivery (i.e. showing up for work and can prove he is not just an angel investor) I wouldn’t even bring it up.
If you haven’t seen it before, here’s the IRS Bulletin that started it all – click here.
For more references you can visit my web site at http://www.talkfilm.biz/filmworkshops1.htm