- Internal Revenue Code Section 409A May Be Applicable to Profit and Participation Interests in Entertainment Contracts
- December 22, 2008 | Authors: Marla J. Blackburn Aspinwall; C. David Anderson; Dana Scott Fried; Alan J. Tarr
- Law Firms: Loeb & Loeb LLP - Los Angeles Office; Loeb & Loeb LLP - New York Office
We want to make sure you know about an important tax issue that may require you to take action by the end of this year. Internal Revenue Code Section 409A, which was enacted several years ago in response to abuses by Enron executives of deferred compensation rules, is potentially applicable to profit and participation interests in entertainment contracts. These rules apply not just to traditional employment contracts, but also to interests granted to some independent contractors.
Section 409A may be applicable to any agreement for the performance of services where part of the fixed or contingent compensation is paid in a tax year after the year in which the services were performed. Initially, it did not appear that these Section 409A provisions would apply to things like profit participations with respect to films or record royalties. It is now clear that the IRS believes that Section 409A can be applicable to these kinds of arrangements. There is significant uncertainty and even disagreement among practitioners regarding how these rules apply in many contexts.
Although the full application of these new Section 409A rules has been partially suspended by the Internal Revenue Service until now, the rules will apply fully as of the end of this year, and in some cases will also have retroactive effect. Violation of the new rules under Section 409A has the potential for severe penalties. The penalties, together with regular taxes and interest, can add up to more than 100% of the income being received.
Many clients will not be subject to 409A at all, for example, because they consistently perform services as an independent contractor for multiple unrelated studios, producers, record companies, etc. There are several other factors that may cause Section 409A not to apply to you. However, there are so many different circumstances that govern its applicability, it is impossible to set forth general parameters.
If your contracts are subject to the Section 409A requirements, there is a limited window of opportunity to conform existing contracts to the new rules by making changes with regard to the structure or timing of payments. These changes must be made before December 31, 2008.
If contract changes are necessary, they may not be onerous for many of our clients, and the penalties for failure to act can be extremely large. Therefore, we encourage you to pay close attention to this issue. At a minimum, you should have your tax adviser: i) review your circumstances relating to compensation contracts, old and new, which provide for fixed or contingent future payments; ii) determine whether the Section 409A rules may be applicable to you; and iii) determine whether any of your existing contracts should be amended before December 31, 2008.