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. If you use our firm for tax advice, please feel free to contact (or have your accountant or business manager contact) any of the following members of our Tax Department:
Again, if changes are required, they must be made by the end of this year. Because there are many agreements which need to be reviewed in this short period, we encourage you to consult your tax adviser as soon as possible to allow time to determine whether changes to your contracts would be desirable and whether the other party to the contract will agree to make them.
This alert is a publication of Loeb & Loeb LLP and is intended to provide information on recent legal developments. This alert does not create or continue an attorney client relationship nor should it be construed as legal advice or an opinion on specific situations.
Circular 230 Disclosure: To ensure compliance with Treasury Department rules governing tax practice, we inform you that any advice contained herein (including any attachments) (1) was not written and is not intended to be used, and cannot be used, for the purpose of avoiding any federal tax penalty that may be imposed on the taxpayer; and (2) may not be used in connection with promoting, marketing or recommending to another person any transaction or matter addressed herein.