Mofo New York Tax Insights - Winter 2012

Edited by Timothy A. Gustafson and Nicole L. Johnson,

Inside This Month

• Should Filmmakers Be Content to Have Taxing Authorities Judge Their Content?
  By Hollis L. Hyans and Open Weaver Banks
• Individual Liability for Company Taxes
  By Mitchell A. Newmark and Richard C. Call
• Potential Unity and Business Income in California
  By Eric J. Coffill and Timothy A. Gustafson
• Managing Withholding for a Mobile Workforce: Special Treatment of Deferred Compensation and Stock Options
  By Paul H. Frankel and Debra S. Herman
• California's Property Tax Exclusion for Solar Energy Power Plants: Waiting to Sell Until New Year's Day Might Produce a Huge Hangover
  By Peter B. Kanter

SHOULD FILMMAKERS BE CONTENT TO HAVE TAXING AUTHORITIES JUDGE THEIR CONTENT?

By Hollis L. Hyans and Open Weaver Banks

The vast majority of states have enacted tax incentive programs for qualifying motion picture and television productions. These tax incentives are available in many forms, including income tax credits (typically transferable), sales tax exemptions, hotel tax exemptions and cash rebates of qualified expenditures. Although the features of each state's program vary, the common purpose of these programs is to spur local economic growth by incentivizing the motion picture and television industries to locate their productions in the state offering an incentive program.

So what happens when a production company meets all the eligibility requirements for a tax credit, but cannot get past the state's censors? As we learned recently in New Jersey, the shooting location of the reality television series Jersey Shore, tax credits might be revoked if the state decides that the television program makes the state look bad.¹ On September 26, 2011, Governor Christie informed the New Jersey Economic Development Authority that he vetoed its award of $420,000 in tax credits to the producers of Jersey Shore.² Governor Christie explained: "I have no interest in policing the content of such projects; however, as Chief Executive I am duty bound to ensure that taxpayers are not footing a $420,000 bill for a project which does nothing more than perpetuate misconceptions about the State and its citizens."³

State Review of Motion Picture and Television Production Content

While Governor Christie's veto of the Jersey Shore tax credits made national news, New Jersey is not the only state that reviews the content of productions before granting tax incentives. In 2010, the New York Times reported the statements of Michigan's Film Commissioner in connection with the denial of tax incentives for the motion picture, The Woman. Noting the film's subject matter, "namely realistic cannibalism; the gruesome and graphically violent depictions described in the screenplay; and the explicit nature of the script," the Michigan Film Commissioner stated, "[t]his film is unlikely to promote tourism in Michigan or to present or reflect Michigan in a positive light."⁴ Similarly, the Texas Film Commission refused to pay $1.75 million in tax incentives to the producers of the motion picture Machete, citing a state law that allows the state to refuse to pay incentives for content that portrays Texas or Texans in a negative fashion.⁵

The producers of Jersey Shore could not have anticipated that their tax credits would be revoked because New Jersey's incentive program, like the programs in most states, does not disqualify productions that make the state look bad. However, a handful of states, like Texas, have enacted such criteria into their laws or created similar standards in their application review guidelines.⁶ Utah's Motion Picture Incentive Fund application instructions provide that the state is not required to grant incentives to projects that include "inappropriate content" or "content that portrays Utah or Residents of Utah in a negative way."⁷

In Wisconsin, a production will not qualify if it will hurt the reputation of the state.⁸ A production with content that portrays West Virginia in a "significantly derogatory manner" is ineligible for West Virginia film credits.⁹ Wyoming limits the definition of a "qualified production" to filmed entertainment that would likely encourage members of the public to visit the state of Wyoming.¹⁰ Similarly, Kentucky's program requires a determination that the production will not negatively impact the tourism industry of the Commonwealth and Pennsylvania's application guidelines indicate that the Pennsylvania Film Office may consider whether the project will tend to foster a positive image of Pennsylvania.¹¹

The majority of state motion picture and television production incentive programs have not openly expressed a similar concern about productions that may portray a state in a negative fashion. However, states normally carve out broad categories of productions that do not qualify for tax incentives, such as news, sports events, award programs and even documentaries and reality television shows.¹² It is also typical for incentive programs to contain some manner of prohibition on productions that contain sexually explicit or obscene material.¹³ By requiring tax incentive applicants to submit a script, screenplay or synopsis of the production, state film commissions charged with administering incentive programs are also able to review the content of proposed motion picture and television productions. Some state incentive programs actually require production companies to submit a copy of the final version of the production to qualify for tax incentives.¹⁴

First Amendment Principles

Although the producers of Jersey Shore may have more than one avenue for challenging Governor Christie's veto of their tax credits, the interesting question with multistate ramifications is whether Governor Christie crossed a First Amendment line when he denied tax credits to Jersey Shore based upon the content of the production.¹⁵ The First Amendment provides that Congress shall make no law abridging the freedom of speech and is made applicable to the states through the Fourteenth Amendment.¹⁶ First Amendment jurisprudence recognizes:

Under our system of government there is an accommodation for the widest varieties of tastes and ideas. What is good literature, what has educational value, what is refined public information, what is good art, varies with individuals as it does from one generation to another. . . . But a requirement that literature or art conform to some norm prescribed by an official smacks of an ideology foreign to our system.¹⁷

Obscenity Is Not Protected Speech

In the area of First Amendment jurisprudence, one thing that is clear is that obscenity is not protected speech.¹⁹ Nonetheless, the Supreme Court recognizes that state statutes designed to regulate obscene materials must be carefully limited.²⁰ Provided that states adopt the proper First Amendment standards for determining whether particular material is obscene, motion picture and television production incentive programs that deny tax benefits to productions containing obscene material are probably facially constitutional.²¹ In an individual case, however, it would be necessary to consider the application of the relevant standard to the production seeking to qualify for tax benefits.

Many states rely on the federal standard set forth by the Child Protection and Obscenity Enforcement Act of 1988 to define the category of sexually explicit content that is not eligible for motion picture and television production incentives.²² Other states have their own definition of "obscene material" or "obscene content."²³ Any definition will likely be interpreted and applied by a relatively small group of people who form the local film commission that is charged with reviewing and approving tax incentive applications. As evidenced by a recent scandal in Iowa's Film Office involving improperly awarded credits, state film commissions have a tremendous amount of discretion and are susceptible to errors in judgment.²⁴

Supreme Court Cases Considering the First Amendment and State Taxes

Outside of obscene material, the state of constitutional law when First Amendment rights are impacted by government funding (or denial thereof) is somewhat unclear. On one end of the spectrum are two United States Supreme Court cases extending First Amendment protection in the area of tax exemptions.

In Speiser v. Randall, the Court reviewed a California rule enacted in 1954 that required veterans seeking property tax exemptions to sign a declaration stating that they did not advocate the forcible overthrow of the Government of the United States or of California.²⁵ Veterans who refused to execute the oath were denied the exemption. The Supreme Court struck down the oath requirement, stating "when the constitutional right to speak is sought to be deterred by a State's general taxing program due process demands that the speech be unencumbered until the State comes forward with sufficient proof to justify its inhibition."²⁶ In Speiser, the Supreme Court concluded that California lacked a compelling interest that would justify suppressing the speech at issue. In reaching this decision, the Supreme Court specifically rejected California's argument that because a tax exemption is a privilege or bounty, its denial does not infringe speech.²⁷ The Supreme Court stated that "[to] deny an exemption to claimants who engage in certain forms of speech is in effect to penalize them for such speech. Its deterrent effect is the same as if the state were to fine them for this speech."²⁸

Nearly thirty years later, in Arkansas Writers' Project, Inc. v. Ragland, the Supreme Court held that Arkansas' selective application of its sales tax to magazines violated the First Amendment's guarantee of freedom of the press because it differentiated between magazines based on their content.²⁹ The Arkansas statute provided an exemption for religious, professional, trade and sports publications. According to the Supreme Court, "[r]egulations which permit the Government to discriminate on the basis of the content of the message cannot be tolerated under the First Amendment."³⁰ In order to justify such differential taxation, the Supreme Court stated that Arkansas must show that its regulation was necessary to serve a compelling state interest and was narrowly drawn to achieve that end.³¹ Arkansas was unable to meet this standard.

Arkansas Writers' Project was technically not a "freedom of speech" case. Rather, the Supreme Court decided that the Arkansas sales tax scheme violated freedom of press. Nonetheless, Arkansas Writers' Project is cited in cases evaluating freedom of speech claims and stands for the principle that state governments wander into dangerous territory when the grant of a tax exemption requires government scrutiny of the content of speech.³² The reasoning of Arkansas Writers' Project is particularly relevant to state motion picture and television production incentive programs because the Supreme Court has held that expression by means of motion pictures is included within both the free speech and the free press guarantees of the First and Fourteenth Amendments.³³

Supreme Court Cases Considering the First Amendment and Government Spending

On the other end of the spectrum are nontax cases in which the Supreme Court has upheld government review of the content of speech when the government is the speaker or when the government acts as a patron. At the outset it is important to note that the following cases both involved facial challenges to laws involving speech and, therefore, the challengers of these laws faced a heavier burden. We do not know how these cases would have been decided if a challenger presented an "as applied" situation for the Supreme Court's review.

In Rust v. Sullivan, the Supreme Court considered a facial challenge to federal regulations that prohibited counseling concerning the use of abortion in federally funded family planning programs.³⁴ Petitioners, grantees and doctors who supervised the family planning funds, argued that the regulations violated their First Amendment rights by impermissibly imposing viewpoint discriminatory conditions on government subsidies and thus penalizing certain speech.³⁵ In a controversial 5-4 decision, the Supreme Court rejected the First Amendment challenge, finding "[t]he Government can, without violating the Constitution, selectively fund a program to encourage certain activities it believes to be in the public interest, without at the same time funding an alternative program which seeks to deal with the problem in another way."³⁶

Rust is distinguishable from the Jersey Shore situation because New Jersey did not enact its film production credit in order to establish a program for funding motion picture and television productions that make New Jersey look good. New Jersey's incentive program, like those of other states, was enacted to spur economic development in the state.

If New Jersey decides to hire a production company to make a film for the express purpose of portraying New Jersey in a positive light, then under Rust, New Jersey can exert some level of control over the content of the film. However, this does not mean that states such as Texas or Utah can constitutionally deny film credits to productions that portray the states or their residents in a negative manner simply because their incentive programs have identified such content as a basis for denial of incentives. The decisive inquiry should be whether the incentive program represents "government speech" in which the state should have some say about the message that is being conveyed.

In National Endowment for the Arts v. Finley, the Supreme Court upheld a 1990 amendment to federal law requiring the chairperson of the National Endowment for the Arts ("NEA") to take into consideration general standards of decency and respect for the diverse beliefs and values of the American public when judging the artistic merit of grant applications.³⁷ The legislative history indicated that the change in law was at least in part due to a Congressional reaction to the use of NEA grant money to fund a 1989 retrospective of the works of controversial photographer Robert Mapplethorpe.

Originally, in Finley, a group of artists who were denied NEA grants challenged the law as being both unconstitutional as applied to them, as well as unconstitutional on its face. However, during the course of the litigation the as applied constitutional claims were settled (with the plaintiffs receiving the amount of the vetoed grants, damages and attorney's fees) and the case proceeded solely as a facial challenge to the law under the First Amendment.

Expressing reluctance to invalidate legislation on the basis of its hypothetical application to situations not before the Court, the Supreme Court in Finley found that the new requirement to take into consideration general standards of decency seemed unlikely to introduce any greater element of selectivity than the determination of "artistic excellence" already required by the law for the judging of applications for artistic grants.³⁸ The Supreme Court also recognized that any content-based considerations that may be taken into account in the NEA grant-making process are a consequence of the subjective nature of arts funding.³⁹ The NEA has limited resources and it must deny the majority of the grant applications that it receives, including many that propose artistically excellent projects.⁴⁰ Ultimately, the majority opinion in Finley held that the government may take into consideration general standards of decency and respect for the diverse beliefs and values of the American public in connection with allocating competitive funding, even though such criteria might be impermissible were direct regulation of speech or a criminal penalty at stake, because Congress has wide latitude to set spending priorities.⁴¹ In effect, the federal government in Finley was "acting as patron rather than as sovereign."⁴²

After Finley, can a production company challenge the denial of specific tax incentives based on the content of the production? The answer should be "yes." While Finley acknowledges that some level of content review is permissible when the government funds the arts, state motion picture and television incentives programs were not enacted to support the arts, but to encourage the creation of jobs and spending in the enacting state. New Jersey should not be considered a "patron" for Jersey Shore or any other production applying for New Jersey tax credits. The end result may be an artistic production, but the purpose of motion picture and television incentive programs is to bring a production to the state to further the state's own economic interests. Thus, eligibility for credits should be based on such factors as the number of persons employed in the production and spending levels within the state, not on the content of the production.

Additionally, a key component of the Finley analysis was the limited number of grants available for NEA applicants and the fact that many, if not most, applicants were rejected for wholly subjective reasons. Although states may have more applicants for film tax credits than they can honor, it is not uncommon for states to administer their programs on a first-come, first-served basis.⁴³ For example, in New Mexico, tax credits are awarded on a first-come, first served basis and when the program's $50 million cap is reached, the remaining amounts are placed at the front of a queue and awarded in the next fiscal year.⁴⁴

States like New Mexico do not look at the entire pool of applicants to determine which productions are most worthy of a grant, as was the case in Finley. Thus, the highly selective nature of the NEA grants that made content review a permissible factor in Finley does not exist in motion picture and television production incentive programs with a first-come, first-served feature.

Even when the state may be considered a patron of the arts, a post-Finley decision involving an as applied challenge to the denial of arts funding by New York City interpreted Finley as upholding the "decency" and "respect" considerations only by reading them, on their face, as not permitting viewpoint discrimination.⁴⁵ In that case, then-Mayor Giuliani advanced arguments similar to those raised by Governor Christie, stating that New York City did not have to fund an art exhibit at the Brooklyn Museum that it found to be offensive and that while the exhibit could be shown privately, "the taxpayers don't have to pay for it."⁴⁶ The federal district court rejected this argument, concluding that where the denial of a benefit, subsidy or contract is motivated by a desire to suppress speech in violation of the First Amendment, that denial will be enjoined.⁴⁷

Conclusion

Until courts are asked to decide the extent of First Amendment protection in the area of state motion picture and television production incentive programs, the industry will have to operate in an area of uncertainty. In the meantime, the lesson for filmmakers who want to portray Texas or Utah in a negative fashion is to film your movie in New Jersey. Maybe there is a part for Governor Christie in a remake of A Fistful of Dollars. It worked for Ronald Reagan, why not Chris Christie?

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Footnotes

1 New Jersey suspended its film production tax credit program for fiscal year 2011. N.J. Stat. Ann. § 54:10A-5.39a. The temporary suspension of tax credits applies to the authorization of new credits and the application of previously authorized credits in the 2011 fiscal year. It does not, however, affect the carryover of unused tax credits previously allowed or which may be allowed following the suspension. Assembly Budget Committee Statement to Assembly No. 3011 (June 24, 2010).

2 http://www.state.nj.us/governor/news/news/552011/approved/20110926b.html.

3 Id.

4 Michael Cieply, State Backing Films Says Cannibal is Deal-Breaker, n.y. times, June 14, 2010, http://www.nytimes.com/2010/06/15/movies/15credits.html.

5 Russell Gold, Vigilante Justice? Texas Refuses to Pay 'Machete' Producers, wall street journal, Dec. 9, 2010, http://blogs.wsj.com/washwire/2010/12/09/vigilante-justice-texas-refuses-to-pay-machete-producers/.

6 Tex. Gov't Code Ann. § 485.022(e).

7 State of Utah Motion Picture Incentive Fund Fiscal Year 2011 Information and Application, http://film.utah.gov/documents/MPIF-FY2011.pdf.

8 Wis. Admin. Code § 133.30(4).

9 W. Va. Code § 11-13X-3(b)(8)(F).

10 Wyo. Stat. Ann. § 9-12-403(a)(v).

11 Ky. Rev. Stat. Ann. § 148.546(9); Film Tax Credit Program Guidelines October 2009, http://filminpa.com/wp-content/uploads/2009/07/Film-Tax-Credit_Guidelines-09.pdf.

12 See, e.g., Cal. Rev. & Tax. Code § 23685(b)(15)(D). The statute states that

13 See, e.g., N.J. Stat. Ann. § 54:10A-5.39.e (excluding productions containing obscene material, as defined under state law, from the definition of "film").

14 See, e.g., Connecticut guidelines published by the Office of Film, Television & Digital Media, http://www.ct.gov/ecd/lib/ecd/3-5-10_DigitalMediaMotionPictureTaxCreditGuidelines.pdf (requiring submission of a copy of the final version of the production in DVD format). In North Carolina, qualifying expenses are subject to audit before the credit is allowed. N.C. Gen. Stat. § 105-130.47(d). According to North Carolina Film Office guidelines, a copy of the production (rough-cut or finished copy DVD) will be requested at audit. See http://www.ncfilm.com/uploads/downloads/Film%20Incentive%20Documents/NCFilmIncentive_Rev2010.pdf.

15 It is questionable whether Governor Christie has a veto power to revoke film credits. New Jersey regulations provide that only the members of the New Jersey Economic Development Authority ("EDA") can deny an applicant's eligibility for the program. N.J. Admin. Code § 18:7-3B.5(c). When the members of the EDA deny a request for film credits their decision is submitted to the Governor and the EDA's action is effective 10 days after the Governor's receipt of the minutes, provided no veto has been issued. N.J. Admin. Code § 18:7-3B.5(d). Based on the plain language of the regulation, the Governor did not have the power to veto the grant of the film credit to Jersey Shore's producers. By regulation, he only had the power to veto a film credit denial by the EDA. However, in vetoing the Jersey Shore credits, Governor Christie relied upon a conflicting statute providing general veto power for actions taken at EDA meetings. N.J. Stat. Ann. § 34:1B-4(i).

16 Gitlow v. New York, 268 U.S. 652, 666 (1925).

17 Hannegan v. Esquire, 327 U.S. 146, 157 (1946).

18 Fla. Stat. § 288.1254(4)(b)(4). The statute states

19 Miller v. California, 413 U.S. 15, 23 (1973).

20 Id.

21 According to the Supreme Court, the standards for determining whether material is obscene are: (a) whether the average person, applying contemporary community standards, would find that the work, taken as a whole, appeals to the prurient interest; (b) whether the work depicts or describes, in a patently offensive way, sexual conduct specifically defined by the applicable state law; and (c) whether the work, taken as a whole, lacks serious literary, artistic, political, or scientific value. Id. at 24.

22 See, e.g., Ala. Code § 41-7A-42(8)(b); Ark. Code Ann. § 15-4-2003(8)(b)(iv); Cal. Rev. & Tax. Code § 17053.85(b)(15)(D); Conn. Gen. Stat. § 12-217jj(a)(3)(B); Ill. Comp. Stat. § 16/10(7); Me. Rev. Stat. Ann. § 13090-L(2-A)(D)(6); Md. Code Ann. Tax-Gen. § 10-729(a)(4); Mich. Comp. Laws Ann. § 207.803(j)(1); Ohio Rev. Code Ann. § 122.85(A)(5); R.I. Gen. Laws § 44-31.2-2(4); and S.C. Code Ann. § 12-62-20(3).

23 See, e.g., Fla. Stat. § 288.1254(1)(i)(2); Ind. Code § 6-3.1-32-5(c); Iowa Code § 15.393(4); Ky. Rev. Stat. Ann. § 148.542(15); Mo. Rev. Stat. § 135.750(1)(2)(h); Mont. Code Ann. § 15-31-903 (2)(b)(i); and Pa. Stat. Ann. § 8702‑D.

24 On October 18, 2011, an Iowa District Court sentenced the former director of the Iowa Film Office to two years' probation for felonious misconduct in office arising in connection with his attempts to secure tax incentives for a motion picture production company. Iowa v. Wheeler, Iowa Dist. Ct., No. CR-FECR-243355 (Oct. 18, 2011).

25 Speiser v. Randall, 357 U.S. 513 (1958).

26 Id. at 528-529.

27 Id. at 518.

28 Id.

29 Arkansas Writers' Project, Inc. v. Ragland, 481 U.S. 221 (1987).

30 Id. at 230.

31 Id. at 221.

32 See, e.g., Simon & Schuster v. Members of the New York State Crime Victims Board, 502 U.S. 105, 115 (1991).

33 Joseph Burstyn v. Wilson, 343 U.S. 495, 502 (1952).

34 Rust v. Sullivan, 500 U.S. 173 (1991).

35 Id. at 192.

36 Id. at 193.

37 National Endowment for the Arts v. Finley, 524 U.S. 569 (1998).

38 Id. at 584.

39 Id. at 585.

40 Id.

41 Id. at 587-88.

42 Id. at 589 (wherein the Court also denied the Finley plaintiffs' vagueness challenges to the new law).

43 See, e.g., Ark. Stat. Ann. § 15-4-2008(c)(2); Cal. Rev. & Tax. Code § 23685(g)(1)(D); Fla. Stat. § 288.1254(4)(a); W. Va. Code St. R. § 110-13X-4.2; and Wis. Admin. Code § 133.34(1)(c).

44 http://www.nmfilm.com/filming/downloads/nm25PercentTaxCredit.pdf.

45 The Brooklyn Institute of Arts and Sciences v. City of New York, 64 F.Supp.2d 184, 202 (E.D.N.Y. 1999).

46 Id. at 200.

47 Id.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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