(Dow Jones News) A change in tax rules designed to keep executives from siphoning cash out of companies is hitting Hollywood where it hurts: in the fat advances star actors like to claim.
Some movie and TV stars who have already pocketed multimillion-dollar advances have had to return them, tax lawyers say. Those lawyers also are now often counseling clients not to accept contracts for television series as written.
The entertainment industry is lobbying to get a change in the rules, which have angered top-tier actors, directors, writers and other talent and made it impossible for studios and talent agents to conduct business as usual.
Among those pushing for change is Alan J. Epstein, a partner at Jackoway Tyerman Wertheimer Austen Mandelbaum Morris & Klein PC. The firm represents big-name talent like Nicole Kidman, Cameron Diaz and Vince Vaughn, according to industry reports. Epstein would not divulge the identity of any individuals affected by the tax changes.
Epstein said that some uses of advances "have come to a screeching halt." The common practice of paying a big advance while negotiating a new contract with an actor or actress whose show has become a big hit has been curtailed, according to advisors.
The tax provision "killed a mosquito with a cruise missile," Epstein says.
In entertainment industry contracts, pay is typically stretched out over time and based on a percentage of profits, known in Hollywood parlance as "points." This kind of arrangement falls into the category of deferred compensation, as far as the Internal Revenue Service is concerned, and the tax on it is controlled by a controversial section of the Internal Revenue Service Code known as 409A.
The tax code section was added after the 2001 meltdown of former energy giant Enron Corp., during which executives rushed to cash out their compensation plans. It essentially puts deferred compensation into a lock-box, with heavy tax penalties for anyone who attempts to get their money out sooner than specified by an original contract.
That's where advances become a tax problem: Since they often weren't part of an original studio contract, they can be subject to the penalties.
Daniel L. Hogans, a partner at law firm Morgan, Lewis & Bockius LLP in Washington, D.C., helped to draft 409A. He says the statute does present challenges for various industries because it takes a very broad view, but that the entertainment industry is particularly affected because of its unique pay structures.