By now, everyone has heard of Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”), which has turned traditional deferred compensation on its head by including deferrals in gross income unless they meet strict requirements. While Hollywood may have been the furthest thing from Congress’s collective mind when Code Section 409A was enacted, its provisions are broad enough to reach common entertainment industry agreements. The basic problem is that many service providers in the entertainment industry will not qualify under Section 409A’s exclusion for “independent contractors.”
In the entertainment industry, agreements often require the talent to provide services in one year in exchange for compensation in a later year based on box office receipts. Absent compliance with the strict requirements of Section 409A, the talent might be required to include income in the year he acted rather than the year he was paid (assuming the payment is not subject to a “substantial risk of forfeiture”). To go one step further, suppose the motion picture is widely successful, leaving the audiences clamoring for a sequel. The actor might then renegotiate his agreement with the production company for a bonus against the contingent payments to be paid under the original agreement. In essence, the movie star has renegotiated his rights to future earnings and accelerated his receipt of amounts previously earned and deferred. Section 409A punishes this type of renegotiation.
Section 409A generally does not apply to an independent contractors that meet certain requirements. However, because motion picture projects may require the exclusive attention of the talent for more than one year, the independent contractor exception may not be available.
Section 409A would more fairly apply in the context of entertainment industry agreements if contingent participation compensation were excluded from the definition of “deferred compensation.” However, under its current provisions, Section 409A is a real “gotcha” for Hollywood.