Income

• Author: Lionel S. Sobel
• Pages: 13-45

13

CHAPTER 2

Income

The General Rule

Income of All Kinds

Income

Compensation for Services Rendered

Contingent Compensation; Profit Participations

Residuals

Bonuses

Royalties

Gains from Sale of Self-Created Works and Their Copyrights

Prizes

Unemployment Compensation

Not Income

Gifts

Borrowed Money

Value of Services Donated to Charitable/Nonprofit Organizations

Employer-Provided Housing, Meals, and Transportation

Employer-Provided Health Insurance

Earned Worldwide, by U.S. Citizens (and Some Aliens Too)

Related Issues to Be Covered Later

In the beginning, there has to be income—for food, housing, clothes,

and transportation, of course, but also for this book.

The United States does tax some wealth, using the estate tax. And

the U.S. does tax some purchases, using excise taxes. But those taxes

produce just a sliver of U.S. tax revenues. The estate tax (and its com-

panion gift tax) account for just 1 percent of federal revenues, and

excise taxes only 3 percent; the federal government’s main source of

revenue is income taxes: 50 percent from individual and corporate

income tax, and 40 percent from Social Security and Medicare taxes.1

1. C. B O, B  E O: F Y   ,

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14 CHAPTER 2

(Social Security and Medicare are taxes on wages, and since wages

are simply one form of income, Social Security and Medicare are

income taxes too.)

This book is about income taxes. The reason “there has to be

income” is that those who have no income pay no income tax. Those

who do have income do pay taxes. The details are complicated, but

the general rule concerning how the United States taxes income is

clear enough.

The General Rule

As a general rule, the United States taxes

• income of all kinds

• earned worldwide

• by U.S. citizens, and some aliens too,

• even if they earn that income while living in another country.

Income of All Kinds

Income

Compensation for Services Rendered

Let’s start with something that will seem simple, even if you didn’t

study tax in law school and don’t do your own income tax returns.

(Things will get more interesting in just a bit.) What’s easy is that

compensation for services rendered by entertainers is the kind of

“income” that is taxed in the United States.

Several different terms are used to describe the income of those

who work in the entertainment industry. Employment agreements

between movie studios and actors often provide that actors will

receive specified “compensation” in return for performing “services.”2

Employment agreements between movie production companies and

directors often provide that as “consideration” for the director’s

“services,” the production company will pay the director specified

“compensation.”3

at 135 (2011), available at http://www.cbo.gov/sites/default/files/01-26_fy2011

outlook.pdf.

2. See, e.g., Long Form Performer Services Agreement (Studio Version), Entertainment

Industry Contracts Form 11-1A (LexisNexis).

3. See, e.g., Director Employment Agreement—Theatrical Motion Picture (Long Form),

Entertainment Industry Contracts Form 10-1 (LexisNexis).

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Income 15

Regardless of the terms used in actor and director employment

agreements, the compensation they receive is “income.” Internal Rev-

enue Code § 61(a)(1) makes it so by providing that “income means

all income from whatever source derived, including (but not limited

to) . . . Compensation for services.” The result would be the same,

even if the agreement referred to the actor’s or director’s compensa-

tion as a “fee,” because §61(a)(1) specifically includes “fees” among

those things that are “income.”

Contingent Compensation; Profit Participations

Some of the compensation provided for in actor and director employ-

ment agreements is paid as ordinary salary in specific amounts stated

in the contract, like compensation paid to all kinds of employees in

and out of the entertainment industry. In addition to that kind of

compensation, actors, directors, and others of a certain stature also

are promised something more: contingent compensation or “profit

participation.”

Contingent compensation is paid only if and when something

happens, usually after the movie is finished. In some agreements, the

contingent compensation clause provides that the recipient will be

paid a specified amount if and when the production company makes

a distribution deal. Other contingent compensation clauses provide

that the recipient will be paid a percentage of the movie’s “profits, if

any,” in addition to other compensation.4

The key characteristic of both of these forms of compensation is

that they are uncertain. They may never be paid, because the contin-

gency might never occur. Even profitable movies may never generate

profit participations, because the “profits” referred to in profit partici-

pation clauses are not profits in the accounting or income tax sense of

the word. They are “profits” as defined in the employment agreement

itself, in detailed clauses that usually run on for pages and pages.

This is why employment agreements say “profits, if any.” Often, there

aren’t any “profits” as the employment agreement defines them, even

if the movie is profitable as far as the production company and tax

law are concerned.

So, the question is whether contingent compensation and profit

participations also are “income” for tax purposes, despite their uncer-

tain nature and despite the fact that quite often they never become

payable and aren’t in fact paid. If you think contingent compensation

4. See, e.g., id.

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