Concerned that these costs were being expensed more rapidly than was justified, the Internal Revenue Service in 1989 issued Rev. Rul. 89-23, which affected post-1986 expenditures for home-video and sound-recording packaging. The ruling required all costs be capitalized rather than expensed. It states that the package design costs include "materials, labor and overhead associated with the design, including all design exploration and study, refinement of the basic design selected, testing and preparation of the final comprehensive design." This would cover the costs for graphic artists, printing, plate production, photography, make up and wardrobe.

A related revenue procedure (89-17) allowed taxpayers to amortize the package design costs over 60 months if an election was made.

Usually, the package design for a sound recording has a useful life no longer than the record master. If a record is unusually popular, the record jacket may be replaced over the years with updated graphics. In this situation, the packaging design has a useful life less than the master. Since the useful life of most sound recordings is less than five years, the new IRS rules possibly extended the period over which these costs would be depreciated.

Recently, however, IRS attorneys in the Income Tax and Accounting Section of the associate chief counsel's office responsible for drafting the 1989 ruling have privately said the five-year amortization period is not applicable to package design costs that can be shown to have a limited life that can be estimated with reasonable accuracy. Instead, because of the close relationship between a recording master and the associated packaging of the records, the package design costs should be amortizable like the master. The fact that record masters have determinable useful lives subject to depreciation has not been a matter of contention with the IRS. Therefore, sound-recording package design costs should be amortizable outside the strict five-year rule. This usually will result in a significantly faster tax write-off.

The Uniform Capitalization Rules contained in the Tax Reform Act of 1986 required that certain expenses incurred by artists, photographers and writers be capitalized and deducted as future revenues were recognized. The creative community lobbied strongly for relief from these rules as they applied to individuals. In May1988, the IRS granted partial relief by announcing special rules providing for a depreciation of the capitalized costs over three years.

Congress granted statutory relief in the Technical Correction Act of 1988. But the House committee report included an exception later echoed in IRS Notice 89-67. That is, the exemption from the harsh capitalization rules "does not apply to any expense that is related to printing, photographic plates, motion picture films, sound recordings, video tapes or similar items."

Regulations interpreting this statute have not been written, but the IRS is considering a broad interpretation of the "related to" language in the committee reports. Consequently, the IRS has considered the costs associated with a writer in drafting a movie script to be capitalizable. Ultimately, the script is produced with a view to being included in a motion picture film. Therefore, IRS views this as being "related to" a motion picture, and thus not exempted.

Carrying this logic to other trades, expenses incurred by individual songwriters would be capitalizable since to economically exploit them, they must be recorded. Therefore, the songwriting would be "related to" the production of a sound recording. Under an interpretation such as this, it is difficult to determine what the exemption in the 1988 act really exempted.

In a Tax Court case reported last February, Frank and Linda Lockwood were permitted to fully write-off their investment in a classical music master sound recording as an abandonment loss. Lockwood V. Commission of Internal Revenue, 94 TC 252. The Lockwoods had purchased the masters largely with non-recourse debt, and tried to market the recordings for two years. After deciding the recordings were not economically viable, the Lockwoods put the masters in a home closet that was not temperature or humidity controlled.

The Tax Court held that putting the tapes in the closet would destroy their usefulness and the taxpayers knew it. Therefore, the Lockwoods had demonstrated an intent to irrevocably discard the tapes. Consequently, the tapes were considered permanently retired from use, and a loss was allowed for the remaining basis in the tapes.

However, concluding that the mere placement of masters in a closet or other non-climate-controlled environment will ensure immediate loss recognition seems unwise. For example, if a recording is currently being distributed or contract negotiations are ongoing for the licensing of the recordings, it's unlikely an intent to irrevocably abandon the master tapes could be found.

In December 1989 and December1990, the IRS released two revenue procedures dealing with per diem allowances paid to employees, Rev Procs. 89-67 and 90-60. These rules apply to travel, meal and incidental expenses reimbursed to film crews, touring artists and road crews.

Both the information reported by the employee and the timing of the reports are affected by the rules. These procedures reflect changes in the law made by the Tax Reform Mt of 1986 and the Family Support Tax of 1988. They also serve to consolidate other rules promulgated in various forms over the years.

The regulations require employee expense reimbursements to be included in taxable income and reported on Form W-2, unless they comply with certain procedures. This was applicable beginning Jan. 1,1989. In order for reimbursements to be non-taxable, the employee must substantiate the expenses and return any reimbursement or allowance amount in excess of those substantiated. Related temporary regulations on withholding and employment taxes apply to amounts received on or after July 1,1990 (Reg. Sec. 31.3121)

(Therefore, although per diems not meeting the rules were considered taxable taxable beginning with those paid Jan.1, 1989, employers weren't required to comply with the related withholding

rules until July 1990. The small changes to the rules found in Rev.Proc. 90-60 weren't applicable until January 1991.)

Instead of reimbursing the actual expenses substantiated, the revenue procedures provide for a method whereby the employer can pay a per-diem allowance for lodging, meals and incidental expenses only while the employee is away from home.

The per diem allowance must meet certain requirements, which include:

Per diem allowances may be provided either for lodging, meals and incidental expenses, or merely meals and incidental expenses. The amount of the daily allowances deemed as fully substantiated expenses vary depending upon the area of travel. Separate tables set forth the rates for continental U.S. travel, non-continental U.S. travel and to reign travel. The tables reflect rates for all major cities. The use of an amount for meals and incidentals only was established by Rev. Proc. 90-15, issued last March15. The tables can be found as Appendix A to Chapter 301 of the Code of Federal Regulations.

For those entertainment employers using a per diem to cover lodging as well as meals and incidentals, there is the option to use one rate rather than a separate rate for each locality. The single rate is broken down, however, to $85 per day in specified low-cost areas, and $122 per day in specified high-cost areas. If the employer is using per diems only to cover meals and incidentals, the tables must be consulted for each locality to determine the maximum allowable. Generally, employees in high-cost localities are allowed $34 per day for meal and incidental costs. Employees in other localities in the continental United States are allowed $26 per day.

 Mr. Curtis is a partner in the Brentwood, Tenn., accounting firm of Curtis & Company, PLC