When a service provider utilizes a loan-out corporation they receive the benefits of the “corporate veil.” A corporation is considered a separate legal entity from its shareholder(s). This means that when a production company – or any other employer – hires a service provider through their loan out corporation, they are in contract with the corporation, not the individual. In theory, should a problem arise during the job, it is likely that the corporation – not the individual – will be liable. In addition, the shareholder will generally not be personally liable for the debts of the corporation. In other words, the shareholder’s personal assets are legally protected from the corporation’s creditors.
CASH FLOW MANAGEMENT
One of the major benefits to having a loan-out corporation is the ability to manage tax payments and cash flow. Many entertainment professionals work on numerous projects every year which means they are on a number of different payrolls. Generally, professionals without a loan-out corporation are paid W-2 wages. The problem with this is that since the professional is on numerous payrolls with irregular pay periods, the tax withholdings could be more than necessary.
For example, we once had a client that did not have a loan-out corporation who had signed a deal for a one-time payment of $55,000. Unfortunately, the production company would not pay him as an independent contractor and they would also not allow him to claim more than one exemption on his W-4. The result? After tax withholdings and agent commissions, the client’s gross payment of $55,000 came through as a measly net of about $15,000. He had plans to live off that money for a period of time but without a loan-out corporation his hands were tied.
By receiving compensation through a loan-out corporation, shareholders are able to defer income by adopting a fiscal year. Some corporations are eligible to select a fiscal year end meaning that the corporation’s taxable year does not line up with the calendar year. For instance, a corporation electing a fiscal year end of 1/31 would collect income and record expenses between 2/1 of the previous year through 1/31 of the current year. Assuming that the service provider’s salary for the year would be paid after 12/31 and before 1/31, he would not be taxed personally on that income until the current year even though the income was predominantly earned in the previous year.
Another tax planning benefit of utilizing a loan-out corporation is the ability to take advantage of Qualified Pension and Benefit Plans. In the case of an S-Corporation, certain shareholders are able to deduct health insurance premiums. In addition, pension contribution limits can be more than double that of a standard 401(k) plan when administered properly.
Perhaps one of the biggest benefits of using a loan-out corporation is the potential to save on taxes. The S-Corporation election is one of the ways to reap immediate benefit. Service providers can save money on FICA taxes by receiving a “reasonable salary” from the corporation and allowing the remaining profit to pass-through to their tax return as ordinary income taxed only at their ordinary, marginal tax rate. Taxpayers should consult a tax professional before making a determination regarding what constitutes a “reasonable salary.”
By using a loan-out corporation, service providers are able to deduct their ordinary and necessary business expenses. Traditionally, service providers that were paid as an employee (W-2 wages) were only allowed to claim business expenses as itemized deductions subject to a 2% AGI floor. Under the new Tax Cuts and Jobs Act the itemized deduction for employee business expenses is repealed. There is no limit on business deductions for corporations assuming that the expenses are ordinary, necessary, and not specifically disallowed by the Internal Revenue Code.
While there are a number of benefits to opening a loan-out corporation, there are a few factors that should be considered before pulling the proverbial trigger. Bottom line: a corporation is expensive and time consuming to manage. For starters, in California, corporations are subject to a Minimum Franchise Tax of $800. In addition, corporations require meticulous recordkeeping and reporting including: accounting, payroll, tax filings, information filings, corporate minutes, and more.