The "Loan Out" Corporation
By, Peter Jason Riley, Certified Public AccountantFor Actors, Directors and Performers
The major change in the new Tax Cuts and Jobs Act of 2017 bill is the elimination of the deduction for employee business expenses. This is going to have a devastating effect for many performers, as Actors Equity, SAG-AFTRA and other organizations require that compensation be paid on a W2. As of 2018 these performers lose all ability to take their professional, out of pocket expenses.
This is leading to a renewed interest in what is called the "loan out" corporation. The function of a "loan out" corporation is that the entertainer – an actor, for instance – is an "employee" of the loan out corporation (for which they are generally the sole shareholder). The corporation then enters into contracts with other businesses such as a film producer, production company or theatre. Then the loan out corporation "loans out" the services of the actor to the production company. The performer becomes a shareholder/employee of their own corporation and takes all the associated business expenses 100% as deductions directly on the corporate tax return. In that way the performer gets the full value of all the deductions as well as obtaining the liability protection that the corporation gives them. In exchange for this benefit, the performer complicates their life substantially with the administrative hassles of the corporation, so one must carefully weigh out the pros and cons before jumping in.
The first complication for the performer, of course, is the corporation itself. Be sure to engage a knowledgeable attorney to set up the new entity. The performer is creating a separate legal, tax filing entity that must file its own return and might have other state filing requirements depending on what states they are operating in. Along with this is, I think, the primary complication; payroll itself. The performer must become an employee of their new corporation and must process a reasonable W2 for themselves. Payroll includes all the withholdings, tax deposits and filings and creates an administrative headache. The bottom line is that most performers will want to have a qualified accounting and tax firm like Riley and Associates PC handle the new corporation, process payroll as well as the corporation filings and tax planning. Also, depending on the size of the new corporation, there may need to be formal accounting records kept.
The other factor to consider is the section 199A 20% "Qualified Business Income Deduction" calculated on your net business income. This new tax provision is part of the 2017 TCJA tax reform bill for 2018 provides an additional deduction based on your net corporate business income. For folks in creative fields there are 2 limitations in the calculation. Performers such as actors, musicians, actresses and singers are considered as part of the laws "specified service businesses" and are thus limited to the 20% deduction but ONLY if their taxable income is less than $157,500 if single and $315,000 if married (after that it phases out).
Based on current Internal Revenue Service regulations, writers and visual artists do NOT appear to be part of the "specified service business" group, but the calculation of the 199A deduction becomes more complex in that it involves both net business income as well as payroll. In the case of very successful writers and visual artists they will be compelled form a loan out corporation in order to leverage 199A.
The question then becomes, when does a loan out corporation make any sense for me? We feel the individual would need at least $100k to $125K in gross income before the loan out corporation would make any sense financially, but this would also depend on the level of expenses one was going to lose under the 2017 Tax Cuts and Jobs Act legislation. Consequently, this is a movable calculation depending on the mix of gross income and expenses.
My firm is in Massachusetts (many states would have a similar group of costs) and we have arrived at this baseline income number because the costs of the corporation itself are going to be at least $2,500. This is made up of the combination of the Massachusetts minimum excise tax of $456, the annual report filing fee of $125, the cost of the corporation return preparation at +/- $700, cost of payroll processing +/- $500, workers compensation insurance at $300 and finally state and federal unemployment taxes of +/- $400. This means that the corporation adds approximately $2,500 of additional expenses for the business owner. Ideally, we want the corporation to SAVE us at least this amount in taxes so the performer is at break even with the loan out corporation.
n a S corporation structure, the one we prefer for smaller operations, the performer will claw back the heretofore lost deductions plus some FICA tax savings and perhaps (depending on income levels) section 199A 20% "Qualified Business Income Deduction" that will generally offset the additional fees and taxes the corporation incurs. If you are dealing with larger amounts of income, one might look at the C corporation and the ability to defer income into other years by using a fiscal year end as well as some additional employee benefit options that the C corporation structure provides
Here is a list of common reasons performers set up loan out corporations:
Our firm has had tremendous success in using "loan out" corporations for writers. The concept is similar to that for performers discussed above but generates its tax savings not by additional deductions but in ameliorating self-employment and ACA taxes such as Medicare and NIIT. In a recent example for a writer grossing around $335K; the S corporation structure yielded a tax savings of $14K even with giving the tax payer a $150K W2. When you added in the solo 401k deduction, the savings jumped up to an impressive $36K in a single year.In Closing
The final advantage I often mention in this structure is that, generally speaking, your chances of getting audited by the Internal Revenue Service drop substantially inside the corporation. That is because the Internal Revenue Service does not do as much sampling or DIF scoring of business returns like they do on personal income tax returns. Secondarily the Internal Revenue Service does not require 3rd party 1099 reporting when the payment is made to a corporation. Consequently, the business will not receive 1099's.
That being said, here’s some further reality checks:
The loan-out is simply a business and legal entity that provides a strategic tool to protect and manage your earnings. While it can provide substantial tax benefits and other bonuses, a loanout requires proper planning, formation, maintenance and administration. Otherwise, it can end up being a major headache. Therefore, it’s worth the time and money to seek out professional help from a tax advisor familiar with the entertainment industry, as well as, an entertainment lawyer who understands the industry and your needs.
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