Loan-out corporations have a long and storied history. These entities gained additional relevance and popularity among performing and creative artists, as well as other celebrities of every stripe, following the Tax Cuts and Jobs Act of 2017 (TCJA).
What is a Loan-Out Corporation (LO)?
Simply put, it is a US-owned business entity – usually an S Corporation or C Corporation. Other types of entities have been used for an LO, but such instances are limited and rare. Typically, an LO is a sole-owner entity. The LO entity contractually “loans out” the owner’s services to a third party, who, in turn, pays the LO directly for the services provided. Handled this way, the artist is an employee of their LO and NOT an employee of the third party, resulting in many benefits, which we will cover below.
What are some of the major tax and other benefits of an LO?
Under the TCJA, employees can no longer deduct employment-related expenses (e.g., in an artist’s case their expenses of their agent, manager, accountant, publicist, union dues, etc.) for federal income tax purposes (for tax years 2018 – 2025). When an artist operates under an LO, the third party pays the LO rather than pay the artist directly. The LO is not prevented under the TCJA from taking federal income tax deductions for the expenses the artist was denied as an employee of the third party. Consequently, the LO will deduct these same business-related expenses, so the impact of using an LO is the taxable compensation of the owner is reduced by the artist’s expenses that would have otherwise been non-deductible (i.e., the LO will pay its artist-owner a salary, which is the net of the third-party fees paid to the LO less the business-related expenses).
As a simplified example, an artist with a gross income of $1 million and $350,000 of business-related expenses will pay federal income tax on $1 million absent the LO. This is because a $1 million fee paid by a third party directly to the artist is a $1 million salary (paid to an employee and reported on Form W-2 from the third party), which precludes the artist from deducting their $350,000 of business-related expenses. However, by utilizing an LO, the third party pays the $1 million fee to the LO, allowing the LO to pay and deduct $350,000 of business-related expenses, thus paying a salary to the artist-owner of the remaining $650,000 (this example is simplified, and it should be noted that additional expenses incurred by using an LO have been ignored, but these are largely inconsequential to this example). The artist will pay federal income tax on a $650,000 salary, rather than a $1 million salary, – resulting in a potential tax savings of a third or more on the $350,000 of business-related expenses (likely over $100,000 of tax savings). Other tax benefits are possible through the payment of medical insurance by the LO and using various private retirement plan options. There may be other plausible benefits to discuss with your tax advisors.
While there’s an allure of tax savings, using an LO structure will result in some additional costs. The goal is for the tax savings to significantly outweigh the additional costs.
What are some of the additional costs of using an LO structure?
At the inception, the formation of an LO generally requires the services of an attorney and an accountant. Thereafter, regular payment of both the employer and employee portions of Social Security and Medicare taxes are required under an LO structure. Absent the use of an LO, the artist would only bear the employee portion of these payroll taxes.
The artist will usually also incur the cost of general and excess liability policies, workman’s compensation insurance, as well as possible other expenses that would not otherwise be incurred. Generally, the artist’s anticipated income and expenses should be analyzed to determine the net effect of operating as an LO. In our experience, an artist earning an income surpassing $150,000 annually from contractual engagements should evaluate the impact of operating as an LO.
Here’s an example of a current client scenario to illustrate the big picture of a Loan-out:
Our client is a prolific artist in the film industry who provides services through an LO that we’ve established and helped the artist manage. For this client, we function as both their personal and business accountants.
For a particular project, our client, the employee of their LO, has a service contract for a $7.5 million fee. As their business accountants, we prepare the LO’s books and records, handle all banking transactions (deposits and bill payments), tax planning and compliance, computations to determine federal and state income tax withholdings, as well as the annual salary received from the LO. In addition to the services provided to the LO, we also prepare the artist’s individual income tax returns. This is facilitated by maintaining books and records for the artist as an individual, allowing for the coordination of the tax filings for both the individual and the LO. When the dust settled, the combined business-related income tax deductions of the LO structure totaled $2.5 million, resulting in approximately $1 million of income tax savings.
We’re here to help
If structured and appropriately managed, a loan-out corporation offers substantial benefits recognized and well-supported by tax law. With years of experience working alongside actors, screenwriters, directors, voice artists, visual artists, musicians, authors, athletes, and more, Schulman Lobel has firsthand insight into tax mitigation vehicles, which loan-out corporations have become. We encourage performing and creative artists, as well as other potentially appropriate candidates to give serious consideration to forming a loan-out corporation. We advise you to speak with an experienced, trusted advisor, as every situation has unique characteristics and nuances that require tailoring. Schulman Lobel is one such advisor and is willling to answer your questions about loan-out corporations to help you determine if a loan-out corporation is the appropriate business structure for you.