The Tax Benefits of a Loanout Corporation
The two most commonly cited benefits for actors and other creatives to do business through a loan-out company are (1) limited personal liability, and (2) advantageous tax treatment. In our previous article, we questioned whether limited personal liability really is a major benefit of doing business as a loan-out company, given how undercapitalized such companies generally are. In this article, we will examine some of the tax advantages offered by loan-out companies.
Increased deductibility of various expenses
For many artists and other service providers, the “most significant tax benefit” of doing business through a loan-out company may be the increased deductibility of business, medical, and other expenses, as “[t]he loan-out structure almost always provides more generous deductions than traditional employee status.” In the entertainment industry, an artist’s business expenses attributable to such matters as agent commissions, talent managers, attorneys, accountants, and union dues may add up to as much as one-third or more of the artist’s total income. An individual employee’s ability to deduct such expenses was already limited before passage of the Tax Cuts and Jobs Act of 2017. The new tax law exacerbated the issue by eliminating most or all employee business deductions beginning in 2018. But if an artist-owner does business through a loan-out company, the company still has the full benefit of business expense deductions that have been eliminated or are otherwise limited for individual employees.
A loan-out company may also deduct the medical expenses, including health insurance premiums, of its employees, as well as their spouses and dependents, as business expenses, and the employees generally may exclude such expenses from their gross income. By contrast, employees paying their own such expenses out of pocket may deduct them only to the extent they exceed 10 percent of adjusted gross income, through the 2020 tax year, and 7.5 percent thereafter. And loan-out companies can also deduct, and their employee-owners can exclude, the costs of disability insurance and a certain amount of life insurance, while an employee or self-employed individual may not deduct those costs.
Another one of the primary tax benefits of doing business through a loan-out company is the ability to establish “tax-deferred retirement plans at substantially higher levels than would otherwise be possible.” While employees are limited in the amounts they can contribute to their individual retirement accounts, a loan-out company can establish and customize a retirement plan allowing “significantly larger contributions” than could be made to an IRA.
In addition to greater contributions, there is also more flexibility in having a pension plan established by the artist’s loan-out company. For example, an artist can generally borrow up to $50,000 from the loan-out company’s pension plan, so long as certain conditions are met, while self-employed individuals do not enjoy that luxury.
Individual freelance employees are taxed on the income they earn between January 1 and December 31 in any given year. But loan-out companies can select a fiscal year, which does not have to align with the calendar year, thereby giving the artist-owner the flexibility to shift income recognition to a later taxable year if that works to the taxpayer’s advantage. One legal scholar has explained that “[b]y having the loan-out adopt a fiscal year that spans two calendar years and by postponing most or all of the employee-owner’s taxable distribution (salary, interest, rents, and/or royalties) until the end of the loan-out’s fiscal year, the shareholder-employee will recognize income during the second calendar year rather than the first. This deferral mechanism allows the owner-employee to direct income to the calendar year in which she may be subject to a lower effective tax rate.”
Obviously, whether these, or any other, financial benefits are available to an artist-owner of a loan-out company must be determined in consultation with a tax professional on an individual basis. It can generally be said, however, that one or more of the financial benefits of doing business through a loan-out company will likely be realized and provide a much more substantial reason to form a loan-out company than the more questionable benefit of securing limited personal liability for the artist-owner.
See, e.g., Bozzio v. EMI Group, Ltd., 811 F.3d 1144, 1147 (9th Cir. 2016) (citing Aaron J. Moss & Kenneth Basin, Copyright Termination and Loan-Out Corporations: Reconciling Practice and Policy, 3 Harv. J. Sports & Ent. L. 55, 72 (2012)); Great Entm’t Merch., Inc. v. VN Merch., Inc., No. 95 CIV. 9333 (LBS), 1996 WL 355377, at *1 n.1 (S.D.N.Y. June 27, 1996) (loan-out companies “are common in the entertainment industry where performing artists offer their services or rights through separate corporations in order to reap tax and retirement benefits, and shield themselves from personal liability”); Home Box Office, Inc. v. Directors Guild of Am., Inc., 531 F. Supp. 578, 597 (S.D.N.Y. 1982), aff’d, 708 F.2d 95 (2d Cir. 1983); Michael Lovitz, Loan-Out Companies: Unintended Consequences for Creators?, 35 Del. Law. 16, 17 (Fall 2017); Mary LaFrance, The Separate Tax Status of Loan-Out Corporations, 48 Vand. L. Rev. 879, 884-904 (1995).
See eMinutes Blog, The Benefits of a Loan-out Company: Is Limited Personal Liability Really a Major Benefit? (Aug. 4, 2020).
LaFrance, supra note 1, 48 Vand. L. Rev. at 885.
See id.; 1 Thomas D. Selz, et al., Entertainment Law 3d: Legal Concepts and Business Practices § 8:36 (Westlaw updated through Dec. 2019) (unlike an individual actor or other employee, “[a] loan-out corporation … can freely deduct 100% of its itemized miscellaneous expenses,” including “agents and lawyers fees”).
See LaFrance, supra note 1, 48 Vand. L. Rev. at 887; 1 Selz, supra note 5, § 8:36 (“A loan-out corporation is able to freely deduct medical and insurance costs.”).
See LaFrance, supra note 1, 48 Vand. L. Rev. at 888; 1 Selz, supra note 5, § 8:36.
Home Box Office, 531 F. Supp. at 597; see also LaFrance, supra note 1, 48 Vand. L. Rev. at 888 (through a loan-out company, “many individuals can obtain better retirement plans than they would obtain through either a sole proprietorship or a more traditional employment relationship”).
LaFrance, supra note 1, 48 Vand. L. Rev. at 889; see also 1 Selz, supra note 5, § 8:35 (an artist-owner’s loan-out company “can create its own pension plan, permitting the artist to shelter a portion of his or her income”).
See LaFrance, supra note 1, 48 Vand. L. Rev. at 889 (an individual who forms a loan-out company “enjoys greater latitude in establishing and customizing a retirement plan”).
See 26 U.S.C. § 72(p); LaFrance, supra note 1, 48 Vand. L. Rev. at 892; 1 Selz, supra note 5, § 8:35. The borrowing privilege may be limited in the case of a loan-out company formed as an S corporation. See LaFrance, supra note 1, 48 Vand. L. Rev. at 892.
See LaFrance, supra note 1, 48 Vand. L. Rev. at 892. The ending months for a loan-out company’s fiscal year that can be selected may be limited. See 1 Selz, supra note 5, § 8:37; 26 U.S.C §§ 441(l), 444.
LaFrance, supra note 1, 48 Vand. L. Rev. at 893. The IRS can challenge the allocation of income, deductions, credits, exclusions, and other allowances between a personal service corporation and its employee-owners if necessary to prevent avoidance or evasion of federal income tax or to reflect more clearly the income of the personal service corporation or any of its employee-owners, see 26 U.S.C. § 269A, but Section 269A has proven to be “highly ineffective … as a means of challenging loan-outs,” LaFrance, supra note 1, 48 Vand. L. Rev. at 919.