When it comes to managing personal finances in the gig economy, rumors, conjecture, and flat-out bad advice run rampant. And perhaps one of the most buzzed about topics is the loan-out company.
Will it save me thousands of dollars? How many thousands of dollars do I need to make it worthwhile? Do I need a cool name?
It can be enough to make any freelancer’s head spin. Fortunately, Wrapbook has got your back. Today, we’re going to tackle one of the most frequently debated (and ill-informed) subjects in the freelance ecosystem: The Loan-Out Company.
A loan-out company or loan-out corporation is a form of legal business entity in the United States established for the purpose of “loaning out” the services of its creator to third parties. When an individual creates a loan-out corporation, they effectively become both its owner and sole employee.
The individual is, technically, employed by their own loan-out company. The loan-out company, in turn, acts as a contractor through which the individual sells their services.
A loan-out company can take many different forms, such as an S-Corporation, C-Corporation, or LLC. As you might expect, each of these classifications carries their own distinctive advantages, disadvantages, and regulations. However, when functioning as a loan-out corporation, the fundamental concept remains the same.
Carefully, chat over the differences with both your lawyer and CPA before incorporating – you’ll need them both to open your loan-out company.
Loan-out corporations are frequently encountered in the fields of music, professional sports, film, television, and essentially any other entertainment industry. The reason for this is that the lifeblood of these fields stems from labor and services performed on the bases of contracted individuals.
This means that a significant portion of the individuals working within these fields are not on recurring payroll with a specific company, as may be the case in, for example, healthcare or education. Instead, they’re paid on an irregular basis for work specifically defined within a contract. These employees are generally not performing roles responsible for tasks that are ongoing or indefinite. Instead, the parameters of their contracts are highly specified according to set time or task limits.
At a glance, utilizing a loan-out company might seem like a complicated ordeal. In practice, however, loan-out corporations are relatively simplistic.
Let’s say, for instance, that you’ve set up a loan-out company for a writer. If a production company wants to hire this writer to complete a screenplay, they won’t technically be hiring them directly.
Instead, the production company will enter into a contract with the writer’s loan-out, meaning their legal relationship on the contract is with another corporation, not the individual. From there, the writer’s loan-out company will “loan-out” the services of the writer. The production company will pay the loan-out corporation the contracted amount of money on an agreed-upon schedule, then the loan-out corporation will, in turn, pay the writer a salary for the services that they’ve rendered.
The writer is, in essence, still being hired and paid to do a simply defined job, but their contract for that job is routed entirely through their loan-out. Returning to the original question- “What is a loan-out company?”- the short version is that it’s a legal middleman, designed to protect its owner.
The loan-out company of comedy super creator, Greg Daniels, you've probably seen this after binging Office episodes.
Ever notice the vanity cards that air after an episode of your favorite TV shows? These are the writers’ loan-out companies, which not only shield them from tax burden but also act as production companies for the show.
There are several potential advantages to having your own loan-out corporation, but that doesn’t mean they all necessarily apply to you and your unique business circumstances. If you’re thinking of starting a loan-out of your own, it’s crucial that you personally consult with qualified legal and financial advisers in your state before taking any action.
As a general rule, the higher your level of income is, the more appealing it becomes to work through some form of a loan-out company. This is because one of the primary attractions of a loan-out company is its ability to mitigate the high income taxation associated with traditional self-employment.
For now, let’s dive into a brief overview of the pros and cons of owning and working through a loan-out company.
Perhaps one of the biggest reasons freelancers establish loan-out companies for lower tax rates. While individuals are taxed on a sliding scale according to their earnings, corporations are usually taxed a flat fee.
The savings can be significantly less than the amount of money you would owe as a freelancer out in the wild. However, you have to be taking in at least $75,000 before you’d begin to see savings.
This is because after the company pays taxes on everything it took in, then the employee must pay on whatever it was paid.
Many laborers in entertainment establish loan-out companies ability, because they allow you to select a fiscal year. As an freelance individual, you’re taxed on the income you’ve made between January first and December thirty-first of any given year, no matter what.
As a corporation, you’ll also be taxed on annual basis, but the beginning and end of that twelve-month cycle does not have to align with the calendar year. If you choose your fiscal year wisely, your loan-out corporation could net major tax savings in its first year by deferring a sizable portion of its taxable income to the following fiscal year. Beyond that, a well-chosen fiscal year may stabilize your income and expenses by spreading a portion of them out over time.
If you’re an actor who spends most of your expenses around pilot season, then might set up your loan out company’s fiscal year to start just before March. A loan-out company may offer a variety of tax advantages to its owner, but this, in particular, stands out.
If you’ve worked as a freelancer of any stripe, the second major tax advantage of a loan-out company is likely already familiar in principle.
A loan-out company, like a freelancer, can deduct business expenses from its taxable income. Therefore, the owner of the loan-out company has the ability to process her or his business expenses through the loan-out, meaning they’re treated as corporate expenses rather than personal employee expenses.
Because the loan-out is legally defined as a corporation, it has access to several deductions that an individual is restricted from taking on their personal tax return. With the right strategy and organization, the owner of a loan-out company can drastically minimize their taxable income.
It can also make your write-off have a greater impact. While freelancers can write-off medical expenses to a degree, a corporation can write-off the same expenses as “employee benefits,” which can greatly offset your taxes.
The benefits of a loan-out corporation are not limited to the realm of taxes, however. Another significant advantage of loan-out companies is their ability to protect their owners’ assets.
Because the loan-out is a separate legal entity from its creator, the creator is not legally liable for any claims against the company. If the company is sued, for instance, any assets listed as the company’s will be at stake, but not those of the owner personally. This also works the other way around. Hypothetically, if you’re in a car accident, and the other driver decides to sue, the loan-out company’s assets are off the table for that lawsuit.
In either example, the loan-out corporation is helping its creator compartmentalize their assets for the sake of greater security against external threats.
As you can imagine, this “asset armor” is particularly attractive to high-profile individuals who are more likely to face predatory financial behavior, which is why loan-out companies are frequently associated with celebrity figures who maintain a high net worth.
Looking at the facts, you might even argue that loan-out companies are tailor-made to specifically benefit these individuals of exceptional wealth.
For the average freelancer, this is where the downside comes into play.
A celebrity loan-out corporation might process hundreds of thousands- if not millions- of dollars of income within the bounds of its fiscal year. With revenue that substantial, it’s easy for the corporation’s creator to take advantage of the unique strengths of a loan-out. When it comes to individuals of more modest means, however, it’s much more difficult for a loan-out company to realize its potential.
In fact, if an individual isn’t making at least $75,000 per year in applicable business activity, a loan-out company isn’t likely to be beneficial at all, and a high likelihood of realizing a loan-out’s advantages isn’t achieved until an individual is making over $100,000 per year.
You can chalk most of this up to economies of scale. After all, there are costs to running a loan-out company. A loan-out corporation in California, for example, must pay an annual filing fee of $800. When you add legal fees, additional tax-filing fees, and the dreaded possibility of double taxation into the mix, a loan-out company quickly becomes a recipe for disaster when it comes to individuals earning below the $75,000 threshold.
On top of the obvious financial cost, there are considerable organizational challenges that come with establishing and maintaining a loan-out corporation.
The question of exactly how to run a loan-out company is a big one, requiring serious commitment and attention to detail. A failure to keep appropriate records, make appropriate state filings, or maintain any required element of the corporate existence may result in losing the advantages of the loan-out and possibly exposing yourself to unexpected tax liability.
Plus, the IRS isn’t exactly a fan of loan-out corporations established to avoid taxation and has been known to intervene if a loan-out corporation is not properly established or documented.
As far as the law is concerned, a loan-out corporation isn’t technically different than any other corporation. Their formation follows the same basic process, regardless of their status as a loan-out.
You’ll first be required to file articles of incorporation with the state government. If you’re establishing an LLC, this document will instead be known as articles of organization. In either case, the document is a corporate charter that contains some basic information and establishes the existence of your company.
All of these considerations are crucial to establishing a loan-out that gives you the most savings. Entertainment law firms are best found through recommendation of friends, although websites like LegalZoom offer help as well.
You’ll also be required to comply with any other state filing requirements. These vary from state-to-state, but they generally include preparing your corporation’s operating documents (a corporate records book, corporate bylaws, operating agreement, etc.), issuing stock, and obtaining an employer identification number (EIN) for tax purposes.
If you’re establishing a loan-out corporation in California, you should also be prepared to file a statement of information form within 90 days of filing your articles of incorporation and to pay an $800 annual minimum tax during the first quarter of your fiscal year.
Additionally, be sure to comply with any further requirements specific to the tax classification of your loan-out. If you want to establish an S-Corporation as a loan-out corporation in California, for instance, you’ll need to file an additional status election form within two months and fifteen days of the beginning of your corporation’s first tax year.
Beyond the standard corporate formation tasks, you’ll have to enter into an official loan-out agreement with your new corporation. This loan-out agreement is essentially the same thing as a standard employment contract in that it lays out the ground rules for your “employment” through the company. The only detail that makes this situation unique is that you’re entering into this contract with your own loan-out, meaning that you’re essentially entering a legally binding agreement with yourself.
Once you’ve established your loan-out corporation, companies will no longer be hiring you as an individual. Instead, they’ll be hiring your company, which will then loan-out your services to them. Loan-out agreements can be easily added and stored in Wrapbook.
It’s important to note that it may not be unusual for a client to ask you to sign what’s known as an “inducement agreement”, which basically guarantees that you, as an individual, will still complete the contracted services in the event that something happens to the loan-out corporation as a separate entity.
Once you’ve landed a job, you’ll need to make sure that whoever’s paying you is going to send the checks to your loan-out, instead of you personally.
If you’re being paid through an entertainment payroll service, like Wrapbook, linking your loan-out company is easy.
Once you’ve accepted the terms of your job, you’ll be invited to set up your profile so your employer can pay you. Click that you have a loan-out and you’ll be prompted to enter its EIN number.
And that’s it. You’re ready to get paid. If any of your employers pay you through Wrapbook, you won’t have to link your loan-out again, as this will be your default.
If you’re seriously considering establishing a loan-out corporation to support your business needs, it cannot be stressed enough that you should seek guidance from tax and legal advisers before taking any action.
It’s easy to answer the question, “What is a loan-out company?” However, the question of whether a loan-out company is right for you, specifically, can only be answered through a careful analysis of your unique circumstances. Tax and legal professionals can help you figure out how to run a loan-out company tailored to your individual needs.
If you have any lingering questions about loan-out companies, reach out to us anytime.
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