Most professional actors, musicians, artists, or other entertainers contract their services through a so-called “Loan-Out Company.” Nevertheless, I have discovered a lot of confusion amongst these same professionals about why they established a Loan-Out Company in the first place, or whether establishing a Loan-Out Company is even a good idea for their circumstances.
What is a “Loan-Out” Company?
A Loan-Out Company is a separate business entity (e.g. a corporation or LLC) established for the purpose of “loaning out” the services of its owner/employee to third parties. For example, the Loan-Out Company of a musician “loans out” the musician’s services (recording, production, live performance) by entering into contracts with the end users of those services, whether a record label, a music publishing company, or concert venue.
How Do I Form a Loan-Out Company?
Establishing a Loan-Out Company is the same as forming a standard corporation or LLC. You must comply with state filing requirements, which includes filing articles of organization with the state, preparing your company’s operating documents (Bylaws, Operating Agreement, etc.), issuing shares or interests, and obtaining a EIN/Tax ID number.
There may be tax advantages for the principal to take a consistent, smaller salary, rather than having any money immediately pass through to the owner/employee, but you should consult with a tax professional before deciding on which structure would better suit your specific circumstances.
From that point on, prospective employers will hire the Loan-Out Company, not the individual.
However, most hiring parties will require that the principal also personally enter into an “inducement” agreement. This is typically a paragraph, tacked onto the end of a contract, that generally states that if anything should happen to the Loan-Out Company, the individual will still provide the agreed-upon services. People with leverage-able assets can most likely avoid signing an inducement, but non-superstars should expect to abide by this requirement.
Benefits of a Loan Out Company
For most entertainers, a Loan-Out Company is only worth considering once he or she is consistently generating a certain level of income. A typically prescribed threshold being at least $75,000-$100,000 per year. At that point, the benefits can become quite substantial, the most significant of which are:
1) Asset Protection
The Loan-Out Company is a separate legal entity, so property held in the name of its owners cannot be used to repay the debts of the company, or be used to satisfy a judgment against the company. That means, if your company gets sued, someone can’t come after your personal assets as a result. Take, for example, a situation where your company has $5,000 in its account, its owner has $10,000 in his personal bank account, and the company gets sued for $10,000 and loses. If the $5,000 is the only asset the company has, the winner of the lawsuit cannot come after the owner for the remaining $5,000 that the company would still owe.
2) Tax Savings
A Loan-Out Company may also see tax savings that would not be available to a musician if he or she is providing services without one.
First, Loan-Out Companies are a great way to reduce tax exposure. Businesses are allowed to subtract expenses from their calculations of income, while individuals are not. There are, however, various deductions available to individuals, such as the “home office deduction,” but these are only partial write-offs, allowing you to subtract only a portion of these expenses from your taxable income.
As mentioned above, there may also be advantages to having the Loan-Out Company pay the principal a consistent salary, rather than simply passing any money immediately straight through the company, but that’s a math question that relates to your specific circumstances.
Main Costs of a “Loan-Out” Company
While the advantages to forming a Loan-Out Company may be significant, there are additional costs and expenses associated with forming and maintaining a business entity, and the tax consequences if one doesn’t do so correctly can be substantial.
1) Fees to Form/Maintain Business Entity
Forming a Loan-Out Company is no different from forming any other LLC or corporation. It begins with filing the company’s Articles of Organization with the state, the fee for which varies by states. For example, in New York, the state filing fee to form an LLC is $200 plus attorney’s fees. Additionally, there may be minimum state taxes ($800 in California), and other small filing fees due within a few months after the company is established.
2) Annual Operating Expenses.
Additionally, a Loan-Out Company must maintain its status by making annual filings and tax payments to the state in which it was formed, and possibly to other states where it conducts operations. For example, a Delaware LLC whose owner is an artist with homes in New York and California, where he or she renders substantially all of his or her services, will be required to “qualify” in those states as well. That means that the artist will have to pay certain fees to register in New York and California, and pay taxes to New York and California based on the income generated in each state.
Another expense that many younger artists don’t think about is expense is unemployment insurance, which may be necessary if you get injured and can no longer provide services and generate an income. In order to maintain unemployment insurance, you will need to pay yourself a fair salary, which means that a portion of your revenue must be set aside to pay yourself, but with the traditional withholdings and deductions.
3) IRS May Disregard the Entity or Reallocate Income
The IRS is against the use of Loan-Out Companies strictly as a tax avoidance device. Therefore, if the company isn’t properly documented and used consistently, one may find the IRS taking the position that a Loan-Out Company is simply a tax avoidance scheme, and disregard it for tax purposes. This means that you could find yourself being charged the higher, personal tax rate, despite paying the different costs and expenses associated with forming your Loan-Out Company.
If the IRS deems it necessary to prevent tax avoidance, it has the authority to reallocate income between taxpayers sharing common ownership and control. Mostly, this occurs when the company is formed after the signing of the contracts for the artist’s services. Therefore, to minimize the risk, one should definitely form a Loan-Out Company prior to entering into a contract on its behalf.
Is there a Loan-Out Company in My Future?
As explained above, a properly structured Loan-Out Company can provide substantial tax and other benefits, but without proper planning and administration, business problems and additional expenses can outweigh the potential advantages. Many businesses turn to hiring a bookkeeper to assure they account properly, but you should consult with your tax advisor as well as an experienced entertainment lawyer before making any decision.