A loan-out company is a business entity in which an individual is the sole owner as well as the employee who furnishes their personal services to outside production companies. It is very common for performers and high income earners in the entertainment industry to form a loan-out corporation or a limited liability company in order to provide themselves with liability protection and to take advantage of tax savings. Although some of the advantages of a loan-out company are obvious, taxpayers should understand the withholding requirements in different jurisdictions and the entity type that is most beneficial when determining whether or not it is worthwhile to set up a loan-out company.
Benefits of a Loan-Out
Typically, entertainers enter into contracts with production companies as an employee of their loan-out company rather than as an independent contractor so as to shield their personal assets. When liability occurs, the loan-out company will be liable as it is a separate legal entity.
Performing services through a loan-out company also reduces the entertainer's income tax liability by allowing the loan-out to deduct expenses on the entity level tax return that are normally not deductible on an individual income tax return, such as the employer's portion of payroll taxes.
Before you conclude that setting up a loan-out company is the way to go in the entertainment industry, there are other tax implications that should be considered.
Payroll Tax Withholdings
Since the entertainer is an employee of the loan-out company that is a C corporation or S Corporation for tax purposes, the loan-out is responsible for withholding the employer's portion of the payroll taxes rather than the withholding occurring at the production company level. To the extent the loan-out is a limited liability company the payroll tax withholding is performed at the individual level. Most talents in the entertainment industry work on a project-to-project basis. There are often times when they are unemployed or work less than full-time for an extended period and they may be eligible to file for unemployment insurance benefits. Hence, it is crucial that the loan-out companies withhold their portion of the payroll taxes so the employees can establish an unemployment insurance claim with the Employment Development Department or similar state agencies when they are not working on projects.
State Income Tax Withholdings
The requirements for withholdings vary in different jurisdictions. Loan-out companies may be obligated to withhold employment taxes from wages of the employees who perform services outside of their state of residence. For instance, the State of California requires anyone who pays California-sourced income to a nonresident to withhold seven percent of all payments that exceed $1,500 in a calendar year. California-sourced income includes compensation for services performed in California and payments for rents or royalties on property located in California, to name a few. With California being the center of entertainment and film production, a large number of actors and artists travel to California to work on projects. As a result, loan-out companies need to ensure they comply with the tax withholding requirements on any California-sourced income to nonresidents of the state. It should be noted that residents of California are not subject to this requirement since they have to report 100% of their worldwide income on their individual income tax returns.
While loan-out companies have a responsibility to withhold income taxes for the employees in some states, production companies should also beware of their own withholding requirements when using services by entertainers through loan-out companies. Georgia provides attractive tax incentives to encourage film production in the state. The Georgia Entertainment Industry Investment Act offers up to 30% of the Georgia production expenditures in transferable tax credits. In order to claim these tax credits, production companies are mandated to withhold Georgia income tax on payments to all loan-out companies for services performed within the state, regardless of their residency status. This requirement makes sure that the state captures tax revenues from payments to nonresidents who might not need to, or choose not to, file a Georgia income tax return. In terms of the compliance process, Form G2-FP is issued to the loan-out company from the production company to show the amount of production withholding. Then, the loan-out company must file Forms G2-FL and G-1003 with the state of Georgia to allocate the withholding payments to employees of the loan-out company. In general, the loan-out company should issue the employees a W-2. These employees typically do not file a composite Georgia return, and must file an individual Georgia income tax return with the Form G2-FL attached, to receive credit for the production income tax withholding on their behalf.
Entity Type Consideration
C corporations, S corporations and limited liability companies are the most common business entity types for a loan-out company. For U.S. citizens and residents, an S corporation is usually more favorable than a C corporation. For example, an S corporation is a flow-through entity that does not pay federal income tax and pays only the greater of the $800 minimum tax or 1.5% of its net income in California; whereas a C corporation potentially faces double taxation at both the corporate and the individual level.
Additionally, if the owner-employee of the loan-out receives any income from a foreign country and pays taxes on the foreign source income, the tax credits may flow from the S corporation to the owner and be utilized to offset individual tax liability. In a C corporation, the Foreign Tax Credits can only be applied to the tax liability at the corporate-entity level.
Just like an S corporation, a limited liability company does not pay federal income tax but it may be required to pay a minimum tax or an annual fee to some states. In California, limited liability companies need to pay an annual minimum tax of $800 to the Franchise Tax Board in addition to a tax based on gross receipts at the entity level, and the entire net income is taxed at the individual level. In Georgia, the net income also passes through to the individual members and is taxed at that level for limited liability companies. For both California and Georgia, annual registration or Secretary of State fees may apply.
There are many more tax implications that need to be considered before forming a loan-out company. Depending on each taxpayer's needs, everyone might need a different entity type or a different business location. If your annual gross income is over $100,000, it might be worth your while to consult with a tax advisor and discuss whether a loan-out company is the best solution in your situation.