THE VALUE OF A LOAN-OUT CORPORATION
By Scott J. Feinstein
One question I am frequently asked by clients who are SAG and AFTRA members is whether is whether or not to incorporate, e.g. establish a loan-out corporation for their services. The answer to this question comes down to one main issue – COST vs. BENEFIT.
There are various COSTS involved in establishing a loan-out corporation including legal fees to set up the corporation and related state and federal filing fees (one time out-of-pocket expenses) plus annual expenses for legal and accounting fees, as well as payroll and corporate income taxes. On the other hand, there are numerous BENEFITS that come with incorporating including the ability to establish a pension plan, the right to deduct medical expenses and the transfer of other business expenses from your personal tax return (where they are subject to certain limitations on the amounts that can be deducted) to a corporate tax return where there are very few limitations on deductions for business expenses. Let’s start with the good news – the BENEFITS. The benefits of having a corporation fall into three basic categories, business expenses, pension plans and medical expenses.
First, as an employee of a production company/studio you are the recipient of W-2 income and any employee-related business expenses, such as commissions, union dues, head shots, travel expenses, etc., would be included on Schedule A (Form 2106) of your personal income tax return. Unfortunately, there are limitations as to the type and amount of expenses that can be included on a Schedule A. In addition, if your business expenses are large enough you could be subject to what is referred to as “alternative minimum tax.” In simple terms, you could lose a significant portion of the tax deduction. For example, an actor earning $150,000 per year will likely have at least $40,000 in actual business related expenses, including commissions of 15%. With a Schedule A and the alternative minimum tax, he or she would only be able to deduct approximately $10,000 or less than 30% of total business expenses. This would leave approximately $30,000 of legitimate out of pocket business expenses paid during the year for which he or she will receive NO TAX DEDUCTIONS. With a corporation, there are no such limitations. Nearly 100% of all business expenses are deductible. It should also be noted that the standard of proof on a personal tax return can, at times, be greater than on a corporate tax return. In other words, the IRS generally respects the deductions of a corporation.
Second, as a studio/production company employee the only retirement account you can voluntarily set up is an IRA. Unfortunately, in most cases, if you are a member of a union, although you have the right to contribute to an IRA the contributions do not qualify as a tax deduction. Conversely, a corporation can set up a pension plan and you would be able to contribute up to $42,000 (and in some cases, even more) to the plan. As with business expenses, 100% of pension plan contributions are tax deductible. This alone can save you significant tax dollars.
As for medical and other business expenses, a “C” corporation can adopt a medical reimbursement plan, which in effect, allows the corporation to pay all of your medical expenses directly to the doctor or hospital and take a tax deduction of all amounts paid (less amounts covered by medical insurance). These can include costs for mental health, eye care, chiropractic, etc. Of course, all of these benefits do come with a price – the COSTS. The costs involved with having a corporation also fall into three basic categories, initial legal fees, ongoing accounting/legal fees, and taxes. Initial legal fees (including State filing fees) to set up a corporation should run between $1,500 - $2,000, but there may be additional fees for the preparation of an employment agreement between you and your corporation.
Once established there will be annual costs to maintain and administer the corporation including legal fees for the preparation of corporate minutes, usually not exceeding $300 - $400 annually, and accounting fees that usually run between $2,000 - $4,000 per year and cover the preparation of all federal and state corporate and payroll tax returns as well as quarterly financial statements and tax planning. These fees can go significantly higher (up to 5-6% of your gross income) if “business management” services are also provided, although some firms are now charging a fixed monthly fee for these services rather than a percentage of gross income. Business management involves turning over almost all responsibility for your finances to a business manager. They, in turn, pay all of your corporate and personal bills, invoice production companies for your services and monitor the collection of income, assist with insurance and real estate issues, provide investment guidance, etc.
With respect to corporate taxes, while the State of California has a minimum annual “fee” of $800 for the right to do business in the state, there is no minimum federal tax and, when properly managed a loan-out corporation should not pay any federal taxes. Then there are payroll taxes. As an employee of a production company/studio Social Security and Medicare taxes are automatically withheld from your paycheck. Your employer (the studio) then matches that amount and forwards the entire amount to the Social Security Administration. In addition, your employer also pays federal and state unemployment insurance on your behalf. With a loan-out corporation you are still the employee, but your corporation is the employer (instead of the studio) and is liable for the payment of all payroll taxes including matching amount of Social Security and Medicare taxes. Payroll taxes are based solely on the salary you receive from your corporation and will, of course vary with your income level. For example, payroll taxes on an annual gross salary of $100,000 will be approximately $7,000, $8,500 on an annual gross salary of $200,000 and $10,000 on an annual gross salary of $300,000.
In addition to federal and state corporate and payroll taxes, the City of Los Angeles recently enacted legislation requiring all loan-out corporations “doing business” in the City to pay a business tax. At the time of writing this article the specifics of the new law including income basis and tax rates have not been finalized, however, it appears that corporations generating less than $300,000 in gross income may be exempt from this tax.
In sum, you can expect to spend approximately $1,500 to set up a loan-out corporation plus an estimated $12,000 per year for accounting/legal fees and taxes (all of which are fully tax deductible). Now, while this may seem like a heft price to pay, under the right circumstances the tax savings will more than make up for it. Which brings us to the million dollar question – “Is a loan out corporation right for me?” Well, the answer depends on your income. In general, the point at which it makes economic sense to set up a corporation, e.g. when the Benefits outweigh the Costs, is when your annual income is approximately $150,000. However, under certain circumstances, it can make economic sense for individuals with annual incomes of as little as $100,000. The more difficult question for many in the entertainment industry is “What will my income be next year?” These are tough questions but ones definitely worth discussing with your tax professional.
Scott Feinstein, President of Feinstein & Berson, has been a CPA and Business Manager for over 20 years and has established a strong client base consisting almost exclusively of SAG, AFTRA, IATSE and DGA members. For additional information, call 818/981-3115.