As a freelancer, you could potentially get a lower tax rate while protecting your personal assets with something called a loan-out company. By setting up a loan-out company, you could enjoy these benefits while using the savings to offset setup costs.
Rumors, conjectures, and misleading advice are common when managing personal finances in the gig economy. One of the most buzzed 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 tackle one of the freelance ecosystem's most frequently debated subjects - the loan-out company.
Main points
- Setting up a loan-out company can lower tax rates and protect freelancers' personal assets.
- Freelancers making at least $75,000 annually may benefit significantly from a loan-out company.
- Legal and tax professional consultation is essential before establishing a loan-out company.
What is a loan out company?
A loan-out company or loan-out corporation is a legal business entity in the United States established for "loaning out" the services of its creator to third parties. When an individual creates a loan-out corporation, they become 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 forms, such as an S-Corporation, C-Corporation, or LLC. As you might expect, each classification carries distinctive advantages, disadvantages, and regulations. Generally, the fundamental concept remains the same when functioning as a loan-out corporation.
Discuss the differences between your lawyer and CPA before incorporating them. You'll need them both to open your loan-out company.
Who uses a loan out company?
Loan-out corporations are frequently encountered in the professional sports, music, and entertainment industries. The reason for this is that the lifeblood of these fields stems from labor and services performed as contracted individuals.
As a result, unlike teachers or healthcare professionals, most people in these fields are off recurring payrolls.
Instead, they're paid irregularly for work defined explicitly within a contract. These employees are generally not performing roles responsible for ongoing or indefinite tasks. 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 complicated. In practice, loan-out corporations are relatively simplistic.
Example: a loan out company for a writer
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 will only hire them indirectly.
Instead, the production company will enter into a contract with the writer's loan-out. It means 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 writer's services.
The production company will pay the loan-out corporation the contracted amount of money on an agreed-upon schedule. In turn, the loan-out corporation will pay the writer a salary.
The writer is still being hired and paid to do a defined job, but their contract 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 show? These are the writers' loan-out companies, which shield them from tax burden and act as production companies for the show.
Why do you need a loan-out company?
There are several potential advantages to having your own loan-out corporation. Not all will apply to your individual circ*mstances.
The first step to creating a loan-out company is consulting with a qualified legal adviser.
As a general rule, the higher your income level, the more appealing it becomes to work through a loan-out company. Its main attraction is its potential to lower high-income taxation associated with self-employment.
Let's briefly dive into the pros and cons of owning and working through a loan-out company.
1. Lower tax rates
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 money you would owe as a freelancer out in the wild. To see significant savings, you must be making at least $75,000.
This is because after the company pays taxes on everything it takes in, the employee must pay taxes on whatever they get as a salary.
2. Flexible fiscal year
As a freelance individual, you're taxed on your income between January 1 and December 31 of any given year, no matter what. As a loan-out company, you can arbitrarily fix the start and end dates of the fiscal year.
As a corporation, you'll also be taxed annually, but the beginning and end of that twelve-month cycle do not have to align with the calendar year.
If you choose well, you could net significant tax savings. Your loan-out corporation is in its first year by deferring some of its taxable income to the following fiscal year. Beyond that, a well-chosen fiscal year may stabilize your income and expenses by spreading them out.
For an actor whose major expenses are around the pilot season, 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.
3. More write-offs
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.
Like freelancers, a loan-out company can deduct business expenses from its taxable income. Thus, the owner of the loan-out company can process their business expenses through the loan-out. It means they're treated as corporate expenses rather than personal employee expenses.
As a corporation, a loan-out can access more deductions than an individual. With careful planning, a loan-out company can reduce your taxable income.
It can also make your write-off have a greater impact. While freelancers can write off some medical expenses, a corporation can write them off as "employee benefits," greatly offsetting your taxes.
4. Protect assets
The benefits of a loan-out corporation are not limited to taxes. Another benefit 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. For instance, if the company is sued, any assets listed as the company's will be at stake. However, the owner's personal assets are insulated.
This also works the other way around. Hypothetically, if you're in a car accident, and the other driver decides to sue, assets under loan-out company are off the table.
In either example, the loan-out corporation helps its creator insulate their assets from legal risk.
This "asset armor" is often used by high-profile individuals at greater risk of predatory lawsuits. Consequently, loan-out companies are often associated with high-net-worth celebrities.
Looking at the facts, you might even argue that loan-out companies are tailor-made to benefit these individuals of exceptional wealth.
Why don’t you need a loan-out company?
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 per fiscal year.
With that much revenue, it's easy for the corporation's creator to take advantage of its unique strengths. For individuals of more modest means, it's much more difficult for a loan-out company to realize its full potential.
A loan-out company isn't likely to be beneficial if an individual isn't making at least $75,000 per year in applicable business activity. There is a high likelihood of realizing a loan-out's advantages is only achieved once an individual makes 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. For example, a loan-out corporation in California must pay an annual filing fee of $800.
When you add legal and administrative fees and the risk of double taxation, a loan-out company is a liability for anyone making less than $75,000.
Additionally, considerable organizational challenges exist in establishing and maintaining a loan-out corporation. There is also the question of exactly how to run a loan-out company. It requires serious commitment and attention to detail.
Adherence to all legal requirements could also lead to huge fines and increased tax liability.
Plus, the IRS is different from loan-out corporations established to avoid taxation. It has been known to intervene if a loan-out corporation is not properly established or documented.
How do you set up a loan-out company?
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.
1. File articles of incorporation
You'll first need 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 establishing your company's existence.
To do this, you'll need to hire a lawyer who is familiar with the benefits of each company type and your entanglements. Are you in a union, like SAG or the DGA? Do you have an agent?
These considerations are crucial to establishing a loan-out company that gives you the most savings. You can find law firms through friends or websites like LegalZoom.
2. Prepare additional operating docs
You'll also need to fulfill any other state filing requirements, which are different in each state.
Generally, they include preparing your corporation's operating documents (a corporate records book, corporate bylaws, operating agreements, etc.). Additionally, they are involved in issuing stock and obtaining an employer identification number (EIN) for tax purposes.
For example, in California, you must file a statement of information form within 90 days of filing your articles of incorporation. Additionally, you must pay an $800 annual minimum tax during the first quarter of your fiscal year.
Ensure you follow any further requirements specific to the tax classification of your loan-out company. For instance, there are extra requirements when setting up an S-Corporation as a loan-out corporation in California. You must file an additional status election form within two months and fifteen days of the beginning of your corporation's first tax year.
3. Sign a loan-out agreement
Once the company is set up, you must enter an official loan-out agreement. This loan-out agreement is the same as a standard employment contract.
It lays out the ground rules for your "employment" through the company. The only unique detail is that you're entering into this contract with your loan-out. It means that you're 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 loan out your services to them. Loan-out agreements can be easily added and stored in Wrapbook.
It's common for a client to ask you to sign an "inducement agreement." It guarantees that you, as an individual, will still complete the contracted services if something happens to the loan-out corporation as a separate entity.
4. Inform your payroll company
Once you've landed a job, you'll need to ensure that whoever's paying you will send the checks to your loan-out company 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 company, 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 company again, as this will be your default.
Wrapping up
If you plan to set up a loan-out corporation to support your business needs, seek guidance from tax and legal advisers before taking action.
It's easy to answer the question, "What is a loan-out company?" Whether a loan-out company is right for you is more complex.
That question can only be answered by carefully analyzing your unique circ*mstances. Tax and legal professionals can help you determine how to run a loan-out company tailored to your unique needs.
An excellent place to start would be to make a rough estimate of how much you would. Factors such as your state's tax laws, your individual income level, and the consistency of your income will all come into play.
If you have any lingering questions about loan-out companies, contact us anytime.
Final FAQs
Who will get the most benefits from setting up a loan-out company?
An individual freelancer who works on short-term gigs and makes at least $75K per year is the ideal candidate for this type of corporation.
Should you set up a separate bank account for your loan-out corporation?
Yes. Always set up a separate bank account to get the most tax savings from your loan-out company by charging all your expenses to the account.
Are there downsides to setting up a loan-out company?
Yes. If you earn more income, the administrative expenses could stay within the tax savings. Additionally, it comes with fixed annual fees, regardless of how you make that year.
Should you consult a lawyer when setting up a loan-out company?
Yes. It cannot be stressed enough how important it is to seek legal advice when setting up a loan-out company.
