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A Loan-Out corporation, also known as a Loan-Out Company, or Personal service corporation, is a form of business entity in which the creator is an 'employee' whose services are 'loaned out' by the corporate body. The creator of the corporation are typically the sole shareholder,[1] and is thus used as a means to reduce their liability, protect their assets and exploit taxation advantages. Loan-Out corporations are especially prominent in the entertainment and professional sports industries, as the creator's services are typically performed on individual contract bases.
The corporate body is engaged by external third parties to fulfil services, rather than the individual directly. Consequently, it is the creator's Loan-Out Corporation that is referred to and liable in contracts to perform the services required.
History[edit]
The OECD Model Income Tax treaty of 1930, lies as the foundation by which Loan-Out corporation structures may be exploited. Under Article 17, the model outlines the manner in which athletes, celebrities, or sportsmen/sportswomen operating across numerous countries, and therefore earning income under numerous taxing systems, may only be taxed in their home jurisdiction's, source of income even without an established governing corporate body. This rationale was initiated due to the difficulties of taxing individuals who operate on numerous contracts, such as professional sportspeople or artists.[2]
Major changes have come into effect as 2017, increasing the benefits and incentivising the exploitation of the Loan-our corporation structure. The predominate change that has come into place through the passing of the Tax Cuts and Jobs Act 2017, lies in the expulsion of employee's being able to deduct all business expenses.[1] The consequence of this legislation is that all individuals operating on a contract-by-contract basis, can no longer deduct expenses from their taxable income. This legislation has sparked a rejuvenation of the concept of operating under a corporate body, which facilitates all payments, with the individual creator of the corporation loaning out their services, as the creator's can maximise their profits under the same income.
Benefits[edit]
When a corporation loans out the services of an individual, the borrowing party pays a contractual amount of the services, and therefore in turn pays a salary to the individual performing the services, via the corporation. The borrowing entity may pay a token dividend or provide additional fringe benefits to cover insurances, medical, or retirement plans. [3] An effective use of the corporation status for taxation purposes rather than an individual employment contract, may minimise the corporation's taxable income to near zero, even in the case of a C corporation. The key benefits of initiating a Loan-Out corporation business entity are expense deductions, asset protection and tax deferral.
Expense Deductions[edit]
The Loan-Out corporation is considered a seperate tax entity to that of the creator, and thus, the creator may take advantage on the minimisation of taxable income, through tax deductible expenses. The creator's business expenses may be processed through the Loan-Out corporation, and thus treated as corporate expenses rather than employee expenses. This entitles the creator to deduct more expenses, as employees are only able to deduct their unreimbursed business expenses to a value of 2% of their gross income, compared to the corporate adjusted income, and can therefore deduct almost all business expenses, minimising their taxation liability. [3]
Asset Protection[edit]
Due to the corporation being a separate legal entity to the creator, the creator is not liable for claims against the corporation's assets in the event of a legal dispute, or to repay debts. That is, if the company is sued or required to pay substantial debts that it is unable to honor, the assets of the creator are not subject to liquidation, only the corporate body's asset's are liable.[4]
Tax Deferral[edit]
The corporation is able to select its taxable year of income, from any fiscal year. The consequence of this, is that the creator of the corporation may use a fiscal year that ends early in the year. This is beneficial as the corporation may select a taxable year that finishes early in the calendar year, such that it minimises their current year tax liability, and therefore allows for tax obligations to be delayed for nearly a year. [5]
Common Law[edit]
Section 482 of the Internal Revenue Code: Reallocation of Income[edit]
This section allows the commission to reallocate income through the Loan-Out corporation to the individual, if necessary to avoid tax evasion, or to more reasonably reflect the genuine revenues generated through the corporation.
In the case of athletes, their services or talents are considered to be a business in its own right, and therefore athletes may be recognised as multiple operating entities. This can be avoided by athletes if they only perform services through the Loan-Out corporation, not forming additional contracts with other external parties for their athletic services. [5]
Drawbacks for Creators[edit]
Although Loan-Out corporations are typically established to exploit taxation benefits and asset protection, there is risk associated with the poor formation and management of Loan-Out corporations.
Double Taxation[edit]
In a general corporate setting, the corporation pays tax on profits made from generating business revenues, and pays out a dividend to shareholders. Subsequently, these shareholders pay tax on the income received in the form of dividend. However, in the Loan-Out corporation, the creator of the corporation is typically the sole shareholder. To avoid paying tax twice, at the corporate and personal income tax levels, the Loan-Out corporation will pay out it's profits to the sole shareholder as a salary and/or bonus. Since the payment is treated as a salary expense, it is tax deductible as it is a typical part of business operations, rather than the elective payment of a dividend.[6]
Unreasonable Compensation[edit]
Employers may be denied a tax deduction on salaries, if the compensation paid to the sole shareholder is seen as unreasonable. The 'allowed' compensation faces scrutiny and controversy, as there is no definitive measurement of what is reasonable. Consequently, the only basis for reasonable comparison is other incomes seen in the industry. Even if portion of the payable salary gets denied, both the corporation, and the creator, will be subject to taxation.
References[edit]
- ^ a b Riley, Peter Jason (2018). "Loan Out". www.artstaxinfo.com. Retrieved 2019-05-12.
- ^ Nitikman, Joel A. (2001-08-01). "Article 17 of the OECD Model Treaty – An Anachronism?". Intertax. 29 (8): 267–274. doi:10.54648/351467. ISSN 0165-2826. S2CID 198607299.
- ^ a b LaFrance, M. (1995). The Separate Tax Status of Loan-Out Corporations. Scholarly Commons @ UNLV Law, 426, 880-944.
- ^ Freedman, Adam (2018-08-28). "Benefits of Establishing a Loan-Out Company for a Music Artist". Medium. Retrieved 2019-05-12.
- ^ a b Kanis, Bret M. (15 January 1995). "Utility of Personal Service Corporations for Athletes". Pepperdine Law Review. 22: 630–666.
- ^ Short, G. (1981). The Loan-out Corporation in Tax Planning for Entertainers. Law and Contemporary Problems, 44(4), 51-78. doi:10.2307/1191224