From the Tax Law Offices of David W. Klasing - Could Loan Out Corporations Be Banned First in California and Eventually Across the U.S.?

IRVINE, Calif., Aug. 6, 2024 /PRNewswire/ -- In California, Loan-out corporations are a common way of doing business, especially in the entertainment industry. However, these types of corporations have recently come under fire, and many are afraid that California lawmakers might take additional steps to limit or even outright ban loan-out corporations.

Why Should I Care if I don't live in California?

California law changes with subsequent tax enforcement that raise revenue are commonly viewed by other states in the union as an "awesome idea". Most states raise a significant portion of revenue through W2 withholding which comes in much faster through payroll withholding than through quarterly estimated tax payments. Audits of loan out corps often produce unsupported deductions which are rightfully viewed as fraudulently lowering California's revenue even where the independent contractor behind the loan out corporation is employed and paid as an employee of the loan out corporation.

A loan-out corporation is a business usually structured around one person. The corporation essentially loans out the services of the individual as an independent contractor. When clients pay for these services, they pay the loan-out corporation rather than the independent contractor directly. This is a very popular way of doing business among people in California's vast entertainment industry. Earlier this year, in 2024, several Hollywood guilds that represent many actors and entertainers warned their members that loan-out corporations might soon be banned in the entertainment sector. The California Employment Development Department (EDD) has said this is not true, and loan-out corporations will not be prohibited any time soon.

What Are Loan Out Corporations and How Do They Operate in California?

A loan-out corporation is a way of structuring a business. Generally, loan-out corporations are popular among people who work as independent contractors. They are also very popular among people in the entertainment industry who might provide work for all sorts of clients. For example, an actor, singer, or another performer might book a gig doing a commercial or a spot on a TV and be paid through their loan-our corporation.

The way it works is that an individual formally starts a loan-our corporation. The purpose of the corporation is to provide services from the individual, whatever those services may be. When clients pay for those services, they pay the corporation. Then, the individual who runs the loan-out corporation pays their own salary from the corporation. Essentially, a loan-out corporation allows people to provide their services to others without having to become someone else's employee.

These types of businesses are very popular in California in the entertainment industry. Artists and performers may set up loan-out corporations, provide creative work for numerous entities, and be paid through their loan-our corporation. Our California tax lawyers can help you make sure your loan-out corporation is in compliance with any tax laws.

Banning Loan Out Corporations in California

In 2024, the payroll agency Cast & Crew, which works primarily with the entertainment industry, conducted an audit based on a directive that the EDD would no longer be accepting loan-out corporations. A notice from Cast & Crew stated that the EDD would start requiring employers to pay for services directly to contracted employers, not to the loan-out corporations. This would have significant tax implications for independent contractors working for loan-out corporations.

This information appears to be the result of a still unknown miscommunication. The EDD has recently stated that loan-out corporations will not be prohibited in California and will not take any action against them. The EDD maintains that its commitment is only to ensure taxes are collected per state law.

At this point, it is still unknown exactly where the notion of a ban on loan-out corporations came from or what it means for the future of these businesses and people working in entertainment. Many people working with loan-out corporations enjoy certain tax breaks and benefits. Whether these tax benefits are in jeopardy remains to be seen.

The Pros and Cons of Loan Out Corporations in California

Loan-out corporations are popular in the entertainment industry as they provide many workers with tax breaks and benefits. However, these tax implications can be a bit confusing, and it is not unusual for people to make errors when doing their taxes. Call a tax attorney to help you make sure you do not make any serious tax mistakes.

Advantages

Having a loan-out corporation can help workers by providing certain tax breaks. For example, an actor who works for a loan-out corporation they established may deduct certain work and business expenses, reducing their tax liability. If an actor must travel because they are filming on location, they can deduct travel costs as business expenses.

Loan-out corporations also provide a certain degree of liability protection. If something goes wrong with a client and they want to file a lawsuit, the corporation might be liable, but the worker is not.

Disadvantages

Loan-out corporations come with certain downsides that you should consider before you decide to set one up. First, loan-out corporations can be expensive to establish. Simply creating a corporation requires legal work and various fees along the way. The corporation should also have its own assets, like business accounts for accepting payment and distributing salaries.

While the individual person behind a loan-out corporation may enjoy certain tax breaks and benefits, there are other tax implications for the corporation itself. The corporation might be liable for corporate income taxes, Social Security taxes, and paying into Medicare.

EDD and IRS Worker Classification Audits / Payroll Audits of Loan Out Corporations

California has outright attempted to outlaw the use of independent contractors in California as a revenue raising measure through AB 5 and its progeny. If you find yourself facing an audit by the IRS of California's Employment Development Department (EDD) we can help. We have extensive experience dealing with state and federal payroll audits of all types. 

We Are Here for You

Regardless of your business or estate needs, the professionals at the Tax Law Offices of David W. Klasing are here for you. We are open for business and our team will help ensure that your business is too. Contact the Law Offices of David W. Klasing today to discuss your business with one of our professionals.

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