An increasing number of people are finding themselves either self-employed or engaging in short-term employment arrangements. These individuals are typically actors, content creators, gig economy workers or consultants. These employment arrangements can come with many benefits, however, they may also pose a tricky tax situation.
An effective strategy for self employed individuals to reduce their effective tax rate is forming a Loan Out Company. We discuss what a Loan Out Company is, the business benefits, and how to properly set one up.
What Is a Loan Out Company?
A self employed individual can use a Loan Out Company to turn short-term employment arrangements into independent contractor relationships. The company effectively employs the individual and “loans out” their services to the companies for which they work.
Through a Loan Out Company, the individual can reduce their effective tax rate by avoiding self-employment taxes (including Medicare and Social Security tax). Additionally, the company can provide the individual with personal protection from things such as contract liability.
Is A Loan Out Company An LLC?
The Limited Liability Company (LLC) is the most popular entity type for small businesses, including Loan Out Companies. LLCs are flexible, cost effective and simple to operate. They can be used to protect a wide variety of business types with minimal red tape.
Who Uses Loan Out Companies?
People earning $100,000 or more per year through a series of short-term employment engagements use Loan Out Companies to secure a lower tax rate and protect their personal assets. At that level of income, the tax savings more than pay for the administrative costs of the LLC.
Some common examples include: Hollywood actors, musicians and writers who contract with movie production companies or concert venues. This arrangement can also benefit workers outside the entertainment industry, like consultants.
“Gig economy” type workers also use Loan Out Companies. These include people who sell their services through third party channels like mobile apps. For example, a registered nurse who uses Care.com to find patients for her elder care service could form a Loan Out Company to contract with patients directly.
How Much Does A Loan Out Company Cost?
The cost of forming a Loan Out Company as an LLC will depend on which state you choose to form it in. In Delaware, the most popular state for LLCs, the initial filing fee is $50. An LLC must also pay the Delaware annual franchise tax of $300 each year after formation. Additionally, an LLC must appoint a registered agent and pay the associated registered agent fee.
Loan Out Company Benefits
The primary benefits of forming a Loan Out Company are:
- A reduced effective tax rate:
A Loan-Out Company can reduce the individual employee’s effective tax rate. This is largely because part of the employee’s income can be exempted from self-employment tax.
- Liability protection for personal assets:
A Loan Out Company also affords the individual a greater degree of asset protection from contract liability than being an employee or sole proprietor. The Loan Out Company can provide even more protection by obtaining additional insurance, such as personal injury liability insurance.
How Is a Loan Out Company Structured?
A common structure of a Loan Out Company is a single-owner LLC that elects to be taxed as an S-Corporation. By making the “S-election”, the Loan Out Company can reduce up to half of the self-employment taxes for the social security portion, potentially saving thousands of dollars per year. This can be done by:
- Paying out half the profit after deductible benefits and expenses as salary subject to the combined 15.3% Medicare and Social Security Contributions; and,
- Taking out the other half of the profit as Subchapter S Dividend not subject to the 12.4% Social Security contributions.
A Loan Out Company is not a different type of entity. It is just a way to describe a single owner company whose purpose is to improve asset protection and provide tax benefits for an individual employed through short-term engagements.
Who Owns a Loan Out Company?
The individual selling their talent is typically the person who owns the loan out company. The most common type of entity used is an LLC. The individual typically serves as both the sole employee and the President/CEO of the LLC.
Tips For Operating A Loan Out
The owner of a Loan Out Company should keep their personal wealth separate from the company by doing the following:
- Open a separate bank account for the income and expenses of the Loan Out Company.
- Contracts should be entered in the name of the company with the manager signing in the signature block. A separate contract should be maintained between the Loan Out Company and its owner for the owner’s personal services in case of a lawsuit, audit or questions by a production company.
Anyone interested in determining the amount of tax savings should seek out the assistance of a tax advisor. The tax advisor may suggest the Company also consider a C-Corporation tax election. This may achieve a lower tax result under the 2017 Tax Act. If applicable, creative people should ensure that their Loan Out Company does not result in the transfer of copyrights for creative works. This arrangement is not an alternative to long-term employment for ordinary employees, just those in the gig economy.