Loan-out corporations in California are a common way of doing business, especially in the entertainment industry. However, these types of corporations have recently come under scrutiny, and some are afraid that California lawmakers might take additional steps to limit or even ban loan-out corporations.

Loan-out Corporation Explained

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 businesses pay for these services, they pay the loan-out corporation rather than the independent contractor directly. 

For example, an actor, singer or other performer might book a gig doing a commercial or a spot on TV and be paid through their loan-our corporation. This is a popular way of doing business among people in California’s vast entertainment industry. 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.

EDD Thoughts

Earlier this year the payroll agency Cast & Crew, which works primarily with the entertainment industry, conducted an audit based on information that the California Employment Development Department (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 the EDD will not take any action against them. The EDD maintains its commitment is only to ensure taxes are collected per state law.

At this point, it is still unknown 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. 

On May 28, the EDD issued the following statement regarding loan-out corporations:

“We understand the great importance of California’s film and television industry and are proud of our work to support California’s employers and industries. We have received various inquiries highlighting questions about loan-out corporations’ ability to operate in California. As we have previously stated, EDD is not taking action to ban these companies in California.

“We are one of the nation’s largest tax collection agencies and work closely with businesses to collect payroll taxes that fund vital Unemployment Insurance and State Disability Insurance benefits for workers. Our commitment is to ensure these taxes are collected according to state law.

“We will continue our communication with industry representatives to ensure their concerns are heard and understood. We are optimistic that this dialog will help bring further clarity and information for the benefit of everyone who works in one of California’s most iconic industries.

“We understand taxes can be complex, and we are here for those who have questions. We are committed to providing excellent service to California employers, communicating with industries, and supporting a fair payroll tax system for the benefit of all Californians. Our Office of the Taxpayer Rights Advocate is responsible for protecting the rights of taxpayers during all phases of a tax administration process.”

If the EDD, in its normal audit selection process, does select a loan-out corporation for audit it will also look at how the corporation is run and whether they are following the requirements such that it is doing things correctly for a loan-out corporation. If something is not being done correctly, then the EDD will make assessments as required under the law.

Loan-out Corporation Advantages

Many people working with loan-out corporations enjoy certain tax breaks and benefits. Whether these tax benefits are in jeopardy remains to be seen. However, these tax implications can be a bit confusing, and it is not unusual for people to make errors when doing their taxes. 

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. Thus, the worker will have more control over what business expenses are paid by the corporation vs. what another employer might pay for business expenses. The worker will have more options on what type of retirement plan the loan-out corporation may set up than what they may be entitled to, if any, as an employee of many different business entities.

After these costs are paid there are less funds available to pay the worker a salary, thus less paid for various taxes, such as Social Security, Medicare and California Disability Insurance.

If the worker was a direct employee of entity needing their services, then some of these “business expenses” would either be limited on their individual tax returns or entirely not allowed.

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.

Loan-out Corporation Disadvantages

Loan-out corporations come with certain downsides that should be considered before deciding to set one up.

First, they can be expensive to establish and maintain. Simply creating a corporation requires legal work and various annual fees. The corporation should also have its own assets, like business accounts for accepting payment and distributing salaries.

To ensure the loan-out corporation is being managed and run correctly the corporation may need regular services of legal and financial advisers. While the individual behind a
loan-out corporation may enjoy certain tax breaks and benefits, there are other tax implications for the corporation itself. For example, the corporation might be liable for corporate income taxes, Social Security and Medicare taxes.

Because gross compensation paid to the worker will be lower than when working directly with the hiring business, the potential Social Security benefits will be lower at the time of retirement.

In September, California Gov. Gavin Newsom signed into law SB 422 that stated loan-out corps are declared the employer of IC. The also bill states this “is declaratory of, and not a change in, existing law.” To read the text of the bill, visit https://leginfo.legislature.ca.gov and search “SB 422.”