A loan-out corporation, also known as a loan-out company, or personal service corporation, is a form of US business entity in which the creator is an 'employee' whose services are loaned out by the corporate body. The creator of the corporation is typically the sole shareholder, and thus the corporation is used as a means to reduce their personal 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 basis, and receive large, irregular sums of income throughout the year. The corporate body is engaged by external third parties to fulfill 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 The OECD Model Income Tax treaty of 1930, lies as the foundation by which loan-out corporation structures may be used. Under Article 17, the model outlines the manner in which athletes, celebrities, or artists operating across numerous countries, and therefore earning income under numerous taxation systems, may only be taxed in their home jurisdiction's source of income, even without an established corporate body. This rationale was initiated due to the difficulties of taxing individuals who operate on numerous contracts, such as professional sportspeople or artists. Major changes have come into effect as of 2017, increasing the benefits and incentivizing the exploitation of the loan-out corporation structure. The predominant change that has come into place through the passing of the Tax Cuts and Jobs Act 2017 lies in end of the itemized tax deduction for unreimbursed employee expenses. The consequence of this legislation is that all individuals representing themselves, operating on a contract-by-contract basis, will be able to deduct almost all reasonable, business related expenses from their taxable income whilst operating under the loan-out corporate body. 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, while allowing for expense deduction and asset protection.
Benefits When a corporation loans out the services of an individual, the borrowing party pays a contractual amount for the services, and therefore 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. An effective use of the corporation status over that of 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 creating a loan-out corporation business entity are expense deductions, asset protection and tax deferral.
Expense deductions The loan-out corporation is considered a separate tax entity to that of the creator, and thus, the creator may take advantage on the minimization of taxable income, through tax-deductible expenses. The creator's business expenses may be processed through the loan-out corporation, so treated as corporate expenses rather than personal employee expenses. This entitles the creator to deduct more expenses than otherwise applicable. Prior to the introduction of the new Tax Cuts and Jobs Act, employees were only able to deduct their unreimbursed business expenses up to a value of 2% of their gross income. But under the new legislation, employees are no longer able to deduct unreimbursed business expenses at all. Consequently, there is no limit to the value of corporate expense deductions, and can therefore deduct almost all reasonable business expenses, and thus minimize their taxation liability.
Asset protection Limited liability companies (LLC) offer personal liability protection, ensuring that a financial loss or incident that occurs to the corporation does not impact shareholder's own finances or assets. The loan-out corporate structure is therefore ideal as it forms a separate legal entity to the creator, and thus the creator is not liable for external claims against the corporation's assets in the event of a legal dispute, or the repayment of debt. That is, if the company is sued or required to pay substantial debt that it is unable to honour, the assets of the creator are not subject to liquidation; Only the corporate body's asset's are liable.
Tax deferral Loan-out corporations are able to defer their taxable income to the following taxable year. This is a result of the corporation being able to select its taxable year of income, from any fiscal year. However, the loan-out corporation must select a fiscal year that ends between September and December. The advantage of this, is that the creator of the corporation may use a fiscal year that ends earlier than that of the U.S. Personal income tax period, which ends December 31. The corporation must pay its shareholder(s) compensation as bonuses equal to or less than the payment made in the prior tax year, or 95% of the corporations taxable income earned in the taxable year ended December 31. Consequently, a loan-out corporation experiencing increasing revenues will benefit from the use of fiscal year tax deferral.
Common law
Section 269A of the Internal Revenue Code: Personal service corporations formed or availed of to avoid or evade income tax Section 269A of the Internal Revenue Code defines the conditions upon which the creator's of a loan-out corporation body must satisfy, for the official recognition of a loan-out corporation business entity structure. The corporate structure must satisfy the following two conditions to render the entity as an official loan-out corporate structure:
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