Counseling clients in the entertainment industry, it is clear the road to success is a difficult one for those in the arts. It can take years for actors, musicians and others to reach a point where their efforts begin bringing in a notable return. If and when these types of clients begin to make a consistently significant income, their hard-earned pay should be properly protected. One method that deserves consideration is organizing a loan-out corporation.

From a legal standpoint, these corporations are essentially identical to single-member limited liability companies or sole-shareholder corporations. The term "loan-out corporation" is generally exclusive to the entertainment industry and reflects that these companies—typically consisting of one owner—allow entertainers to "loan out" their services into independent contract relationships with third parties. Substantial tax benefits and asset protections make these types of enterprises attractive once an entertainer begins taking in a more sizable income and is subjected to higher personal income taxes.

Often, entertainers may not understand why forming a loan-out corporation is in their best interests, or how to set one up that will be acceptable to the Internal Revenue Service (IRS). This is where an attorney's knowledge is vital in helping an entertainer determine the best route as they progress in their career.

When to Start a Loan-Out Corporation?

For example, let's say a film and TV actor is beginning to get a steady stream of well-paying work. Once his income begins to increase to around $100,000 per year, the entertainer's counsel should broach the idea of a loan-out corporation. This is a general figure, but it is around that income level that the potential tax savings begin to outweigh the initial costs and annual fees of operating a corporation.

Another set of factors for legal and financial advisers to note before suggesting a loan-out corporation is the state under which the corporation will be created, as certain states have varying fees. Costs of living are also a consideration, as they may affect at what income level it is most beneficial to begin the process.

Once an entertainer reaches the rare heights of fame and starts earning a multimillion-dollar annual income, they might have multiple enterprises and companies, but the loan-out corporation remains their method for contracting themselves to film studios, production companies, record companies and other third parties.

What Are the Main Benefits?

• Tax savings: Clients in the entertainment industry may be used to receiving payment from various production companies as an employee, with all of their wages subject to a self-employment tax that covers Medicare and Social Security. Following 2017's Tax Cuts and Jobs Act, however, self-employed performers are no longer able to deduct business expenses, except in rare occasions. Businesses, however, have few limitations on deductions, so a loan-out corporation employee can deduct expenses on a corporate tax return.

By establishing a loan-out corporation, clients would be eligible to take an S election. This allows them to take a distribution as an owner, rather than collecting a full salary directly from the production company. As such, an entertainer can avoid the payroll tax on a significant portion of their income, and potentially reduce up to half the Social Security portion of their self-employment tax and more. Add it up, and it's a substantial amount of income per year.

• Asset Protection: Since a loan-out corporation is a separate legal entity from the individual, property held in the name of its owner or principal is protected from judgment against the corporation. That means if the company is sued, the owner's personal assets can't be touched to satisfy a judgment—only those held by the company. This becomes especially important as entertainers' personal assets rise in value.

For more protection against personal injury liability, the company can—and oftentimes should—obtain an insurance policy (and almost always its own bank accounts). Additionally, in the event of an audit, questions from a production company or, in the worst-case scenario, a lawsuit, a separate contact should exist between the company and its principal for the latter's personal services.

What's the Catch?

Forming a loan-out corporation is no different than forming a corporation or LLC. While the entertainer is focused on creating their art, touring or shooting a television show, this is the pivotal time when their attorney steps in to form and structure the new business. There are multiple filing requirements, such as obtaining a tax ID number, drafting the operating document or bylaws, and a number of other procedural steps to complete depending on the type of business entity being formed.

These details do not go away after the business is formed. There remain annual operating expenses and often filings to maintain the entity, and if it is not properly documented and consistently used in the proper fashion, it may draw the unwanted attention of the IRS. The IRS recognizes that entertainers are creating these companies to save on taxes, so it will look for any reason to declare one a tax avoidance mechanism.

Trusted legal counsel and tax and financial advisers are an entertainer's best friends in avoiding that outcome. While the performers get down to the business of creating their art, it's the experts behind the scenes who keep the business going.

Maxwell Briskman Stanfield is an attorney at Meyer, Unkovic & Scott. He focuses his practice on corporate, business, financial and commercial real estate law, and he has a wide variety of experience in the entertainment industry. He can be reached at [email protected].