With the passing of the Tax Cuts and Jobs Act of 2017, many actors, writers, directors, and other professionals in the entertainment industry will likely see their taxes increase beginning in 2018. The entertainment professionals who earn wages are being hit the hardest because employee business deductions will no longer be allowed in 2018 going forward. Prior to the passing of the new bill, entertainers receiving a W-2 were able to deduct the costs for their union dues, agent commissions, talent managers, accountants, attorneys, and other ordinary business expenses. Altogether, those business expenses typically add up to roughly 20 percent to 35 percent of an artist’s income but will no longer be deductible going forward. The disallowance of these expense deductions will have a particularly negative impact on the entertainment industry.
Loan Out Corporations – To be or not to be?
In light of the new tax reform changes, many accountants are advising their entertainment clients to form a loan-out corporation for them to deduct their business expenses. Under a normal employment arrangement, a movie, TV show, or theater production would hire the individual actor, writer, or director. Under a loan-out arrangement, the individual would incorporate and set up a loan-out company. The loan-out company would employ the individual and “lend out” their services to the movie, TV shows, or theater production. Prior to the enactment of the Tax Cuts and Jobs Act of 2017, the main benefit of the loan-out corporation was a full benefit of the business expenses otherwise limited on the personal returns, as well as avoiding the alternative minimum tax. Under the new law, loan-out corporations remain unaffected whereas entertainers receiving a W-2 can no longer deduct any business expenses to offset their income. The benefits of having a corporation fall into three basic categories, business expenses, pension plans and medical expenses.
Here is a list of common reasons performers set up loan out corporations:
1. One of the major benefits of having a loan-out corporation is the ability to manage tax payments and cash flow. Many entertainment professionals work on numerous projects every year which means they are on some different payrolls. Generally, professionals without a loan-out corporation are paid W-2 wages. The problem with this is that since the professional is on numerous payrolls with irregular pay periods, the tax withholdings could be more than necessary.
2. Another tax planning benefit of utilizing a loan-out corporation is the ability to take advantage of Qualified Pension and 401ks. In the case of an S-Corporation, certain shareholders are able to deduct health insurance premiums. In addition, pension contribution limits can be more than double that of a standard 401(k) plan when administered properly. The S-Corporation election is one of the ways to reap the immediate benefit. Service providers can save money on FICA taxes by receiving a “reasonable salary” from the corporation and allowing the remaining profit to pass-through to their tax return as ordinary income taxed only at their ordinary, marginal tax rate. As for medical and other business expenses, a “C” corporation can adopt a medical reimbursement plan, which in effect, allows the corporation to pay all of your medical expenses directly to the doctor or hospital and take a tax deduction of all amounts paid (less amounts covered by medical insurance). These can include costs for mental health, eye care, chiropractic, etc.
3. The other factor to consider is the new section 199A 20% “Qualified Business Income Deduction” calculated on your net business income. This new tax change for 2018 provides an additional deduction based on your net corporate business income. For folks in creative fields, there are 2 limitations in the calculation. Individuals in the arts are considered as part of the laws “specified service businesses” and are thus limited to the 20% deduction but ONLY if their taxable income is less than $157,500 if single and $315,000 if married (after that it phases out). This is a deduction not available to an employee, but if a performer were to set up a “loan out” corporation, they might be able to avail themselves of this new tax benefit.
The question then becomes, when does this make any sense for me? We feel the individual would need at least $100k to $125K in gross income before the loan out corporation would make any sense financially, but this would also depend on the level of expenses one was going to lose under the 2017 Tax Cuts and Jobs Act legislation. Consequently, this is a movable calculation depending on the mix of gross income and expenses.While a loan-out corporation seems like a great alternative to mitigate the increased tax burden for entertainment professionals, it may not be the best solution for everyone. Entertainers must consider the costs associated with incorporatingwhich include attorney fees to set the entity up (at least $1,000), the annual report filing fee of$125, the cost of the corporation return preparation at +/- $700, cost of payroll processing +/- $500, a minimum $800 corporate franchise tax per year (for California residents), and additional payroll taxes, which include the employer’s portion of social security taxes (as high as $9,800 or 7.65 percent of wages paid up to about $128,000), workers compensation insurance at $300 and $300-$400 in Federal and state unemployment taxes. The additional costs of incorporating may offset any tax benefit received, and government compliance can be an administrative burden for the entertainer. This means that the corporation adds over $13,000 of additional expenses for the business owner. By forming a loan-out corporation, an entertainer is also forfeiting their opportunity to claim unemployment.Ideally, we want the corporation to SAVE you at least this amount in taxes, so the performer is at break even with the loan out corporation.
These fees can go significantly higher (up to 5-6% of your gross income) if “business management” services are also provided, although some firms are now charging a fixed monthly fee for these services rather than a percentage of gross income. Business management involves turning over almost all responsibility for your finances to a business manager. They, in turn, pay all of your corporate and personal bills, invoice production companies for your services and monitor the collection of income, assist with insurance and real estate issues, provide investment guidance, etc.In addition to federal and state corporate and payroll taxes, the City of Los Angeles enacted legislation requiring all loan-out corporations “doing business” in the City to pay a business tax (however, corporations generating less than a certain threshold in gross income may be exempt from this tax).
With an S corporation structure, the one we prefer for smaller operations, the performer will claw back the heretofore lost deductions plus some FICA tax savings and perhaps (depending on income levels) section 199A 20% “Qualified Business Income Deduction” that will generally offset the additional fees and taxes the corporation incurs. If you are dealing with larger amounts of income, one might look at the C corporation and the ability to defer income into other years by using a fiscal year-end as well as some additional employee benefit options that the C corporation structure provides.
The final advantage I often mention in this structure is that generally speaking, your chances of getting audited by the Internal Revenue Service drop substantially inside the corporation. That is because the Internal Revenue Service does not do as much sampling or DIF scoring of business returns like they do on personal income tax returns. Secondarily the Internal Revenue Service does not require 3rd party 1099 reporting when the payment is made to a corporation. Consequently, the business will not receive 1099’s.
Don’t ignore the low-hanging fruit
For those consistently working actors, they know the QPA (Qualifying Performing Artists) is and has been, virtually worthless for many years as the qualifying threshold is unrealistically low (adjusted gross income of $16,000 or less before deducting expenses as a performing artist).However, for those actors, who are getting started, stage performers or don’t book a ton of workthis is a great way have your performing-arts-related business expenses deductible whether or not you itemize deductions.If you meet all the requirements for a qualified performing artist, include the part of the line 10 amount attributable to performing-arts-related expenses in the total on Form 1040, line 24 (or Form 1040NR, line 35), and attach Form 2106 to your return.
One of the best ways to build savings when starting your acting career is to fully fund a Roth IRA. In 2018, you can put $6,500 (If under 50) into a Roth IRA (grows tax-free and distributions are tax-free). The contributions can be withdrawn without taxes or penalty (the earnings cannot be withdrawn until age 59.5). But if you’re 18 or older, not a full-time student and are not claimed as a dependent on another person’s return, then you can take the Saver’s tax credit. The amount of the credit is 50%, 20% or 10% of your Roth IRA contributions up to $2,000 ($4,000 if married filing jointly), depending on your adjusted gross income (phased out at $63,000). Remember a tax credit is a dollar for dollar reduction of your tax bill.
Book your own kids
As the owner of a business, you have the advantage of being able to hire your child to work in your business, and that creates tax-saving opportunities for both you and your child.They can do print modeling, video, and social media marketing for your business.The new standard deduction means that a single taxpayer such as your child can earn up to $12,000 in W-2 wages and pay not a penny in federal taxes.Especially if you’re already paying them an allowance or putting money away for college. As a California resident, you do not get a state tax deduction for contributing to your child college saving 529 plan (as a few other states do).
When you hire the child under age 18, the Form 1040, Schedule C business and the partnership with only the child’s parents are exempt from Social Security, Medicare, and federal unemployment taxes. The S and C corporations and the non-spouse partnerships do not qualify for this benefit. They have to pay the payroll taxes on all employees—period. There is no parental benefit. (Similarly, the self-employed individual or the spouse-only partnership with a child age 21 or over does not qualify for any employment tax breaks.)
Talk with your tax advisor to see if you qualify for the tax-favored educational assistance program. If so, you can hire your child age 21 or older. Grant the education program to all your employees, including your employee child. Now, you may deduct up to $5,250 of your employee-child’s college tuition and book fees. The $5,250 is the annual, per-employee limit on Section 127 educational assistance.