Most people in the entertainment industry are aware of the tax and other benefits of utilizing a loan-out corporation. However, the question of whether to form a “C” corporation or an “S” corporation (or, as we tax people like to say, “C corp” or “S corp”) is more difficult.
Let’s first look at the basic differences between these entities:
C corp is taxed as its own separate entity:
A C corp takes in its income and pays its expenses, including the owner’s salary, and it pays tax on its net income, if any. If the C corp has no net income, it pays no income tax (other than the $800 annual minimum California Franchise Tax).
S corp’s net income or loss passes through to its owner:
The S corp pays no federal income tax, and only the $800 minimum California Franchise Tax, or 1.5% of its net income, whichever is greater. The owner includes the income or loss from the S corp in his or her personal tax return.
Formerly, the major advantage of using a C corp as a loan-out was that there were greater pension benefits that could be provided in a C corp than in an S corp. But that is no longer the case — pension benefits have been equalized.
Now, however, the balance may have shifted to favor the S corp, at least for U.S. citizens and residents. C corp loan-outs must pay out all their net income or be subject to penalty taxes and possibly extend the statute of limitations for tax audits from three to six years, whereas S corps are not subject to such rules.
S corp owners like to leave as much income as possible in the corporation as it can be distributed to them free of Social Security, Medicare, SDI, and other employment taxes. (Of course, in California, any income left in an S corp loan-out is subject to that 1.5% California Franchise Tax.) However, the IRS is wise to this and generally will require the owner of the S corp loan-out to treat all payments to the owner as employee salary, subject to employment taxes.
Frequently, when the loan-out’s owner is working in a foreign country (or in certain U.S. states), individual income taxes are withheld on payments from the studio or production company even if the payments are to the owner’s loan-out company. Those taxes are available as Foreign Tax Credits to offset the owner’s individual U.S. taxes, but only if these are passed through to his or her individual income tax return.
As noted, a C corp pays its own taxes and keeps any credits it is due. So when a C corp loan-out pays out all its income in salary to the owner, the C corp has no taxes against which to apply any Foreign Tax Credits — the credits just sit there and accumulate.
Therefore, when working abroad, an S corp loan-out is definitely necessary so that any Foreign Tax or other credits can pass through to the owner instead of being trapped, uselessly, in a C corp.
However, this benefit of S corp loan-outs is available only to U.S. citizens or residents. Nonresidents may not utilize an S corp loan-out — their loan-outs must be C corps.
One of the last remaining benefits available to the owner of a C corp that is not available in an S corp is a medical reimbursement plan:
Under this type of plan, the C corp pays expenses that are generally excluded from coverage under normal health insurance. As long as the medical reimbursement plan is not discriminatory as to the C corp’s employees, a C corp owner may exclude the medical payments from his or her income. Note that, although it is not perfectly clear, it appears that medical reimbursement plans will not be subject to the Obamacare rules and limitations, possibly making this benefit even more valuable.
In conclusion, as you can see, taxes are very, very complicated. Before you make any decision as to how to structure your loan-out, it is vital to confer with your own tax advisors to consider your specific situation and requirements.
— April 2016