When writers are first starting out, they’re typically hired to work for a company like an employee might: they agree on what services will be provided for what pay, they’ll fill out a bunch of tax forms to get inputted into the company’s payroll system, and the payroll system will issue a check payable to the individual that deducts taxes and other withholdings.
At some point, though, writers may find it more beneficial to incorporate and loan their services out to the production company through an intermediary. This post will take a look at how that works and in what situations that might be preferable.
The general reason for wanting to loanout company is because it allows you to handle your own withholdings and tax reporting. Rather than relying on a production company or payroll service to do it for you, a loanout company puts that responsibility in your hands.
Writers without loanout companies are often referred to as direct hires. That means the contract is between the writer and the company (e.g. between Production Company, Inc. and Joe Writer) and the checks are made out to the writer (Pay to the order of Joe Writer). Since the production company is responsible for paying the writer, their payroll system typically deducts withholdings and then pays you the balance, just like any other employer would.
Writers with loanout companies, on the other hand, have an intermediary entity that they’ve formed which lends his or her services. In other words, the contract is between Production Company, Inc. and Joe’s Loanout Company, Inc. for the services of Joe Writer. Checks are made payable to Joe’s Loanout Company, Inc. with no withholdings because the loanout company is responsible for paying taxes on that money.
For example, let’s say Joe Writer the direct hire agrees to a deal where he’s to be paid $25,000 for commencement of a rewrite, but the actual check, depending on Joe’s tax situation, might only be for around $16,500 after taxes and withholding.
If Joe Writer had a loanout, on the other hand, the loanout company would receive a check for the full $25,000 because Joe’s loanout company has agreed to be responsible for handling Joe’s withholdings instead of the production company.
Now, some of you might be wondering why it matters whether the production company’s payroll accountant takes the taxes out first, or whether they’re paid by your loanout’s accountant later. Here’s why it’s important:
Screenwriting, unlike steady, full-time employment, is paid in sporadic bursts. That has a unique and potentially detrimental effect on the way your income is taxed.
By establishing a loanout company and having it managed by a tax professional, you can mitigate those effects by handling your own tax reporting rather than relying on a payroll company (which most likely will try to treat you like a regular employee) to do it for you.
Let’s use a practical example and compare Joe Screenwriter to his full-time administrative support office friend, Jane Assistant. And let’s pretend that Joe has one screenwriting job this year, that pays the same as Jane’s year of full-time employment: $52,000.
Bear with me, because this is going to get real technical… but it’s important to understand. Also, see my disclaimer about not being a tax professional; this example is only for illustrative purposes of one potential scenario and should not be misconstrued as legal or tax advice.
Since Jane has regular, full-time employment, her tax rate is easy to calculate and, more importantly, it’s steady. $52,000 that year puts her in a certain tax bracket. According to the 2016 brackets, an income between $37,651 and $91,150 makes her federal tax rate $5,183.75, plus 25% of the amount over $37,650. Do the math and that’s $8,771.25 in federal taxes owed. Divide that by Jane’s 26 regular biweekly paychecks, and she’s paying $337.36 of the $2,000 she earns every two weeks to taxes.
Joe, however, isn’t quite as lucky because his pay isn’t being distributed over the whole year… it’s being paid in big chunks (two $26,000 payments, one for commencement and one for delivery) and only being distributed over his period of employment. So if his rewrite gig is for, say, eight weeks of work, how does the payroll company calculate a tax rate that’s defined by annual taxable income? In a lot of cases, they project it out across the whole year.
So Joe isn’t being taxed for an income of $52,000; he’s being taxed as if he makes $52,000 every eight weeks for an entire year. Which means that even if Joe is making the same amount of money as Jane, tax entities are looking at him like he’s making $338,000. And the tax rate for someone making that kind of money? $46,278.75, plus 33% of the amount over $190,150.
This is the point where I should probably clarify that all of this stuff eventually gets cleared up when you file your tax return. Your return will show your actual earnings for the year and the IRS will go, “Oh, obviously he didn’t actually make $338,000 last year, so we need to adjust his tax bracket down to the 25% rate that someone who made $52,000 per year pays.”
However, the practical impact on Joe’s screenwriting checks is this: since he’s in a higher tax bracket at the time the payroll company is calculating the payment, the payroll company will withhold 33% from his check, not 25%. So even though they’re taking home the same gross wages, Joe is paying an extra 8% to Uncle Sam, which in this example amounts to $4,160.
Again, Joe will get it back when he files his return, but if he performs that work and gets paid this month (February 2017), he won’t see that return until he files his return a year from now in 2018.
And this is just one potential example of why direct hires can experience difficulty in how they’re paid. While this scenario isn’t necessarily true of everyone (different tax situations result in different reporting, and different payroll companies handle the projection of freelance income differently), wonky stuff like this is not at all uncommon when a payroll system designed to handle regular employees has to handle freelancers who get paid in big intermittent chunks.
Eventually everything sorts out and there are ways to minimize the impact of some of these obtuse tax issues, but this is also why a lot of writers choose to incorporate and lend their services through a loanout.
Instead of hassling with the above, Joe’s loanout would be paid the full $52,000 and could handle the tax reporting each year through his own accountant preparing a more accurate return for the sporadic income that he’s making.
There are a lot of other benefits of having a loanout company as well. You can get a company credit card to charge business expenses so they don’t pass through your personal bank accounts, for example. Depending on your situation, it might make sense to keep some of the money paid in the loanout (as opposed to transferring it all to your personal accounts) to reduce your tax implications.
Again, though, all of these specifics are best discussed with your tax and legal professionals to understand just how a loanout can work to your advantage.
WHEN TO FORM A LOANOUT
There are a lot of blogs and other sources of advice out there that all cite different thresholds for when you should incorporate. Some say when you reach $100,000 in annual income. Others say $250,000. Some even go low and say $50,000 while others go high and say $500,000.
Put the exact number aside and look at it this way instead:
It’s worth creating a loanout when the amount of money you’d save offsets the administrative cost of creating and maintaining the loanout.
I know that sounds really generic, so let’s look at what a loanout will cost you.
First, there are initial expenses associated with forming the loanout. You’ll probably want an attorney and an accountant to prepare and review your filings and other corporate paperwork to make sure everything’s in order.
Second, there are recurring annual expenses involved in maintaining the loanout, including fees and, presumably, the rate your tax and legal professionals will charge you for handling the the more nuanced administration of a business and its corporate tax filings.
As long as those recurring annual expenses are less than the amount you’re saving, a loanout is a good idea. If you’re spending $1,000 a year to maintain a loanout that’s only saving you $500 more than you’d be earning if you were being paid directly, there’s not a lot of incentive to have one. On the other hand, if it’s costing you $1,000 a year to maintain the loanout and you’re saving $3,000 a year… or that $1,000 is worth it in order to have a more accurate form of tax preparation… it makes sense to go to the trouble of setting one up.
Only you and your tax professional know what the right situation is for you. Depending on your financial situation, you might start seeing savings under a loanout when you’re earning $50,000 a year. For someone else, that point at which they start seeing savings through a loanout might be closer to $150,000 or $200,000. There are a lot of particulars involved, so if you’re considering forming a loanout, you definitely need to consult legal and tax professionals who are familiar with your individual situation.
In closing, I’d like to offer the following assorted thoughts on loanouts:
- Be professional. This business name is going to appear on all of your contracts, start forms, and tax paperwork. There’s nothing wrong with infusing a little humor or cleverness in a name (in fact, as someone who sees a lot of them, I appreciate and encourage it!), but make sure it’s a name you’re okay seeing on professional documents and correspondence for a very, very long time.
- Be concise. Remember that there are real-world considerations to take into account. Certain forms and the payee line on checks have a limited amount of space. While it will never prevent you from getting paid, having a loanout like Super Longwinded Annoying Catchphrase Loanout For [Writer Name], Inc. is not going make it easy on assistants, accountants, etc. who will have to find creative ways to cram in all that language (or will end up just cutting it off) on forms and checks that have space-limited standard fields.
- Be aware of the nuances of operating a loanout. There are a lot of nuances to operating a loanout. You have to make sure you’re not piercing the corporate veil. If you set up an LLC as opposed to a C-Corp or an S-Corp, most payroll companies will require an IRS Form 8832 Entity Classification Election so that your LLC conforms to standard tax practices of either a standalone or pass-through corporate structure. You’ll need to have Articles of Organization or Articles of Incorporation drafted up depending on the type of entity you create, and you’ll need to appoint managers or corporate directors. If any of that is at all confusing or unfamiliar to you, that’s exactly why you need legal and tax professionals to walk you through this and manage the entity for you.
If you’re a writer making a consistent writing income, sooner or later you’ll probably want to consider forming a loanout so you can exercise more control over your financial situation. When that happens, make sure you find someone with far more experience and knowledge of your individual situation than me to help you with the particulars.