ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – THE EDD AND THE FUTURE OF LOAN-OUT CORPORATIONS

By Robert S. Schriebman

2024

Introduction

A loan-out corporation is a regularly formed corporation, under California’s law, just like one would incorporate a small business. The term is often used to describe a corporation that provides individuals who will perform services for an unrelated employer sometimes known as a subscriber. These corporations are set up so that the staffing-referral corporation (loan-out) makes itself responsible for employment taxes and other benefits, saving the client-subscriber from various funding and bookkeeping burdens. Sometimes the staffing referral corporation hires the subscriber’s employees then loans them back to the subscriber. Loan-out corporations began to proliferate in the late 1960s and into the mid-80s. They are very popular with athletes, entertainers, and professionals such as doctors and lawyers.

Example: A doctor sets up a professional corporation. The corporation enters into an employment agreement with the doctor as its employee. The corporation then contracts with a hospital or other medical organization for the doctor’s services. The hospital pays the professional corporation and the professional corporation in turns pays the doctor a salary, usually a much smaller amount than what the hospital paid the professional corporation. The professional corporation has the doctor on a salary and takes out state and federal withholding taxes. Excess receipts may be used to fund a retirement plan for the doctor and provide other fringe benefits. These types of arrangements have been blessed by both the IRS and the FTB for decades.

Are Loan-Out Corporations in Danger From the EDD?

I recently received a bulletin from a well-respected publisher of taxation information. Certain members of the entertainment industry, where loan-out corporations have been historically used and honored, where told by the EDD that the loan-corporation concept would no longer be honored by the EDD. The EDD seems to take the position that the gross receipts received from the loan-out corporation’s client will be totally taxed as compensation and that the employment contracts between the professional entertainer and his/her loan-out corporation will no longer be honored. This means that the EDD wants the entire gross receipts of the loan-out corporation to be treated as taxable wages and not the reduced compensation stated in the employment contract between the entertainer and the loan-out corporation.

Clarification was sought from the EDD. Is the EDD really going to refuse to honor these employment contracts? The response from the EDD was vague. The EDD stated, it is not taking action to ban professional loan-out corporations in California. However, the EDD did not elaborate further. The EDD did not say that it would honor loan-out employment contracts, generally.

With any corporate employment compensation, regardless of the presence of a written contract, there are issues of reasonable compensation. If I had to guess, the attack from the EDD will be to refuse to honor these employment contracts on he grounds that the compensation paid to the entertainer, athlete, or professional practitioner is unreasonably low in light of the gross compensation received by the loan-out corporation.

The Impact of AB5 on Loan-Out Corporations

AB5 was enacted with the goal of treating most workers as W2 wage earners. It was amended by AB2257 with many new exemptions but no new rules regarding the elements of the ABC Test. There are exemptions for entertainers, athletes, and professionals. There is also the business-to-business exemption. These may impact future attacks by the EDD to do away with loan-out corporations but exactly how and when the EDD will launch its offensive is uncertain.

Conclusion

No one knows specifically where all this is going. Having said this, it has been my experience in dealing with the EDD on this issue that they do not understand nor follow federal guidelines establishing reasonable compensation. The EDD has its own marketing studies to determine executive compensation in specific industries. The EDD will use these guides to add additional compensation where it sees fit. However, the EDD ignores the maxim that the government can shift and allocate monies paid into the corporation, but they cannot create additional compensation if the funds are not there.

***

Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 50 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD, and he is not employed by the EDD or any other agency of the State of California.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Web Site Article 805