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Loan-Out Corporation Structuring – Washington

Washington’s 9.9% capital gains excise tax and the newly enacted Millionaire Tax mean a single IPO liquidity event can push a founder or tech employee into combined state and federal rates above 50%. The planning window is before the lockup expires, not after.

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Logic-First Proof

How a Loan-Out Corporation Reduces Your Washington Taxable Income After 2027

Without a loan-out structure, personal service income flows directly to the individual as W-2 wages or self-employment income, entering federal AGI in full and flowing into Washington base income under ESSB 6346 on every dollar above $1 million. A loan-out C corporation receives the contract fees, pays a reasonable salary to the owner, and retains the remainder at the corporate level, keeping excess income out of individual AGI. To understand how this works in practice, let us assume annual personal service income of $2,000,000.
Without Loan-Out Structure
All Service Income Flows to Individual AGI in 2028 or Later

$841,000

Let us assume $2,000,000 in personal service income recognized directly by the individual in 2028. Federal tax at 37% on the full amount totals $740,000. Washington's 9.9% millionaire tax applies to the $1,000,000 above the threshold, adding $99,000. Total combined liability reaches approximately $839,000 with no structural offset.

With Loan-Out Corporation
Reasonable Salary Paid to Owner, Remainder Retained at Corporate Level

$518,000

Let us assume the loan-out corporation pays the owner a $900,000 salary, keeping total household income just below the $1 million Washington threshold. The remaining $1,100,000 stays in the corporation, taxed at the 21% federal corporate rate. Individual federal tax on $900,000 at 37% totals approximately $333,000, plus $231,000 corporate tax. Combined liability: approximately $564,000. Washington millionaire tax: $0.

Let us assume annual personal service income of $2,000,000. Washington 9.9% millionaire tax applies to household income above $1 million beginning January 1, 2028. Corporate tax and individual salary assumptions are illustrative and will vary based on actual compensation structure and household income.

Metric No Loan-Out Structure (Post-2027) Loan-Out Corporation Strategy
Total Personal Service Income $2,000,000 $2,000,000
Income Reaching Individual AGI $2,000,000 $900,000 (salary only)
Individual Federal Tax (37%) $740,000 $333,000
Corporate Federal Tax (21%) $0 $231,000 on $1,100,000 retained
Washington Millionaire Tax (9.9%) $99,000 on $1,000,000 above threshold $0 (individual income below threshold)
Total Combined Tax $839,000 $564,000

Estimated Combined Tax Savings from Loan-Out Corporation Strategy

$275,000

Illustration assumes $900,000 reasonable salary, $1,100,000 retained at corporate level, 21% flat corporate rate, and individual household income below the $1 million Washington threshold; actual results depend on reasonable compensation analysis, household income, and entity-level tax elections

Advisor Perspective

Loan-Out Corporation Structuring Under Washington's Millionaire Tax: What Your Advisor Should Flag

A loan-out corporation is not a guaranteed tax shelter. The IRS and Washington Department of Revenue both scrutinize structures where the salary paid to the owner-employee appears below a reasonable market rate for the services performed. Call your advisor before forming the entity. Four scenarios require careful attention before you proceed.
⚠ Reasonable Compensation Requirement

Underpaying Yourself Invites IRS Recharacterization of Corporate Profits as Wages

The IRS requires that owner-employees of C corporations performing personal services receive reasonable compensation for those services. Setting salary artificially low to keep individual AGI below the Washington threshold exposes the entire structure to recharacterization of corporate distributions as wages, eliminating both the corporate tax benefit and the Washington planning advantage in a single audit finding.
⚠ Washington B&O Tax Exposure

The Loan-Out Corporation Itself Is Subject to Washington Business and Occupation Tax

Washington's B&O tax applies to the gross receipts of the loan-out corporation at the applicable service business rate. This is a separate layer of state tax that exists independently of the millionaire tax under ESSB 6346. The B&O tax credit provisions in ESSB 6346 may reduce millionaire tax liability where both apply, but the B&O exposure must be modeled before concluding that the loan-out structure produces a net Washington tax saving.
⚠ Assignment of Income Doctrine

Contracts Must Be Entered in the Corporation's Name, Not the Individual's

The loan-out corporation only works if the corporation is the actual contracting party. If an individual signs the contract and then assigns the income to the corporation, the IRS applies the assignment of income doctrine to tax the income directly to the individual regardless of corporate structure. All client agreements, invoices, and payments must flow through the corporation from inception, not after the income has already been earned.

⚠ Accumulated Earnings Tax Risk

Retaining Too Much Income Inside the Corporation Triggers a Federal Penalty Tax

The accumulated earnings tax imposes an additional 20% federal tax on corporate earnings retained beyond the reasonable needs of the business. A loan-out corporation that retains large amounts of income year after year without a documented business purpose for those retained earnings becomes vulnerable to this penalty, which would reduce or eliminate the combined tax benefit of the structure.

Structuring Requirements

Loan-Out Corporation Setup: Full Requirements Checklist

Not every personal service arrangement qualifies for loan-out corporation treatment. The structure must be properly formed, the contracts must run through the entity, and the compensation paid to the owner must be defensible as reasonable. Under ESSB 6346, a compliant loan-out structure can keep individual income below the $1 million Washington threshold, potentially eliminating state millionaire tax exposure entirely.
Loan-Out Formation Requirements

5 / 5 Complete

Form the Corporation as a C Corporation in Washington or a Tax-Favorable State
The loan-out must be a C corporation to access the 21% flat federal corporate tax rate. S corporations pass income through to the individual owner, defeating the purpose of retaining income at the entity level to keep individual AGI below the Washington millionaire tax threshold. Delaware and Wyoming are common formation states for their flexible corporate law, though Washington registration may still be required for state tax purposes.
Establish a Documented Reasonable Compensation Analysis Before the First Paycheck
Before setting the owner-employee salary, obtain a written reasonable compensation analysis from a qualified advisor or third-party valuator. The analysis should benchmark the owner’s role against comparable market rates for the specific services performed. This document is the primary defense against IRS recharacterization of corporate profits as additional wages and should be updated annually as compensation or service scope changes.
Execute All Client Contracts in the Corporation’s Name Prior to Performing Services
Every engagement agreement, statement of work, and invoice must name the corporation as the contracting and billing party. The individual owner provides services as an employee of the corporation, not as an independent contractor to the client. Any contract signed by the individual personally before the corporation was in place may be subject to the assignment of income doctrine, requiring individual-level taxation of that income regardless of how payment is routed.
Maintain Genuine Corporate Formalities Including Separate Accounts and Annual Minutes
The corporation must operate as a distinct legal and financial entity. This means a separate bank account, corporate credit card, formal employment agreement with the owner, payroll processing with proper withholding, and annual board minutes documenting compensation decisions. Commingling personal and corporate funds or treating the corporation as a pass-through for personal expenses exposes the structure to IRS challenge and potential piercing of the corporate veil.
Document a Business Purpose for Any Earnings Retained Inside the Corporation
The accumulated earnings tax applies when corporate profits are retained beyond the reasonable needs of the business without a documented purpose. Each year, the board should formally record the business reason for retained earnings, such as working capital reserves, planned equipment purchases, or business development investment. Retaining income purely to avoid individual-level taxation without a business rationale is the definition of an accumulated earnings tax vulnerability.
Quick Eligibility Snapshot
Requirement Criteria
Entity type C corporation only; S corporation pass-through defeats income retention purpose
Contracting party Corporation must sign all client agreements before services are performed
Owner salary Reasonable compensation supported by documented market analysis; updated annually
Corporate formalities Separate accounts, payroll, employment agreement, and annual board minutes required
Retained earnings Business purpose documented annually; accumulated earnings tax applies above $250,000 without justification
Washington millionaire tax note Individual salary below $1 million threshold avoids 9.9% ESSB 6346 tax; corporate income taxed at 21% federal rate with no Washington income tax at entity level

Schedule a Free Consultation for Loan-Out Structuring

Once ESSB 6346 takes effect on January 1, 2028, income already committed to flow through existing arrangements cannot easily be redirected. Building the corporation, establishing contracts, and documenting compensation before that date is the only way to capture the full planning benefit.
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Expert FAQs

What is a loan-out corporation and how does it reduce Washington millionaire tax exposure?
A loan-out corporation is a C corporation owned by a high-earning individual that contracts directly with clients for personal services, then pays the owner a reasonable salary while retaining the balance at the 21% corporate rate. Under ESSB 6346, only the salary reaches individual AGI and therefore Washington base income. Keeping that salary below $1 million can eliminate the 9.9% Washington millionaire tax on the retained portion entirely.
No. An S corporation passes all income through to the individual owner’s personal return, meaning the full corporate income enters individual AGI regardless of how much is retained inside the entity. This defeats the core Washington planning benefit. A C corporation is required because it is a separate taxpaying entity; retained earnings are taxed at the 21% federal corporate rate and do not flow into the owner’s individual AGI or Washington base income.
The salary must reflect reasonable compensation for the services you personally perform. The IRS benchmarks this against what a similarly qualified individual would earn in the open market for the same role. Setting salary below reasonable compensation invites recharacterization of corporate distributions as wages, which would collapse the structure retroactively. Your advisor should produce a written reasonable compensation analysis before you set or change your salary.
Income earned under contracts signed in your personal name is subject to the assignment of income doctrine, meaning the IRS taxes it to you individually regardless of how it is routed to the corporation. Existing contracts must be formally novated or renegotiated to name the corporation as the contracting party before new income streams can be sheltered. Income already earned under personal contracts cannot retroactively be assigned to the corporation.
Yes. Washington’s B&O tax applies to the corporation’s gross receipts at the applicable service business rate, independently of the millionaire tax under ESSB 6346. ESSB 6346 provides a credit against the millionaire tax for B&O taxes paid where both apply, but the B&O liability itself remains. The net Washington tax benefit of the loan-out structure must be calculated after accounting for B&O exposure, not before.
Disclaimer: This is not tax advice, and it is recommended to consult a tax professional, as every tax situation is unique.