Real estate agents, it’s that time of year again! You know, the one that you get so excited about! Income tax returns!! I know that that’s as exciting as a root canal, because everybody loves sitting down to find out how much money they owe Uncle Sam, right? That is of course unless you’ve already followed the advice in this article and incorporated your real estate business. Whether you have or not, please read on.
First off, the piece of advice that real estate agents need is: Treat your real estate activity as a business! Why? Because it is a business! Get advice from an accountant about this. It’ll make a big difference in a lot of areas of your business, but especially with income taxes.
A major decision a business owner can be faced with is whether or not to incorporate. There are many advantages to incorporating if you have the right guidance. There are harsh consequences if done haphazardly and the law is not followed.
Real Estate Agents Should Incorporate. Here’s Why!
Real estate agents are by IRS definition statuary non-employees. This means at the end of the year RE-Max, Keller Williams, Century 21, or whichever broker they work for will send them Form 1099-Misc reporting gross commissions in Box 7 Non-employee Compensation. The tax problem with this setup is that as a sole proprietor (operating as in individual) that Box 7 income minus business deductions is subject to a 15.3% self-employment tax. Plus, your usual marginal income tax rate. Real estate agent profit can easily be taxes as high as 40%! This is a real downer for agents. The harder, better, smarter they work, the more they get paid. But, at the same time, the more goes into the hands of someone else.
From a tax accountant’s perspective, if you incorporate and create a strategic tax plan, you are in control.
There are two areas that I’d like to cover in this:
- Reasonable compensation in wages
- Rental agreements between you and the corporation
Reasonable compensation in wages
Corporations are not subject to the 15.3% self-employment tax on business profit mentioned above. However, per the IRS a shareholder-employee must be paid in wages a ‘reasonable salary’ or reasonable compensation’. From the IRS:
S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee. The amount of reasonable compensation will never exceed the amount received by the shareholder either directly or indirectly.
Not all profits necessarily need to be subject to the self-employment tax! If you have a team or have a good marketing strategy in place, part of the profits would be paid out to you in owner’s draws not subject to self-employment tax.
The other benefit with reasonable compensation is that throughout the year you are making Federal tax deposits. The one-time end of year hit in taxes is somewhat alleviated because you were forced to pay throughout the year.
Prospect Financial Solutions as part of our services to our clients prepares a reasonable compensation analysis and plan. We don’t want you to pay yourself too much in wages, but we also want to make sure we are following IRS guidelines in determining reasonable compensation.
Rental agreements between you and the corporation
The corporation will be using your house or apartment and your car. Perhaps other things as well. The nature of your relationship in this regard is you the employee and the corporation the employer. The employer should reimburse the employee for the use of your property. We advise our clients in these situation to enter into bona-fide agreements with their corporations.
Take a home office for example. The corporation should be paying for this office. Money would be sent from the corporation to the shareholder for use of the shareholder’s home. The idea here is to get the cash out of the corporation that is not in wages (i.e. not subject to payroll tax).
Also, the shareholder does not have to file Form 8829, Expenses for Business Use of Your Home. That’s a good thing, because the IRS can view Form 8829 as a highly suspicious form. The home office reporting would be moved to Schedule E which is by far a safer form.
Prospect Financial Solutions offers a comprehensive accounting and tax planning.