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How real estate agents can save taxes, legally and ethically.

Every real estate agent starting on their own automatically becomes a sole proprietorship. You probably already know that according to the IRS, licensed real estate agents are statutory nonemployees and are treated as self-employed for all Federal tax purposes, including income and employment taxes.

In fact a sole proprietorship is the most common type of small business entity in the US. You are the self employed owner (a one person company), so there are no legal formalities involved when you operate your business.

Nor do you have any legal obligations to report your financial information apart from reporting your profits to the IRS and paying taxes on them. However, you are on the hook for business liabilities (losses, law suits etc.).

In this article we will look at and examine two different scenarios – one where agent Mary declares her self employed income and the other where Mary creates a Corporation and saves a bunch of cash …

Here is a quick rundown on the advantages and disadvantages of the most popular business types that most real estate agents could consider using:

Business TypeUnique advantagesTaxation & ProtectionsDrawbacks
Sole proprietorshipVery easy setup.
No paperwork apart from a DBA if needed (see footnote).
One owner.
You ARE on the hook for business liabilities.
Taxed just once—you pay on profits on your personal tax return
Separate tax return not needed.
No personal liability protection
LLCBetter for flexibility in how you manage and run your business.
A board of directors not a requirement.
Unlimited owners allowed
You are NOT personally liable for business liabilities.
LLC’s are taxed once or twice; you get to choose which can help minimize your taxes.
A commitment to ongoing filings and fees in order to stay compliant.
S CorpBetter for smaller corporations.
A total of 100 shareholders maximum.
The owners only get common stock (with voting rights).
You are NOT personally on the hook for business liabilities.
Taxed just once – shareholders must pay on profits received.
A commitment to ongoing filings and fees in order to stay compliant.
Must have a board of directors along with strict rules – holding meetings and keeping records.
Every shareholder must be U.S. citizen or resident.
If you plan on using a business name that’s different from your personal name you are
required to get a DBA (doing business as) in most states or counties.

The tax advantages of forming a Corporation:

How real estate agents can save taxes? Many Realtors are unaware of the tax advantages of forming a company. Becoming an employee of your own S Corp, means that you do not have to pay self employment tax on profits – potentially saving yourself thousands of dollars in taxes each and every year.

Say What? How Much? How does this work?

Whatever Brokerage you work for will pay you your commission splits and then send you a Form 1099-Misc, reporting gross commissions in Box 7 Non-employee Compensation.

If you operate as a sole proprietor then your Box 7 income minus business deductions is subject to a 15.3% self-employment tax (12.4% for social security and 2.9% for medicare). You will also pay your usual marginal income tax rate.

Taxes on your profits can easily be as high as 40%! Ouch! In practice it work like this:

Mary’s commission splits add up to $100,000.

Her gross income is $100,000 paid directly to her by her Broker and reported on a 1099.

Her expenses add up to $20,000.

Her net profit is $80,000.

If Mary operates as a sole proprietor, she will pay self employment tax at the rate of 15.3% X $80,000 = $12,240 PLUS her marginal rate of Federal tax and if applicable, State taxes.

That’s paying $12,240 in just self employment taxes 🙁

Note: You will have to pay Social Security and Medicare taxes to the government whether you’re self-employed or an employee, When you are employed by someone else, you are only responsible for a portion of those taxes, your employer is responsible for the balance. If you are self-employed, you have to pay both portions of this tax. The combined employee and employer portion normally amounts to 15.3%.

Now may be the time to treat your real estate activities as a business.

If you start operating as a S Corp you are not subject to the 15.3% self-employment tax on business profits. There is a proviso – 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.

Creating an S Corp will save taxes:

The main benefit of an S Corp is it’s ability to legally and ethically reduce Self-Employment Tax, also referred to as FICA, (Medicare and Social Security taxes) which total 15.3%.  This is exactly how real estate agents can save taxes.

The reason accountants generally like S corporations is because this avoids a portion of self-employment taxes and because an S Corp doesn’t pay corporate income taxes. The real estate agent who forms an S corporation therefore avoids double taxation.

Let’s get back to Mary again and offer another scenario:

Mary forms an S Corp; Mary Agent Inc.

Mary becomes an employee of Mary Agent Inc. for her services performed selling real estate. Her Broker starts paying her commission splits to Mary Agent Inc.

At the end of the year she gets a W2 for her salary from Mary Agent Inc. Any profits after her salary and expenses (car, mls dues, advertising, transaction costs etc.) will then “pass through” to Mary’s personal tax return in what’s known as a “shareholder distribution” reported to the IRS on Form K1 (which is a  IRS document used to report the income, losses, and dividends of a business).

Let’s do the math again:

Her Broker pays Mary Agent Inc a total of $100,000

Mary Agent Inc pays Mary a salary of $40,000 and she pays both employer and employee taxes reported on a W2. Note that wages are subject to payroll taxes which equate to 15.3%. 

Mary Agent Inc expenses still add up to $20,000, but now you can add W2 taxes paid to an employee – in this case $6,120. Total expenses are now $26,120.

Mary Agent Inc is considered a flow-through entity, so the corporations net income of $33,880 is reported on IRS Form K-1.

Mary then reports the Schedule K-1 income on her personal tax return which is taxed as ordinary income and not subject to self employment tax.

In this example Mary did not have to pay self employment tax on profits of $33,880 X 15.3%:

The tax saving here are $5,183 or 5% of gross commissions!

It only makes sense to register an S Corp status if you will save on taxes. First identify a reasonable salary for someone with your job description. If any profit remains after paying yourself, then it is more than likely worth looking into forming an S Corp. 

How real estate agents can save taxes by forming an S Corp:

Decide for yourself whether to form an S Corp – this interactive forms entries in bold/red are editable – so add your own figures:

Tax savings calculator

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If the savings are at least $2,000 its worth forming an S Corp.

There are various ways available to legally form an S Corp – one of those is to use a formation service such as LegalZoom, which also has a ton of how too’s and advice, to get you on the right track.

Other advantages – rental agreements between you (the employee) and your Corporation.

Let’s take a home office for an example. The corporation pays it’s shareholder (you) for use of the home office. That way you get cash out of the corporation other than wages that are not subject to payroll tax!

Same advise goes for vehicles. Just make sure that you enter into bona-fide agreements with your corporation.

Check with your state’s real estate commission and your broker.

To receive commissions into a corporation you should check to see if the are any restrictions or other requirements. Some states require the agent to have their own broker’s license and/or be an associate broker, and some have mandated that a professional limited liability company (PLLC) is formed in lieu of the LLC. 

Bare in mind that an S Corp has both start-up and ongoing legal and accounting costs. There are also additional fees and taxes in some states, in California for example an S Corp must pay tax of 1.5 percent on its income with a minimum annual amount of $800. Check with your State’s Tax Board for more information.

If you really want to dig deep into this subject of how real estate agents can save taxes, we recommend CPA Mike Pipers book – LLC vs. S-Corp vs. C-Corp: Explained in 100 Pages or Less – available on Amazon

Worth watching:

The Difference Between an LLC and S Corp | Mark J Kohler

Mark is both a CPA and an attorney. He does an excellent job of explaining why all small businesses should be run under the umbrella of an S Corp.

Originally published 2/2/2021

The information and advice offered here does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this site are for general informational purposes only. Every circumstance is different – you should seek advice from an attorney or tax specialist before making legal and tax related decisions.