Realtors are for the most part, treated as self-employed individuals for purposes of taxation. Some realtors are direct employees of a company who takes out of their paycheck. If you are in this family of realtors that has a regular paycheck with taxes taken out, under the current rules of the tax code, sadly this information will be largely invalid for you.
When reporting self-employed earnings on your tax return it is generally most preferable that you utilize form Schedule C as part of the whole tax return. This will allow you to report the gross earnings and subtract deductions directly against that income which will help mitigate both federal taxes and the additional self-employment tax – double effective deductions are great (you are only taxed on the net). They do not however, make things ‘free’. If you can only commit to memory one thing from everything contained here – please make this next thing that one: Do not fall into the trap of thinking that just because you can write it off, it makes it free.
We all have different reasons for working, but I would humbly submit that generally the large majority of us work so that we can pay bills, eat, and have funds to do fun things. To that end, the most important part of your earnings is what is left in the bank after everything is said and done (both expenses and taxes). If you make $20,000.00 in commissions and spend $20,000.00 in expenses – theoretically you would have to pay ZERO taxes on your commissions. What a steal! (sarcasm). I know the example is extreme, but many go to extra lengths to do things to write it off.
“I have to buy X amount of things so I can write it off on my taxes.” If you make 20, and spend 20… What is left in the bank for the bills and the fun? Nothing. Ok, so you don’t spend everything you make on items that you can deduct on your commissions (we sure spent it on something else, but we can’t write it off against our real estate commissions). That means we have net earnings, meaning there are some taxes that will be added to our total tax return – owing taxes or not is unique to everyone’s individual circumstances, what is fact however – is that your total tax obligation will increase with positive net earnings.
The advice that I would give is that while realty expenses do help lower your taxes, you want to maximize your earnings with as little expenses as possible. It does take money to make money, I am not trying to counter that statement. I am talking in the grand picture of maintaining total revenue, while looking at what is spent to get that revenue and seeing what can be cut out or reduced. Increasing your profit, does increase your tax, but in the end, it increases how much money is left in the bank. Say I make $10,000.00 and spend $6,000.00 in expenses, I would have $4,000.00 in profit. That $4,000.00 in profit I pay tax on and lets just pretend it is a clean 30%. I increase my tax obligation by $1,200.00 thus I have $2,800.00 left in the bank for bills and other things. Conversely, if I make $10,000 and have $4,000.00 in expenses, I now pay tax on $6,000.00 which the tax is $1,800.00 and I keep $4,200.00 in the bank. You did pay more tax, but you have a lot more left over for you. I would be bad at my job if I advised you to spend $10.00 to save $3.00 in taxes. Keep the $10.00, pay the $3.00 in tax – and you have more money in the bank. That is the whole purpose in working in the first place!
Ok, now that we aren’t just buying things on the whim of ‘tax savings’ and only spending what it takes to land the sale and keep the clients – we look at other things. Retirement. I’m certain you have all heard of an IRA. There is more than 1 kind of IRA. Traditional and Roth are the most common IRA’s people talk about and read about. As a self-employed individual, you have access to yet a different kind of IRA: a SEP IRA. This kind of IRA allows you to put a portion of your net earnings away for retirement and take a deduction. Sadly, it does not affect the self-employment additionally tax, but it does mitigate the federal taxes. This has a direct correlation with our keeping our net earnings higher, because it allows you to put more away into retirement if you are able. SEP IRA contributions do not have the same limitation as Roth or Traditional – it is possible to put up to $56,000.00 (for 2019, it goes up a little every year typically) per year into the account. That means your earnings have to be really high as you can only set aside 25% of the net earnings, but that is quite the ability to put away into retirement!
If your profit is high enough – please consult with a tax professional to see if you are or aren’t – then opening an S-corp is sometimes an option. This is sort of a tricky one as everyone’s broker handles this differently. What you need to ask is if your broker will issue your commission checks and tax form to your S-corp instead of you. If you need to go through all kinds of hoops and set up a 3rd broker to make it all happen, it might not be worth the hassle and the cost. But if you can… being an S-corp can have a modest, positive impact to your total taxes. It is a lot more paperwork and cost per year, but the tax savings can more than make up for it. This is one that takes some planning and research beforehand and will not work for everyone, but it is worth the time to at least ask and explore the option to see if you can benefit from it.
Estimated (quarterly) taxes. This one is tricky because everyone’s situation is so wildly unique. Generally, if you have taxes due on your tax return (as in have to send in money to the IRS after filing your taxes) year after year – you should consider paying extra taxes quarterly. This is done via the form 1040-ES estimated tax voucher (can be done online too). The IRS says they are mandatory – and technically they are, but if you do not do them, then what? Owing year after year, the IRS looks at your tax obligation from last year, and what you paid in during the current year. In simplicity, if there is more than a $1,000.00 imbalance, you will pay a penalty for not paying enough in during the year. However, the penalty is arguably a very small number. If you have only the patience to pick one, keep track of your expenses and receipts or make estimated tax payments . Then keep track of your expenses and receipts as it will save you more in the long run. Estimated (quarterly) tax payments are something I would advise and suggest doing after you get a good routine for the admin side of your business. I do offer one thought for those that just want to rip off the band-aid and do all the things at once. Between 10% and 20% is a good place to start when setting aside money for paying taxes. It may end up needing to be more with more earnings, but it is a good starting place. Set up a separate bank account, every commission – put your 10-20% in that account… And each quarter (just close your eyes) send half of what is in that account. You still have an emergency fund, but you will have sent in something. It will help lower the penalty and help lower the size of the check you have to send in April. It isn’t a perfect solution, but it is a good starter situation. After a year or two of this, with the help of a tax professional, you can better determine the right percent to set aside, and what each quarterly check could and should be.
Income high and expenses low: Check
Contribute to retirement: Check
Explore if S-Corp is right for me or not: Check
Quarterly payment consideration: Check
We can help solve your tax headaches at Molen and Associates. Give us a call to schedule an appointment with one of our tax advisors so we can get you on the right track.
Senior Tax Advisor