3 specific things real estate agents should do to lower their taxes.
If you're a real estate agent here in California, I want to give you some really practical tips that'll help you mitigate your taxes and keep more of what you can earn. Real estate agents often end up overpaying in taxes because they don't get proactive, aggressive tax planning from a tax expert like ourselves.
Here at Proficient Tax and Accounting, we not only help you with your year-end tax returns and compliance, we help you get perfect bookkeeping throughout the year, and help you work aggressively to reduce your taxes with tax reduction planning.
If you could do only three things to reduce your taxes as a real estate agent or realtor, these are three of the best tips that you can get here in 2022.
When you first start out as a real estate agent, you are taxed as a sole proprietorship rather than an S corporation or a C Corp.
You'll like how you're taxed as an S-Corp vs. an LLC, but I'm not going to spend a ton of time on this. You should know that in a sole proprietorship, all of your income is subject to Medicare tax and everything that you make under the Social Security limit will be subject to a 12.4% social security tax.
Before you pay California state tax, franchise tax, or federal income tax, you are paying Social Security and Medicare taxes.
One of the best ways that you can potentially reduce your taxes and get a myriad of other benefits is to consider converting from a Sole Proprietorship into a S Corporation.
It's always a good idea to set up a LLC for your California base small business, but you need to know that there is additional filing and paperwork you’d need to do in order to setup an S-Corporation.
If you are currently set up as a Sole Proprietorship, you can often file a 2553 form to convert into an S-Corporation.
In short, rather than having all of your income subject to the self-employment taxes of 15.3%, your corporation will pay you a salary and you will then earn dividends or distributions as the owner of the corporation.
Within an S-Corporation, the corporation must pay you as the owner a salary for the work that you do. This salary is subject to self-employment taxes which is the 2.8% Medicare tax and the 12.4% Social Security tax.
It's important to know that all income above the Social Security limit is not subject to additional Social Security taxes, but it is subject to Medicare taxes. Not only that, but you will experience even more Medicare taxation as your income increases.
S-Corporation owner salaries are subject to the self-employment taxes, but the owners distribution is not subject to the self-employment taxes.
The owners distribution avoids the Medicare and Social Security taxes which means you avoid a 15.3% taxation.
Since your owners distribution is not subject to the self employment taxes, you stand to potentially save a ton in taxes if you convert to an S-Corp. But why would a realtor take any salary? Why not just take a zero salary or payroll? Do I have to take a salary?
You must take a salary, and the salary must be reasonable according to your participation in the business and how that participation is valued across the industry.
Long story short, many real estate agents will save thousands or even tens of thousands in Social Security and Medicare taxes when they convert from a Sole Proprietorship into an S Corporation.
The government wants people to save for retirement, and it wants corporations and businesses to help people save. Because it wants people to save, it provides tax benefits for small businesses and large alike to contribute to retirement plans.
One of the best ways a real estate agent can save in taxes is to utilize a small business retirement plan such as a SEP IRA or a 401(k). I'll keep this short because it's kind of boring, but you'll want to take close inventory of the rules and regulations, particularly if you have employees.
When you have statutory employees, which are employees that are full-time and non-family members or shareholders, you will be subject to non-discriminatory rules.
Long story short, you will have to provide similar benefits to your employees as much as you do to your ownership and officers.
If you don't have any statutory employees, a solo 401(k) or an individual K is an excellent investment vehicle which you can do quite a bit with. You might want to contact Schwab or Vanguard and talk to them about their low fee, inexpensive, and easy to set up solo 401(k)s.
Why are these retirement plan such a good tax reduction tools for real estate agents?
You can make an employee and an employer contribution to these retirement plans.
Remember when you worked for another corporation and you had matching contributions from your employer? Well those contributions are called employer contributions and they are incredibly tax efficient. In a solo 401(k) you will be able to contribute up to 25%, not to exceed $61,000, of your S Corp. salary or your net income from your schedule C.
The rules can change every year, but essentially your business can make a giant contribution into your retirement plan and it will be a direct write off on your business, essentially avoiding self-employment taxes and growing tax deferred until you withdraw in retirement.
If you want to lower your taxes, you should consider setting up a SEP IRA or simple IRA if you don't have any employees, and for those that do have employees, you might want to look into a simple IRA.
Did you know that you can hire your minor kids to participate in your business at a very young age as long as they're actually doing legitimate work and being paid in a formal agreement?
If you are a Sole Proprietorship, you will be able to pay your children in a very tax advantaged way and take advantage of some special family owned business tax benefits. In summary, there are provisions for disregarded entities to hire their minor children and the income that they would earn can potentially be free from Social Security taxes and Medicare taxes.
If you are set up as an S-Corporation, you will not get the benefit since you are not a disregarded entity, but there are still advantages to hiring your children.
Besides the special family business tax considerations, most children are in a very low tax situation because they get a large standard deduction and minimal tax rates on the first $40,000 or so of income. By hiring your kids in a legitimate manner and paying them within real market rates and keeping good records, you might be able to shift income out of your very high tax bracket and into their own.
Besides being able to teach them about your business and get them working, they can also start saving into retirement plans such as IRA’s and Roth IRA’s.
So if you want to lower your taxes as a real estate agent, you should consider setting up and maximizing an S-Corp, tapping into small business retirement plans and potentially hiring your children.
