As CRE brokers, how you’re paid by your brokerage firm is often times a choice between W-2 wages or 1099 compensation. Our belief is that 1099 pay for Qualified Real Estate Agents (QREAs) is what you want to best reduce taxes and save the most for retirement. However, electing to be paid 1099 instead of W-2 is only the first of many decisions.
Being paid via 1099 can come to you personally or to an LLC that you have formed. Personally receiving compensation to your Social Security Number means you are self-employed and a Sole Proprietor. A Sole Proprietorship is not a separate legal entity. Sole Proprietorships are common because they are simple and inexpensive to establish. A Sole Proprietor will file a Schedule C on your personal tax return. When you’re a Sole Proprietor, you and the business are one and the same.
Since you’re now effectively operating as your own business you can decide to structure yourself as a Limited Liability Company (LLC). One reason for establishing an LLC is to limit your personal liability from your business activities. Doing so will require organizational documents, a Federal Employer Identification Number (FEIN) and annual registration with your State.
As an LLC you will have to transfer your real estate license to the LLC. In Florida, the name of the LLC must be some form of your legal name. For example, Mike Salmon LLC, Michael T Salmon LLC, etc. but not MTS Investments LLC. You will also have to establish the relationship with your brokerage firm and your LLC, not yourself personally.
An LLC is simply a legal structure and not a tax status. As an LLC you can elect to be taxed as a Sole Proprietor or an S-corp. Choosing S-corp status requires filling IRS Form 2253 separately or with the tax return in its first year you elect this status.
An S-corp is a pass-through entity that will require a separate tax return called an 1120S. Income or losses will flow-through to the owner of the S-corp and will be taxed on the owner’s personal tax return.
The main difference between a Sole Proprietor and an S-corp are self-employment taxes. As a Sole Proprietor, net income will be subject to self-employment tax. The self-employment tax consists of two parts: 12.4% for Social Security and 2.9% for Medicare, for a total of 15.3%.
Net income up to $142,800 in 2021 is subject to the full self-employment tax. Net income above that amount is subject to only the 2.9% Medicare tax. Because half of the self-employment tax comes from the payroll taxes of the employer, you will be able to deduct half of the tax.
The main tax benefit of an S-corp is that not all net income is subject to Social Security and Medicare taxes. These taxes will be applicable to only the salary you pay yourself as an employee. The higher your income, the greater the tax savings.
An S-corp will also allow you more flexibility with retirement plan contributions and to have a lower income requirement to make maximum contributions. Most CRE brokers will see the greatest tax savings with an S-corp.
Knowing the potential for spikes in income due to big sales that can develop during the year, an S-corp puts you in the best position to receive that income that was not on your radar in January. We can help you think through this decision any time throughout the year.
