Most CRE brokers are independent contractors. Therefore, when you are paid via 1099, you have the choice to receive that income personally to your Social Security Number as a Sole Proprietor. Or you can form an entity to be taxed as an S Corporation and have your brokerage firm pay your entity’s Employer Identification Number (EIN).
Every state has a different requirement for what type of entity can be used in real estate sales and brokerage. The most common structure is a Limited Liability Company (LLC). The process for establishing the entity, electing S Corporation tax status and notifying your brokerage firm of the change can take several days to several weeks.
Some states require the entity to hold a real estate license, so you may have to transfer your license with the state, which can slow down the process. In addition, notifying your brokerage firm of the change and having the firm switch your pay to the entity can often take the longest in this process.
Some CRE brokers have heard they should be set up as an S Corp from colleagues, and others have read our content preaching the same thing. So not everyone is in a rush to make this transition before their next commission comes in.
Because the change at the brokerage firm can take longer than you’d expect, sometimes you’ve received several commissions while waiting for them to begin paying your entity’s EIN. Don’t worry about the delays. You can reallocate that income to your entity on your tax returns.
By January of the following year, your brokerage firm will send you two Forms 1099. One will report the income paid to you personally, and the other reporting income paid to your entity. If you had delays in the brokerage firm adopting your new entity, then the amounts reported on each form are not what you intended.
For example, you earned $300k last year. Your brokerage firm reported $200k paid to you personally and $100k paid to your entity. But you actually earned $150k before the entity was formed and another $150k after the entity was formed. Without realizing this, your accountant will report $200k to you as a Sole Proprietor and $100k to your S Corp.
That is correct, but you won’t stop there. Instead, you will “expense” $50k from Schedule C of your personal tax return, where your Sole Proprietor income is reported, and show additional income on your S Corp’s tax return in the amount of that $50k. This is because you’ve now reallocated the $50k that should have been paid to the S Corp, but your brokerage firm was delayed in processing the change. Your accountant won’t know to do this unless you make them aware of the situation.
The income you intend to reallocate on your tax returns must be transferred from your personal checking account to your business account. Therefore, it is best to move those funds soon after receiving the income and leave at least that amount of cash balance in the business account on December 31.
Don’t let delays during the entity formation process unnecessarily cost you taxes. With proper guidance, you can mitigate issues that arise.
