Real Estate Professionals Must Consider S-election To Save Big on Taxes
Attention Real Estate Agents. You hand out keys to property owners on a regular basis, well here is a key just for you. It is known as the S-election. Use it to unlock massive savings by eliminating Self-Employment tax on your commissions. Additional paperwork and expenses are involved, but the tax savings far exceed the inconvenience and costs.
Real Estate Agents have two options when it comes to reporting commission income to the IRS:
- Use Schedule C which is included with your individual tax return. This results in Self-Employment tax.
- Use Form 1120-S which is a separate tax return from your individual return. This eliminates Self-Employment tax.
The choice you make will drastically affect your tax bill. I want you to choose the second option because the numbers make sense, however we need to discuss the additional steps required to make it happen.
The first step is to form a Limited Liability Company (LLC) and obtain an Employer Identification Number. This is an easy process that only takes a few hours. The next step is to make the S-election by filing paperwork with the IRS. You must get their permission to make the S-election, but almost everyone gets approved so no big deal. The final step is adding you to the LLC’s payroll because one of the conditions of maintaining S-election is you must be paid a reasonable salary. One quick aside about payroll. Both you and the LLC must pay Social Security and Medicare tax on your salary, but only the company portion is tax deductible. The company portion is known as payroll tax.
Now everything is setup and ready to go. Moving forward the LLC files an annual Form 1120-S tax return to report commission income and related expenses. Information from the tax return flows to your individual return where income tax is calculated. The LLC does not pay income tax. That falls on your shoulders.
Check out the following two examples to see the tax savings of making the S-election. In both examples the Real Estate Agent earns 250,000 of commission and has 150,000 of business expenses resulting in a profit of 100,000.
Agent does not make the S-election
Commissions earned from sales = 250,000
Business expenses = 150,000
Profit = 100,000
Profit is subjected to both Self-Employment tax and ordinary income tax.
Self-Employment tax = 14,000
Ordinary income tax = 0 to 37,000 depending on your tax bracket
Maximum total tax = 51,000
Agent makes the S-election
Commissions earned from sales = 250,000
Business expenses = 150,000
Profit = 100,000
Now for the changes:
Self-Employment tax is 0 leading to an immediate savings of 14,000. Off to a good start!
Profit is still subjected to ordinary income tax, but we must update the profit to account for the following annual expenses that come into play once the S-election has been made.
Reasonable salary = 40,000
Payroll tax = 3,000
Payroll service (Paychex / Quick Books Online, etc.) = 2,400
Corporate tax return = 600
Profit before annual expenses = 100,000
Total of annual expenses = 46,000
Profit after annual expenses = 54,000
Ordinary income tax on the profit = 0 to 20,000 depending on your tax bracket
Ordinary income tax on the salary = 0 to 15,000 depending on your tax bracket
Agent’s share of Social Security and Medicare = 3,000
Maximum total tax = 38,000
Maximum tax from the first example = 51,000
Maximum tax from the second example = 38,000
Potential tax savings = 13,000
13,000 of annual savings is a staggering amount. Instead of wasting it on taxes you can fund a retirement plan, invest more in your business or spend it however you see fit. Contact Joe Wright CPA today for a free consultation.
Joe Wright CPA PLLC provides the information in this blog as a general guide. Tax laws are extremely complex, and every taxpayer is unique. Some or all of this information may or may not apply to you. We provide simplified situations to clarify some of the major aspects and highlights of the topic at hand. Some of the language used is casual and may be misconstrued. Make an appointment with us soon to discuss your particular circumstances.