According to the Internal Revenue Service, most licensed real estate agents operate their business as a sole proprietorship. This means they have not formed a partnership with other agents, or created a corporation or limited liability company to operate their business. 

Many other real estate agents operate through a limited liability company owned exclusively by a single agent. These single-owner entities are often called Single Member LLCs. The owner of a Single Member LLC reports the company’s sales commissions and related business expenses directly on his or her own tax return. For income tax purposes, the owner is treated as a self-employed sole proprietor. 
 
1. MAKE YOUR ESTIMATED TAX PAYMENTS
The failure to make estimated tax payments is one of the biggest tax mistakes made by many Realtors®. Real estate agents operating as sole proprietors directly or as owners of Single Member LLCs are classified as statutory non-employees and are treated by the IRS as self-employed. Self-employed individuals must report their income and expenses on their tax returns, pay the IRS quarterly estimated tax payments, and pay their own Social Security and Medicare taxes. 

Unlike the typical employer-employee relationship, a real estate broker does not withhold the agent’s share of income, Social Security, or Medicare taxes from commissions, and does not make “employer” contributions of Social Security or Medicare taxes. As a result, on top of income tax, a self-employed real estate agent must pay both the employer and employee’s share of Social Security and Medicare taxes, equaling 15.3 percent of net taxable income. This extra federal tax burden does not include the agent’s state tax liability.

“The large penalties and accumulating compound interest accruals related to tax delinquencies make it imperative for the self-employed agent to budget for and make quarterly estimated tax payments.”

Commonly, a real estate agent’s uneven income and substantial Social Security and Medicare tax liabilities will result in the underpayment or non-payment of estimated taxes. The failure to pay quarterly estimated taxes often becomes a precursor for a real estate agent to under-pay, or simply not pay, the agent’s yearly income tax liability due on April 15 each year. Although it takes 48 months for the “failure to pay” penalty to reach its 25 percent maximum of the unpaid tax liability, the “failure to file” penalty reaches its 25 percent maximum within five months of the tax return due date. 

The large penalties and accumulating compound interest accruals related to tax delinquencies make it imperative for the self-employed agent to budget for and make quarterly estimated tax payments.

2. CONSIDER USING A SUBCHAPTER S CORPORATION
A Subchapter S Corporation is often a useful tool to manage the payment of estimated tax obligations. It can also be helpful for tax planning and to maximize an agent’s tax deductions. The typical employee receives a regular weekly, monthly, or bi-monthly net paycheck, after employer deductions for tax withholding. The typical employee is forced to develop a personal expense budget based on the employee’s pay schedule and net paycheck.

 On the other hand, real estate agents generally receive gross commission payments made on an irregular schedule and in uneven amounts. The agent must balance these irregular receipts against obligations for tax liabilities, business expenses, and personal living expenses. This is often not easy.  

One way for a real estate agent to improve the budgeting and tax withholding process is the use of a Subchapter S Corporation. This structure can be used to convert the agent from a self-employed taxpayer into an employee receiving a net paycheck. Although the net income of a Subchapter S Corporation flows through to a Sub S Corporation’s shareholder, the company is not disregarded for payroll and certain other purposes. 

Unlike a sole proprietorship or Single Member LLC, a Sub S Corporation can pay wages to its shareholder, noted here as the agent, and issue a “net” paycheck after income, Social Security, and Medicare taxes have been withheld and paid over to the IRS. In order to be most effective, this structure often provides for the agent’s broker to pay the agent’s commissions to a third-party recipient, often the company’s accountant or payroll provider.  That third-party will withhold and pay  taxes to the IRS based on the agent’s commissions earned during the pay period, and issue a “net” paycheck to the agent.  

In addition to its tax withholding and budgeting advantages, a Subchapter S Corp can also be used minimize the agent’s employment tax expense. For example, the corporation can divide its profit between salary and dividends paid to its agent. Although the real estate agent will pay income tax on the company’s entire net profit,  (self) employment tax will only be payable on the agent’s salary, not on the dividends paid to the agent. This can result in a significant employment tax savings to the agent and to the company. 

With proper planning, the Sub S Corp can be used to pay and deduct other legitimate business expenses. For example, it may be possible to pay family members deductible wages to perform services for the real estate business of the Sub S Corp. In some cases, the family member (often a spouse) can be the beneficiary of a medical reimbursement plan set up by the Sub S Corp that is tax deductible for the corporation (reducing the net profit reportable by the shareholder) and not subject to the adjusted gross income limitations ordinarily applicable to an individual’s medical expense deduction. The taxation and use of a Subchapter S Corp is often complex, and an agent considering its use should consult with a qualified tax professional. 

"...[Accurately] tracking income, payables, expenses, cash flow and profitability is the only way for a real estate agent to measure financial performance and properly budget for tax, business and personal expenses."

3. SET UP A TAX-DEDUCTIBLE RETIREMENT PLAN 
Every real estate agent should set up a tax-advantaged retirement plan. An agent, whether doing business as a sole proprietor, partnership, limited liability company, or corporation, can choose from a broad array of tax advantaged plans that will provide current tax deductions and allow tax-deferred savings growth. These plans have varying compliance and reporting requirements, and allow for different contribution deadlines. For example, the traditional Independent Retirement Account (IRA) contributions are generally due by April 15, the original return deadline. 

Other more complex plans permit contributions up to Oct. 15 or later. Choice of the proper retirement plan involves a variety of factors, including the agent’s expected income level, whether the agent is operating as a sole proprietor or through an entity, whether the agent or entity has other employees, and the agent’s personal tax and financial requirements. A qualified retirement plan professional should be consulted.. 

4. CAPTURE DEDUCTIONS AND KEEP ADEQUATE RECORDS
A Realtor’s® day is filled with listings, property tours, clients, marketing, and other activities. It is not surprising that the hectic pace makes it difficult to keep records and receipts for business mileage and car expenses, marketing and promotion costs, entertainment and meal expenses, business supplies, insurance costs, and other expenditures. However, accurately tracking income, payables, expenses, cash flow and profitability is the only way for a real estate agent to measure financial performance and properly budget for tax, business and personal expenses. Also, maintaining expense receipts and documentation becomes more critical if a tax auditor knocks at the door. 

Fortunately, Smartphones have made the task of tracking and maintaining receipts and records easier than ever before. A number of excellent mobile Apps have been created that can easily and accurately track and record an agent’s mileage and expenses. In some cases, the mobile device can be used to scan receipts directly into the App for easy, real-time record keeping.  Many of these Apps even create real-time expense reports and financial statements.

5. FILE ACCURATE, HONEST TAX RETURNS
Most importantly, agents must prepare and file tax returns with the same level of professionalism, ethics and honesty that are used to conduct a real estate business. Do not play the “audit lottery” by intentionally under-reporting income or over-stating deductions.

According to the Annual Data Book published by the IRS, audit rates have decreased by 13 percent over the last four years. 
However,  the amount of revenue recovered has grown by more than 20 percent. The IRS still pays special attention to tax returns filed by small business and self-employed (SB/SE) taxpayers, the status of almost all real estate agents. The IRS is using sophisticated information technology and software tools to identify and target SB/SE returns that appear to substantially under-report income or overstate business deductions. 

The consequences of an audit can be severe, including the assessment of large fraud penalties, and in the most egregious cases, criminal prosecution. 

Michael S. Fried is a Founding Member of Fried & Rosefelt, LLC, a law firm that concentrates on resolving federal and state tax issues.