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The S-election Tax Strategy for Real Estate Agents

Attention Real Estate Agents. You provide keys to property owners on a regular basis. Here is a key just for you. It is known as the S-election. Use it to unlock massive tax savings by eliminating self-employment tax on your commissions. Additional paperwork and expenses are involved, but the tax savings are worth it.

Real Estate Agents have two options when it comes to reporting commission income to the IRS:

  1. Use Schedule C which is included with your individual tax return. This results in self-employment tax.

  2. 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. As an example, you had $250,000 in total commissions in 2020. Check out the following charts for a comparison between making and not making the S-election.

If you make the S-election there is no self-employment tax, however you must pay ordinary income tax as well as a small amount of FICA tax. If you don’t make the S-election you must pay self-employment tax and ordinary income tax. The total tax is $12,000 less if you make the S-election. Talk about a great tax saving strategy!

The S-election creates additional expenses which lowers your profit. Lower profit means lower taxes. Don’t worry that your profit is lower because you end up with more money in your pocket at the end of the day.

In both examples you earn 250,000 of commission, however taxes and expenses are different. The following summary brings all of the numbers together.

Agent makes the S-election

Commissions earned from sales = 250,000 Business expenses = 196,000 Profit = 54,000

Your 54,000 profit only gets hit by ordinary income tax.

Self-employment tax = 0

Ordinary income tax on your profit = 8,100

But the tax story continues…

You must pay yourself a reasonable salary to qualify for the S-election. The definition of reasonable is a grey area because the IRS does not provide dollar amounts. The general guidance is you should pay yourself however much you would have to pay someone else to do your job for you. We are using 40,000 in this example.

Your 40,000 salary is hit with ordinary income tax and FICA tax (FICA stands for Federal Insurance Contributions Act and is more commonly known as Social Security and Medicare tax).

Ordinary income tax on your salary = 6,000

FICA tax on your salary = 3,000

Adding these two amounts to the ordinary income tax on your profit leads to a total tax bill of 17,100. Making the S-election saves you close to 12,000 in taxes. That is a lot of money!

It’s not free to make the S-election. You will incur the following expenses:

Reasonable salary = 40,000 Payroll tax = 3,000 (this is different from the 3,000 of FICA you pay) Payroll service = 2,400 Corporate tax return preparation = 600 (definitely leave this to a professional)

TOTAL = 46,000

These expenses lower your profit, so you owe less tax which is a good thing. Another positive is the 40,000 salary gets deposited into your personal checking account net of income tax and FICA tax.

Agent does not make the S-election

Commissions earned from sales = 250,000 Business expenses = 150,000 Profit = 100,000

Your 100,000 profit is hit with self-employment tax and ordinary income tax.

Self-employment tax = 14,000 Ordinary income tax = 15,000 Total tax = 29,000 versus the total tax of 17,100 if you make the S-election. Huge difference!

If you want to proceed with making the S-election, start by forming a Limited Liability Company (LLC) then obtain a Federal Employer Identification Number (FEIN). This is an easy process that only takes a few hours to do yourself, or you can pay a lawyer around six hundred bucks to take care of it for you (it’s worth it to pay the lawyer). Make sure the lawyer knows you plan to make the S-election.

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 it’s no big deal. Request permission with a form that you can fill out in half an hour, or you can pay a professional around two hundred bucks to take care of it for you (it’s worth it to pay the professional).

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. Use QuickBooks Online Payroll to take care of your payroll needs.

Now everything is setup and ready to go. Moving forward the LLC files an annual Form 1120-S tax return that reports your commission income and related expenses. Information from that tax return flows to your individual Form 1040 tax return where income tax is calculated. The LLC does not pay income tax. That falls on your shoulders.

The S-election is a great tax strategy for real estate agents. Contact us now for more details.

JWTW Industries L.L.C. 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. Please make an appointment with us soon to discuss your particular circumstances.

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