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According to the Internal Revenue Code, real estate agents are considered Statutory-Nonemployees. Commission paid Real Estate Agents are self-employed – independent contractors in business for themselves. Instead of receiving Form W2 from their broker each year, commission-paid agents receive Form 1099-MISC reporting their earnings in Box 7, Self-Employment Income. Self-employment income is generally not subject to withholdings by their broker. Instead, each agent is responsible for paying their own taxes.
What is Self-Employment Income? Self-employment income is the revenue a business owner earns from their business. If the business owner is a sole proprietor, as are the vast majority of real estate agents, this revenue is reported on Schedule C, Line 1, as Gross Receipts (Note: All income earned for the business should be included in Gross Receipts, whether a 1099-MISC is received or not). After deducting allowable expenses, any remaining profit, called Net Profit, is subject to Self-Employment Tax.
What is the Self-Employment Tax? Self-Employment Tax is the FICA tax paid by those who are self-employed. FICA is an acronym standing for Federal Insurance Contribution Act. FICA was first passed in 1935 and established the funding used to fund Social Security and Medicare. FICA tax has two components: 12.4% for Social Security and 2.9% for Medicare. The FICA tax rate is 15.3% of earnings up to $132,900 (for 2019 – The social security tax limit that changes nearly every year) and 2.9% for income above this threshold.
Employees and their employers split the FICA tax. Half is withheld from the Employee’s pay (6.2% Social Security and 1.45% Medicare). Employers pay the other half. (Note: when the employees pay for the year surpasses $200,000 and additional .9%, a Medicare surcharge created by the Affordable Care Act, is withheld from the employee’s pay.)
Self-Employment Tax is the business owner’s version of the employee FICA Tax, with three primary differences. First, the self-employed have no paychecks from which to withhold taxes. Second, they do not have employers to pay half of the tax. Finally, the duty is called Self-Employment Tax by the IRS, not FICA tax. Because the self-employed are technically their own employers, they must pay the entirety of this FICA/Self-Employment Tax, all 15.3% of their net business profit (up to $132,900 & 2.9% thereafter).
The Cost of Self-Employment Tax: After calculating net profit, business owners are allowed to trim off 7.65% as a somewhat confusing deduction representing the employer’s share of the tax. After this 7.65% trim, there are no deductions that will reduce self-employment tax, meaning that 92.35% of your self-employed profit is subject to the levy. The result: Self-Employment Tax effective rate is 14.13% (15.3% * 92.35%) of business profit, and it’s the most significant tax paid by most real estate agents and business owners. For each $10,000 your business earns you owe $1,413 in Self-Employment Tax until it reaches $18,778 on $132,900 of profit (after which you will only owe the Medicare portion of the tax). Moreover, this is only Self-Employment Tax; you must also pay federal and state income tax on the same profit!
Self-Employment Tax Challenge #1 – Discipline: The cost of self-employment tax poses two primary challenges for Real Estate Agents and business owners. First, owners must develop the discipline to save and pay their taxes. An employee receiving a W2 has all taxes; FICA, federal income tax, and state income tax removed from their pay before they receive it.
Taking employees out of the loop by forcing employers to withhold their taxes was a shrewdly devious move on the part of our government. Employees can’t spend money they never receive! Even more so – and this is the devious part – by withholding taxes, the government psychologically separate employees from their hard-earned dollars. Employees don’t physically pay their tax bill (they don’t even receive an invoice) for services provided by their government. The separation makes it far less like they will question the price they pay or the quality of service received.
Self-employed individuals, however, don’t have the luxury of having taxes withheld. They are fully aware of how much they owe in tax and must develop the discipline to not spend that money. One of the easiest ways to avoid spending Uncle Sam’s money by placing a percentage of earnings into a checking or savings account used ONLY for taxes. For most real estate agents, I recommend segregating a minimum of 25% of each commission check into this account. From this account, you will want to make quarterly estimated tax payments to the IRS and your respective state. If you’re a super-successful agent or live in a two-earner household, your percentage may need to be higher, but, the 25% minimum will avoid the financial devastation of those who are not prepared. Agents who develop this fiscal discipline prevent such catastrophe. Many even receive refunds large enough for a family vacation!
Self-Employment Tax Challenge #2 - Minimization: The more significant and rewarding challenge facing self-employed real estate agents is this: Learning how to pay less tax! The only way to minimize self-employment and income tax is by making sure you take every deduction to which you are legally entitled. Cutting realtor taxes is why we created the Real Estate Agent Tax Cut Library. The Real Estate Agent Tax Cut Library includes over eight hours of video broken into twenty-nine searchable volumes. The library covers every possible deduction a Real Estate Agent can take on their tax return. We invite you to check out Real Estate Agent Tax Cut library and to browse our courses.
All courses and articles are for informational purposes only and do not constitute tax advice. Taxes are complicated - do not act on course information without consulting a professional. Always refer to treasury regulation before making any tax decision. Read the full disclaimer.
This course package is thorough and will give you a solid handle on how to optimize your business expenses to minimize your taxes and keep appropriate records to handle any IRS challenges. Only want to dive into a particular topic? Jump to that video and scan forward to where your issue is addressed. Or watch the whole series to learn it all!- Josh, Charles Town, WV, Real Estate Agent Tax-Cut Library, Agent Edition Course
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