Estimated Taxes For Real Estate Agents

Estimated Taxes for Real Estate Agents

Did you know that if you’re a self-employed individual, you must pay estimated taxes on your income?  As a real estate agent, this is a very important issue, especially if you aren’t a salaried individual, who might have taxes withheld by an employer.  While mastering this topic isn’t going to make your business bring in more revenue or become more effective, ignoring it completely can result in an IRS letter which can interrupt you at an inconvenient time or worse, severely disrupt your cash flow if you end up owing for back taxes, penalties, and interest.  This article aims to help you conceptualize estimated taxes so that you can:

  • Why you need to understand estimated taxes
  • Understand exceptions that may apply to real estate agents
  • Figure out how to budget for and systematize estimated taxes
  • Determine whether this is something you might want to automate by hiring out or do yourself

Why do I need to know about estimated taxes? 

Let’s talk about why this matters.  According to the IRS, “estimated tax is the method used to pay tax on income that is not subject to withholding.”  If you are a sole proprietor, partner, S-corporation shareholder, or self-employed individual, the IRS requires you to pay estimated taxes if you expect to owe $1,000 or more when you file your return.  Assuming that your tax year corresponds with the calendar year (like individual tax returns do), the IRS requires estimated taxes to be paid on a quarterly schedule with payments due on:

  • April 15
  • June 15
  • September 15
  • January 15 (of the following year)

If the IRS determines that you did not pay enough in estimated taxes, then it may assess you an underpayment penalty.  The IRS will also charge you interest until the owed amount is paid in full.

Exceptions to the estimated tax withholding mandate.  

There are times where you may be exempt from penalties for not having paid estimated taxes.  Since one or more of these situations might apply to you as a real estate agent, especially if you’re starting out, let’s take a quick look at the exceptions:

  • If you didn’t pay any taxes in the previous year. For example, perhaps you just graduated college, turned 18, or you’re just starting out, and your income was low enough that you didn’t have a tax liability.  Note:  if you’re married, you should take your spouse’s income into account when figuring out how low your income is.
  • If your current year’s tax is less than $1,000. Again, this might happen if you’re just starting out.
  • If your total tax bill, minus previous withholdings, is less than $1,000 at the time your tax return is due. For example, perhaps you transitioned from a previous job, and your employer had withheld enough so that you were expecting a refund or a small payment.
  • If your total withholdings and estimated taxes are at least as much as your previous year’s taxes. So, let’s say your business takes off this year.  You made $50,000 last year, and you’re on track to make $150,000.  As long as your estimated taxes are at least as much as last year’s (based upon the $50,000 number), you won’t be penalized if you don’t pay on the $150,000 number.  With that said, this should be looked at as the IRS giving you leeway to do the right thing, not to blow off estimated taxes.
  • If the tax due is no more than 10% of the total taxes, and you paid all estimated taxes on time. For example, your total bill is $10,000.  You paid $9,500, with all your estimated taxes on time, and you owe $500 by your filing deadline.  You simply complete your return, send the $500 to the IRS, and don’t owe any penalties.  So, let’s think about how we get to this point.

How do I properly calculate and withhold estimated taxes?

Below, I will point out the step-by-step instructions on how you do this, so that you can understand the concepts and budget for it.  You can do this manually (which is probably suggested for the first year or two, so that you can understand it), or you can automate this process by hiring a bookkeeper, accountant, or enrolled agent to do this for you.  Once your career demands more and more of your time, you’ll find that hiring this function out should definitely be at the top of your to-do list, but you’ll want to understand the process for yourself so you can still hold your tax professional accountable and ask relevant questions when you need to.  After all, you are still responsible for your tax liability, even if you hire the work out, so it’s important to understand it.  With that said, here we go.

1.  You will want to forecast your total commissions and business expenses for the year.  In order to understand your tax liability, you need to know what your income and expenses are, or have a rough estimate.  If you don’t know where to begin, you can start by looking back on the previous year’s records.  Based upon the way your business is growing, you should be able to use this as a baseline to predict what your future commissions and expenses will be.  Subtract your business expenses from your predicted commission to determine your net income.

Example:  Let’s assume you start with $100,000 in gross income.  We’ll use this number as the example as we go through the rest of these instructions.

2.  Calculate self-employment tax based upon your projected income. You have to pay self-employment tax on your income.  Let’s differentiate this from your wages as a W-2 employee.  As an employee, you pay Social Security & Medicare (also known as Federal Insurance Contributions Act, or FICA).  You pay half, as part of your withholdings, and your employer pays half.  Although there are certain limitations and additional taxes, based upon your income, generally this number is 7.65% for yourself, and 7.65% for your employer, for a combined total of 15.3%.  As a self-employed individual, you are responsible for both ends of this tax.  Since there is a phase-out period on Social Security (you don’t pay Social Security on any amount above $118,500 for 2016), this can get difficult.  You can either this manually by downloading a copy of the IRS Worksheet 2-3 from Publication 505 (Tax Withholding and Estimated Tax).  However, it might be easier to go to an online self-employment tax calculator and let it do the math for you.  Bankrate and Jackson Hewitt both offer online calculators that do this very quickly for you.

Example: self-employment tax on $100,000 equals $14,130.  That would be $11,451 in FICA & $2,678 in Medicare.

3.  Divide your self-employment tax amount by two. I want to explain this step, so you understand the impact that self-employment tax has on your net income.  You are allowed to deduct ½ of your self-employment tax from your income for income tax purposes.  Just keep in mind that you’re not allowed to deduct all of the self-employment tax, so if you’re calculating by hand, you need to divide the total self-employment tax by 2 to get to the amount that you’re able to deduct.

Example:  Dividing self-employment tax by 2 gives you $7,065 in deductible self-employment tax.

4.  Subtract ½ of your self-employment amount from your net income. As explained, this is what you’re entitled to, so actually subtract this amount from your previously calculated net income.

Example:  $100,000 minus $7,065 equals $92,935.  This is the number that you will subtract your deductions and exemptions from to calculate your taxes.

5.  Calculate your Adjusted Gross Income (AGI).  This involves subtracting out adjustments to income.  Some of these adjustments include:

  • Alimony payments
  • IRA contributions
  • Deductions for tuition and fees

You should know what other adjustments you’re entitled to from last year’s tax return.  If your situation has significantly changed, you might want to consult a CPA or enrolled agent to make sure you’re taking all of the deductions you’re entitled to.

Example:  If you paid $5,000 in tuition, and contributed $3,000 to your traditional (not Roth) IRA, this brings you to $84,935.  This number is your AGI.

6.  Subtract your standard or itemized deductions from your net income from step 4. Estimate your itemized deductions or obtain the standard deduction form from the IRS website. Make sure you compare your itemized deductions to the standard deductions allowed for the tax year to maximize your deduction.

Example:  If you estimate $15,000 in deductions, this brings your income down to $69,935.

7.  Subtract the personal exemption allowed for the year from the new number in step 5. For 2016, the personal exemption is $4,050 per person in the household.

Example:  If you have a spouse and one child, you would have three exemptions.  This brings your income down to $57,785.

8.  Calculate the amount of federal tax due on your adjusted gross income (the amount calculated in step 6).  You can look up the tax tables on the IRS website, or you can find a tax calculator on Jackson Hewitt .

Example:  Using 2016 tax rates, the estimated income tax on $57,785 for a married couple filing jointly is $7,740.25.

9.  Add your total estimated federal tax due to the total estimated self employment tax due. Then divide this total by 4.

Example:  $14,130 + $7,740.25 equals $21,870.25, which results in $5,468 (rounded up to the nearest dollar), in quarterly payments.

10.  Make estimated quarterly tax payments of the amount calculated in step 9. Estimated quarterly tax payments are due on April 15, June 15, September 15, and January 15 of each year.  If the payment date falls on a weekend, the due date falls to the following business day.

A quick note.  You should compare your estimate tax liability.  If your current year’s tax liability is less than last year’s, you may want to use last year’s number for quarterly tax purposes.  If you are wrong, you will avoid underpayment penalties as long as you paid 100% of last year’s tax liability on time.

For example, if your total estimated tax bill this year comes out to $6,000 and last year’s number was $7,000, you should use the $7,000 figure for quarterly payments.  That way, if you end up with a banner 4th quarter and end up owing $8,000 in taxes, the IRS will not assess a penalty.  You will still owe $1,000 in taxes when you file your return, but there won’t be a penalty assessed for under withholding.  If, on the other hand, your bill comes in at $6,000, then the IRS will issue you a $1,000 refund.

Should I calculate estimated taxes myself, or should I hire this out?

If you’re truly focused on establishing & growing your real estate business, you should have a tax professional do this for you as soon as you can afford to.  However, it makes sense to have a good understanding of your tax liability for several reasons.

  • You’re responsible for your tax calculation, and the proper payment of taxes. So, unless you can prove to the IRS that your tax professional (only an attorney, CPA, or enrolled agent qualify as tax professionals in the eyes of the IRS) misled you or provided bad tax advice, the IRS will hold you responsible for any underpayments.
  • If you hire this out, you need to understand the process so that you can ask informed questions. Asking informed questions is the best way to ensure that you’re getting the tax advice you’re paying for.
  • Tax planning. The more you know about how the process works, the more likely you are to make tax efficient business decisions.  It just makes business sense.

So, how do I automate estimated taxes? 

  • You can use software like TurboTax to help you file your taxes.  This might be the way to go to help avoid calculation mistakes.  However, software won’t be able to help you identify opportunities for tax planning (not as well as an actual person, anyway).
  • Hire a bookkeeper. You can hire a bookkeeper to manage your books, and you probably should do so as soon as you can hire that service out.  There are some professional enrolled agents and CPAs who perform bookkeeping services on the side.  However, it may be more expensive to hire them.
  • Hire an accountant or enrolled agent. As your career takes off, it may become more complicated.  This is especially true if you plan to invest in real estate or establish other business lines.  Having a long term relationship with a tax professional, such as a CPA or EA, will allow you to identify tax planning opportunities.  Proper tax planning can save you thousands, if not tens of thousands, of dollars over your career.

Why you should automate

This is simple.  Any business owner should automate or hire out any function which isn’t a core part of his or her business.  If you’re a real estate agent, then your value proposition lies in your relationships, and your ability to connect with buyers, sellers, and other agents.  Doing taxes takes you away from your core competency.   Additionally, doing taxes is a mental drain that leaves you less than focused on your business.  And quite frankly, if you like taxes, you should become a CPA or enrolled agent, not a real estate agent.

I hope this article helps you understand more about your estimated tax situation.  However, this article is not a substitute for customized tax advice.  For a more professional assessment of your personal estimated tax situation, you should contact your local tax professional.  If you don’t have one, feel free to email me or contact me through my website.

Tax Deductions for Real Estate Agents – Entertainment Expenses

There are plenty of ‘tax tips’ articles out there for real estate agents.  However, most of these articles provide nothing more than a general, overall understanding of what expense categories are considered eligible for federal tax deductions.  This article will attempt to help conceptualize what types of real-life entertainment expenses can be eligible for tax deductions under federal law.  However, this is an overview, and should not be considered a substitute for sound, personalized advice from a tax professional.  Also, this primer does not provide legal advice–you need to take steps to ensure that your advertising campaigns comply with applicable federal, state, and local regulations.

This article will cover:

  • The specific IRS reference that helps determine deductible entertainment expenses
  • Eligibility criteria
  • The 50% rule, which provides the general guidance for deducting entertainment expenses
  • Exceptions to the 50% rule
  • Examples of entertainment expenses that real estate agents can claim

What Does the IRS Say About Entertainment Deductions?

The IRS policy regarding tax deductibility of entertainment expenses is contained in Chapter 2 of IRS Publication 463, Travel, Entertainment, Gift & Car Expenses.  Chapter 2 specifically discusses business-related entertainment expenses, and outlines what is eligible, and what is not.

According to Chapter 2, you can deduct entertainment expenses only if they are both ordinary & necessary and either the directly-related test or the associated test.

Before we go further, below are the IRS-defined terms outlined above in bold:

  • Ordinary expense: One that is common and accepted in your trade or business.  For example, providing appetizers & bottled water as part of an open house is common and accepted in the real estate world.
  • Necessary expense: One that is helpful and appropriate for your business.  Verbatim from IRS Pub 463:  “An expense doesn’t have to be required to be considered necessary.”   Using the above example, providing appetizers isn’t required to conduct an open house, but can be considered a necessary expense for tax purposes.
  • Directly-Related Test: To meet the directly-related test for entertainment expenses (including entertainment-related meals), you must show that:
    • The main purpose of the combined business and entertainment was the active conduct of business
    • You did engage in business with the person during the entertainment period AND
    • You had more than a general expectation of getting income or some other specific business benefit at some future time.
    • An example would be taking a prospective client out for a cup of coffee to talk about their needs
  • Associated Test: If your expenses do not meet the directly-related test, they may meet the associated test.  In order to do so, you must show that the entertainment is both:
    • Associated with the active conduct of your trade or business. This means you can show that you had a clear business purpose for having the expense.  That purpose might be to get new business or to encourage the continuation of an existing business relationship.  Hosting a networking event would meet this requirement as long as you’re able to document that this is to grow your business.
    • Directly before or after a substantial business discussion. Unless you can show that you actively engaged in the discussion, meeting, negotiation, or other business transaction to get income or other specific business benefit, it will not be considered a substantial business discussion.  This meeting doesn’t have to be for a specific length of time, but you must show that the business discussion was substantial in relation to the meal or entertainment.
    • The IRS points out a couple of additional points:
      • Meetings at conventions: If you attend meetings at an industry convention or similar event, this would be considered a substantial business discussion as long as your reason is to further your trade or business.
      • Directly before or after business discussion. If the entertainment is held on the same day as the business discussion, it is considered to be held directly before or after the business discussion.

What is the 50% rule, and how does it pertain to entertainment expenses?

Simply put, the 50% rule means that you’re allowed to deduct 50% of the total business-related meal and entertainment expenses.  This rule applies to employees or employers, and to self-employed persons, including independent contractors.  If you are reimbursed by your employer or clients, then they would be eligible to deduct 50% of the meals and entertainment expenses from their costs, not you.  This limit applies to business meals or entertainment expenses while:

  • Traveling away from home on business
  • Entertaining customers at your place of business, restaurant, or other location, or
  • Attending a business convention, reception, business meeting, or business luncheon

In essence, any entertainment expense that is allowed is subject to the 50% limit.  However, there are exceptions.

What are the exceptions to the 50% rule?

There are 5 exceptions to the 50% rule, but the following are the ones that might apply to real estate agents:

  1. Employee’s reimbursed expenses. If you are under an accountable employee reimbursement plan, then your employer should not consider your reimbursed expenses as income.  This is a wash:  you don’t have income, you don’t get the deduction.
  2. Self-employed. If you are self-employed, and your client or customer reimburses you or gives you an allowances for expenses in connection with your services, then your client or customer is eligible for (and subject to) the 50% rule, not you.
  3. Advertising expenses. If you provide meals, entertainment, or recreational facilities to the general public as a means of advertising or promoting community goodwill, you are not subject to the 50% rule.  IRS cites TV & radio sponsorships or distributing free food and beverages to the general public as fully deductible.  Keep in mind, an open house would be considered open to the general public, but a limited or private showing would not.

What types of entertainment expenses are deductible?

The following descriptions and examples are directly from Publication 463:

  • Includes any activity generally considered to provide entertainment, amusement, or recreation.  Specific examples include:
    • This includes cost of food, beverages, taxes & tips.  You or your employee must be present when the food or beverages are provided.
    • Trade association meetings. You can deduct entertainment expenses that are directly related to and necessary for attending meetings of certain exempt organizations if the expenses are related to your active trade or business.  This includes business leagues, chambers of commerce, real estate boards, trade associations, and professional associations.
    • Entertainment tickets. Generally you can only deduct the face value (without service fees) for tickets, even if you paid a higher cost.  Skyboxes or luxury seats to a sporting event are specifically limited to the cost of a nonluxury box seat ticket.  However, you can separately deduct food and beverage costs for skybox or luxury seats, subject to the 50% limit
      • Charitable events. There is an exception in which you can deduct the full cost of the ticket if the event’s main purpose is to benefit a qualified charity, the entire net proceeds go to the charity, and the event uses volunteers to do substantially all of the work.
      • Example: you buy tickets to a golf tournament organized by the local volunteer fire department, where the proceeds go to purchase new fire equipment.  The event is run by the volunteers.  The full cost of the tickets are deductible.

What types of entertainment expenses are not deductible?

The following descriptions are specifically excluded under Publication 463:

  • Club dues & membership fees. While business memberships are generally deductible, they are NOT deductible if the primary purpose of the organization is to provide entertainment activities for their members.  For example, dues for a local real estate group, whose primary goal is to meet for the purpose of business development, are deductible.  However, dues to a country club whose membership rules require their members to be members of the real estate industry, would not be.
  • Entertainment facilities. Generally, you cannot deduct any expense for use of an entertainment facility.  This includes depreciation expenses or rent, utilities, maintenance, or other costs.
  • Spouse expenses. You cannot deduct the cost of entertainment of your spouse or a customer’s spouse.
    • However, if you can show that there was a clear business purpose, and the customer’s spouse joins you because it’s impractical to entertain the customer without the spouse, then you can deduct the cost for the spouse. This also extends to your spouse, if they join to accompany the customer’s spouse.
  • Any item that could be considered either gift or entertainment will generally be considered entertainment. However, if you give a customer packaged food or beverages that are clearly intended for later use, then that will be considered a gift, and subject to gift rules.  Gift rules are different from entertainment rules, and are covered in IRS Publication 463, Chapter 3 – Gifts.
    • For example, taking a client out for a celebratory glass of wine would be considered entertainment, but a bottle of champagne would be considered a gift.

As a real estate agent, it’s important for you to be able to keep every dollar that you can.  Tax efficiency is a very overlooked way of reducing your costs, especially on things that you might do every day.  I hope this article clarified how you can deduct entertainment expenses as a part of your business.  However, if there’s a real estate entertainment expense that you think may qualify, please post it in the comments section below.  If you have any questions or concerns, please feel free to visit my website, or email me at:  forrest@westchasefinanicalplanning.com.

Ten Reasons to Hire Your Child as a Real Estate Assistant

Do you have a real estate assistant in your house?
Do you have a real estate assistant in your house?

You’ve gotten through that first year (or two or three), and you’re no longer worried about whether you’re going to make it as a real estate agent.  However, it seems that every evening, you go to bed with a longer to-do list than you woke up with.  Congratulations!  You’ve graduated to the next step as a real estate agent—having too much work and having to hire a real estate assistant.

As you start to streamline your workflows, and build out your processes, you’re doing so with the intent of hiring out your lower-end work to an assistant, so you can focus on the client-facing work.  After all, your ability to close more sales depends on your ability to meet and talk with more clients.  Naturally, you look at your options—using your broker’s office, hiring your own assistant, or perhaps dabbling in the world of VAs (virtual assistants–definitely worth looking into at some point).  However, if you have a child who is eager to learn and take on responsibility, you’re sitting on a gold-mine.

Caveat:  This article is not a legal paper, and does not purport to give legal advice, so check with your state regulations or your broker to ensure you’re in compliance with applicable legal authorities.

Here are 10 reasons why you should consider hiring your child to become your real estate assistant

  1. Children can do a lot! First and foremost, your main reason to hire a real estate assistant should be to free you up to get more clients.  If you’ve got a child with an energetic & entrepreneurial spirit, you can get a LOT of administrative tasks completed.  Additionally, if your child has a driver’s license, they can take your act to the road by helping place flyers in neighborhoods, post “For Sale” signs, and conduct other physical errands that a VA can’t do on your behalf.  Note:  This article does not define what children can and cannot do as unlicensed real estate agent assistants.  As a starting point, REALTORMAG®has a listing, by state, of what unlicensed assistants can or cannot do.  However, you will want to get permission from your broker to ensure you’re in the clear, legally speaking.
  2. Children are less expensive to hire. You pay their rent, you pay their food, and put clothes on their back.  Depending on what website you look at, you can hire a VA for anywhere between $30 to $75 per hour.  While a VA can be worth the price, you may be able to get your child to do a lot of this work for a fraction of the cost.
  3. If you can’t trust your child as an employee, what makes you think any other employer would?  It’s better to recognize up front that you’ve got some work to do as a parent.  On the flip side, you’ll probably be able to trust your child a lot more than someone else you’d hire as a real estate assistant.
  4. Children can help you shelter tax income and ‘keep it in the family.’ According to IRS Publication 929, ‘Tax Rules for Children and Dependents,’ any dependent who earns less than $6,300 in 2016 is exempt from filing a tax return.  For most teenagers, that’s probably a good summer’s income.  Also, if you own a sole proprietorship, or an LLC (not S or C corporation), you can avoid withholding payroll taxes such as Federal Insurance Contributions Act (FICA), Federal Unemployment Tax Act (FUTA), or state unemployment taxes.  For those of you whose children break through the magical $6,300 limit, those children will have to file a tax return, but they’ll be taxed at lower marginal tax rates.  In either case, you can still claim them as a dependent as long as they continue to meet the IRS dependent criteria.
    • What about kiddie tax? If you’ve heard of the kiddie tax, this is a very good question.  However, the kiddie tax, which was designed to prevent parents from hiding their investment income under their children’s accounts to avoid higher tax rates, only applies to unearned income.  Any income your child receives as a result of working for you is considered earned income and is not subject to kiddie tax.
  5. You can start their retirement plan early. You didn’t know there’s no age limit for starting an IRA?  According to IRS Publication 590-A, ‘Contributions to Individual Retirement Accounts (IRAs),’ anyone who is under 70 ½, and has compensation, can open a traditional IRA.  In this sense, the IRS defines compensation as, “what you earn from working.”  This includes earned income.  For Roth IRAs, you can contribute as long as you have compensation, and fall under certain income limits, which is usually not an issue for children (in 2016, the income limit for single taxpayers is $131,000).
  6. You can instill a sense of financial responsibility and ownership. One of my favorite stories is about my childhood best friend, Paul.  When Paul was 15, his dad kicked him off the couch one evening and got him a job at the local pizza joint.  The following summer, Paul was driving around in his own truck, which he paid for (to include insurance, gas, and maintenance).  All of that was from Paul’s pure hustle, which he wouldn’t have recognized if his dad didn’t give him that opportunity.  Who knows what your child can accomplish before college if you give him or her the chance to do so.
  7. Start their career. Who knows whether your child will want to become a real estate agent like you?  Perhaps they like real estate, perhaps they hate being a real estate assistant.  There’s a common statistic that 70% of family businesses never reach the second generation.  The flip side to that is that 30% of them do!  Perhaps, if you’re managing your real estate career like the business owner you are, you’ll have a built-in partner to turn the reins over to as you plan your eventual exit strategy.  If not, they’ll at least have established some early accomplishments to go on their resume to impress their next employer.
  8. Experience.  Speaking of the next employer, perhaps you’re hiring your child to do some busy work that doesn’t really need to get done, or perhaps they’re doing stuff you’d never want them to do once they finish school.  However, work is work, and experience working for their mom or dad counts just as much as working for anyone else.
  9. Getting stuff off your plate can help you realize how much is on your plate to begin with. Perhaps hiring your child to do busy work allows them to ask about all the other stuff you’re doing.  They could be doing a lot of work that you never knew you needed a real estate assistant for.  You know, the stuff you should have outsourced a long time ago, but never did as you were building your systems.
  10. Finally, a temporary hire might help you prepare for that long-term employee you eventually do hire. Perhaps you both know this isn’t a long-term deal.  Even if they’re not the long-term solution, hiring your child to do summer projects might help you systematize the work you eventually hire out so that you can frame it to your eventual employee.

These are just some of a few reasons why you would want to hire your child.  Can you think of any other reasons?  Please feel free to comment on this post, join me on the Facebook page, or email me directly.  I’d love to hear from you, and can be reached through my email or at www.westchasefinancialplanning.com

Tax Deductions for Real Estate Agents – Advertising & Marketing

Introduction

There are plenty of ‘tax tips’ articles out there for real estate agents.  However, most of these articles provide nothing more than a general, overall understanding of what expense categories are considered eligible for federal tax deductions.  This article will attempt to help conceptualize what types of real-life advertising and marketing expenses can be eligible for tax deductions under federal law.  However, this is an overview, and should not be considered a substitute for sound, personalized advice from a tax professional.  Also, this primer does not provide legal advice–you need to take steps to ensure that your advertising campaigns comply with applicable federal, state, and local regulations. Continue reading Tax Deductions for Real Estate Agents – Advertising & Marketing