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.