Taxilla: He's Back!
Scott Hutchinson, who’s been a sales associate for two years, had a tax plan from the day he started. Knowing that payments fall due on the 15th of April, June, September and January, he created an Excel spreadsheet to track his income and tax obligations.
“When I receive a commission check, I take 25 percent and put that money into a separate (interest-bearing) account known as my tax savings account,” he says. “Using the spreadsheet, if my check is $2,000, I enter $500 under taxes and $1,500 income. The program then totals the amount of taxes, net and gross incomes.”
Hutchinson, with Sunburst Properties in Ocala, likens his system to payroll deductions. “If you’re working for someone else, and they’re taking money out, it’s exactly the same thing. You have to be that disciplined,” he says. “Under no circumstances is that money touched unless it is to pay taxes.”
Realtor® Clifford J. Friedman, CPA, a Coral Springs certified public accountant with more than 25 years’ experience in tax planning and preparation, says that failure to make timely quarterly estimated tax payments is one of the most common mistakes real estate professionals make, which can result in interest and penalties.
As sole proprietors, sales associates face unusual challenges when it comes to taxes. Even though they have a boss (the broker), a desk and an office, they’re essentially small-business owners and, as such, must treat their practice like a business. So no matter how many office lunch parties you attend, caravans you go on, Association meetings you attend, you still stand alone in the eyes of the IRS.
Because factors affecting tax status change over time, Friedman advises quarterly reviews with your accountant to keep your strategy current. Numerous options are available to minimize your tax burden, he says, including the timing of receiving income and taking deductions, depending on your expected tax status this year and next. But many opportunities to reduce taxes before Dec. 31 are not available after Jan. 1, so a fourth-quarter tax-planning session is essential. “The importance of this cannot be overstated,” Friedman says. Planning Is Key
As the market fluctuates, understanding available options can be even more crucial to your financial health. Relying on next year’s income to cover this year’s taxes could be a critical mistake.
Susan Ball, with Coldwell Banker Residential Real Estate in Cape Coral, says she learned the importance of tax planning the hard way. She began practicing as a real estate professional in 2004 and, after “a bang-up year,” incorporated in November 2005. “But I had not made quarterly income tax payments throughout the year,” she says. “When my taxes were ultimately filed for 2005, I owed almost $75,000!”
Her accountant advised her to create a Simplified Employee Pension (SEP) account. “This action reduced my tax liability substantially, and I was able to use that money to create a self-directed IRA, allowing me to purchase an investment property in Panama,” Ball says. “Now, I file quarterly taxes on time, and the result is peace of mind and substantially less stress.”
Ball says it’s important not only to seek professional tax advice, but also to consult someone with experience specific to the business and your needs. “We, as Realtors®, know the importance of specialization and further education. It’s critical to success,” says Ball, CIPS. Know Your Limitations
It’s also important to factor in your own limitations. “I’m in the business of selling and marketing. I’m not in the business of accounting,” she says.
That was an element in devising a winning tax strategy for Paul and Jacqueline Morris, top-producing agents with RE/MAX Direct in Wellington.
“We always played the game of quarterly taxes and actually paid some payments on time, but this system proved not to be structured enough for us, and often we would fall behind on taxes year after year,” Paul Morris says. “Finally, in 2005, we hired a company called Paychex to handle our tax payments, state and federal filings, unemployment compensation and monthly automatic debit of estimated taxes from our business account. This was the best thing we ever did for ourselves.” They receive monthly statements and copies of all tax filings and other transactions.
For anyone who does not have the discipline or time to handle tax payments responsibly, he says, this kind of arrangement can be a boon. But Morris points out that the service does not replace what his regular accountant does. It merely supplements it. Missed Opportunity
The tax codes are among the most complex laws on the books, and they’re constantly changing. While many brokers and sales associates are comfortable handling tax payments themselves, without professional advice, they may be missing out on opportunities to keep those obligations to a legal minimum.
“Taxes that real estate professionals must be focused on are the income tax and the self-employment tax, which together can reach well over 40 percent,” Friedman says. “Proper tax planning can generate tremendous savings and should be given serious consideration.” That applies to both full-time and part-time sales associates who split their time with other income-producing activities.
As Ball discovered, retirement planning opportunities can save you a bundle now and provide comfortably for you later. Very large amounts can be set aside, but whether investing in an IRA or some other type of account, it’s essential to know the requirements and restrictions that apply.
On the other end of the spectrum, there are other strategies that can be used to reduce taxes but are often overlooked, Friedman says.
“Hiring your minor children in your business can shift income to them, which will be taxed little or not at all, providing you with additional deductions and your children with responsibility and the pride of earning their own money,” he says. There are strict requirements for this to work, so it’s important to consult a CPA.
Taking advantage of accelerated depreciation of capital assets also can substantially slash current year taxes, he says. Vehicles, furniture, equipment, computers and other assets typically must be depreciated over their useful lives but may qualify for immediate deduction under Section 179, he says. Recent Tax Code Changes
Because tax codes frequently expire and new ones are enacted, it’s imperative to change tax planning accordingly, Friedman says. Here are some recent changes that he says could affect real estate professionals:
• Section 179 accelerated depreciation limits have been increased from $100,000 to $125,000, subject to limitations.
• Family Business Tax Simplification allows an unincorporated business owned jointly by a married couple to file as a sole proprietorship instead of a partnership.
• The maximum amount of net earnings subject to the Social Security part of the self-employment tax has increased to $97,500.
• The standard mileage rate for the cost of operating your vehicle increased to 48.5 cents a mile for business miles driven.
• Mortgage insurance premiums that you pay or accrue for “qualified mortgage insurance” during 2007 in connection with “home acquisition debt” may be deductible as home mortgage interest.
• The Alternative Minimum Tax exemption amount has decreased.
• Stricter new charitable contribution documentation requirements have been enacted for cash donations.
Now is the time for sales associates to start planning for their 2008 taxes. Think about the types of activities that will qualify as deductions, consider setting up a retirement plan, acknowledge that making estimated quarterly tax payments is a necessary evil and allocate a certain amount from each commission check to cover those obligations. Using these strategies, you’ll be much better prepared when April 15 rolls around. Buck Wargo is a Las Vegas-based freelance writer.