How Real Estate Agents and Small Business Owner’s Can Reduce Their Self-Employment Tax

There’s no need to pay more tax than necessary. With a little planning you can reduce your exopsure to the painful 15.4% self-emloyment tax!

What is the Self-Employment Tax?

If you’re a real estate agents or other self-employed individual (e.g. consultant, attorney, doctor, dentist, accountant, etc.) you pay the self-employment (SE) tax, also known as FICA, on the the first $132,900 (2019) of your combined wages, tips, and net earnings. This amount increased to $137,700 for 2020.

The Social Security portion of this tax is 12.4% and the Medicare portion is 2.9% for a combined 15.4%. After $137,700 of earnings most real estate agents and self-employed indivuals will only pay the 2.9% Medicare part of Self-Employment tax on their earnings.

Example

A real estate agent earns $100,000 in net income for the 2020 tax year. Assuming this agent as no other sources of income, they will pay $15,400 in self-employment taxes.

It is important to note that the self-employment tax is in addition to your marginal tax rate that can ranges anywhere from 0-37%.

If this agent is single, they will be in the 24% marginal tax bracket and pay an additional $15,247 in federal taxes, and another $5,458 in New York State taxes. This is a combined total of $28,355 in income taxes and reprents 28.35 of their net income. Ouch!!!

Why Real Estate Agents and Other Small Business Owners are Subject to the Self-Employment Tax

Employees who work on a W-2 basis split the FICA taxes with their employer. The employer pays 7.65% and the employee pays the other 7.65%.

However, as a real estate agent or other self-emloyed person, you are both the employer and the empoyer in the eyes of the IRS, and thus pay both sides of this tax.

As the saying goes, it costs to be the boss.

The Strategy Real Estate Agents and Small Business Owner’s Use to Reduce Their Self-Employment Tax

Luckily there is a strategy that exists that often helps self-employed people reduce their exposure to the self-employment tax.

The strategy includes operating as an S-Corporation instead of a sole proprietor under a single-member LLC (SMLLC).

The S-Corporation is its own corporate entity, seperate from its owner(s) and pays the owner a W-2 wage or salary. The wage or salary is subject to the self-employment tax, while the rest of the S-Corporation’s earnings pass-through to the owners are are subject to federal and state income taxes, but not the self-employment tax.

Example

Continuing the same example above. The real estate agent nets $100,000 and pays $15,400 in self-epmloyment taxes without the use of an S-Corp.

If the agent instead operates under an S-Corp and pays themselve a wage of $50,000, this cuts their exposure in half. The agent is now only paying $7,700 in self-employment taxes instead of the full $15,400. 

As you can see, operating as an S-Corporation can put a significant amount of money back in your pocket. The example above is only one scenerio, in some cases you can save much more than $7,700 by using an S-Corporation.

Potential Pitfalls

While this strategy can save you thousands in taxes there are some things to watch out for when using this strategy.

1. Additional aminstrative tasks are required to meet the compliance requirements of running an S-Corporation.
2. There are additional costs assocated with operating an S-Corporation such as filing a seperate tax return.
3. As an owner of an S-Corp, your salary must be “reasonable” for the work you perform in your business and you must be able to sustantiate it should you ever be audited by the IRS. It can’t just be picked out of a hat.
4. Choosing a salary becomes more complicated as you’re trying to minimize your exposure to the self-emplment tax while maximizing you’re 20% pass-through deduction (introduced by The Tax Cuts and Jobs Act of 2017).

Does this Strategy Make Sense for You?

While everyone has a different set of facts and circumstances, this strategy generally makes sense once you’re earning around $40,000 or more in your business and expect to continue to do so in the years ahead.

How We Can Help

If you’re a self-employed real estate agent or otherwise self-empoyed, we can help you:

• Determine if this strategy is right for you.
• How to properly implement this strategy to avoid the pitfalls described above.

To learn more about this strategy and how we can help you, complete the short form by following this link. One of our team member’s will reach out to schedule a free initial consultation.