Q: I have passed my real estate salesperson test and will be become an "active" agent with a local brokerage in January. I am unsure of how I am supposed to report my future income. I currently work at a "normal" job where I receive a weekly paycheck where federal tax, state tax, and social security are withheld for me.
As a real estate agent, I will have my own business expenses and (hopefully!) large commission checks with no taxes withheld. How do I handle this? When and how do I report? –Anonymous
A: Most real estate agents are independent contractors — self-employed business owners who are affiliated with a licensed real estate broker in their state. As such, they are running independent businesses, even though they must work under a licensed broker’s supervision.
The great majority of real estate agents who work as independent contractors for a real estate brokerage are sole proprietors. A sole proprietorship is a one-owner business. Unlike a corporation, limited liability company, or partnership, it is not a separate legal entity.
The business owner (proprietor) personally owns all the assets of the business and is in sole charge of its operation.
When you’re a sole proprietor, you and your business are one and the same for tax purposes. Sole proprietorships don’t pay taxes or file tax returns. Instead, you must report the income you earn or losses you incur on your own personal tax return, IRS Form 1040.
If you earn a profit, the money is added to any other income you have — for example, interest income or your spouse’s income if you’re married and file a joint tax return — and that total is taxed.
Although you are taxed on your total income regardless of its source, the Internal Revenue Service does want to know about the profitability of your business. To show whether you have a profit or loss from your sole proprietorship, you must file IRS Schedule C: Profit or Loss From Business, with your tax return. On this form you list all of your business income and deductible expenses.
When you’re a self-employed real estate salesperson, no taxes will be withheld from your commissions. It’s up to you to pay your income and Social Security and Medicare taxes yourself. Ordinarily, this is done by making four annual estimated tax payments to the IRS each year, as shown in this chart:
|
Income received for the period: |
Estimated tax due: |
|
Jan. 1 through March 31 |
April 15 |
|
April 1 through May 31 |
June 15 |
|
June 1 through Aug. 31 |
Sept. 15 |
|
Sept. 1 through Dec. 31 |
Jan. 15 of following year |
You must pay estimated taxes if you expect to owe at least $1,000 in federal tax for the year. However, if you paid no taxes last year — for example, because your business made no profit or you weren’t working — you don’t have to pay any estimated tax this year no matter what your tax tally for the year.
You also don’t have to pay estimated tax if you have an employee job and the amount withheld from your pay by your employer will amount to at least 90 percent of the total tax you’ll have to pay for the year.
Paying estimated tax can be tricky because it requires you to estimate what your income for the year will be. This can be particularly difficult for real estate professionals who earn commission income that can vary substantially from year to year. If you don’t pay enough estimated tax, the IRS will impose a penalty.
Fortunately, there is a way to avoid having to estimate how much you’ll make this year. No matter what your income for the current year turns out to be, you won’t have to pay any penalties if the estimated tax you pay is at least the smaller of:
- 90 percent of your total tax due for the current year, or
- 100 percent of the tax you paid the previous year, or 110 percent if you’re a high-income taxpayer (those with adjusted gross incomes of more than $150,000, or $75,000 for married couples filing separate returns).
For more details on estimated taxes, refer to IRS Publication 505: Tax Withholding and Estimated Tax.
Stephen Fishman is a tax expert, attorney and author who has published 18 books, including "Working for Yourself: Law & Taxes for Contractors, Freelancers and Consultants," "Deduct It," "Working as an Independent Contractor," and "Working with Independent Contractors." He welcomes your questions for this weekly column.