Taxes and Your Business: Play the Game
As a real estate professional, you developed a skill, became an expert in your field and found clients. You made them happy and continue to, and now you’re turning a profit. It’s the American dream, better living through entrepreneurship. So should you bother with the legality of it all?
If all you do is perform a service that people love and are willing to pay for, you could be pecked to death by income taxes, so much so that you’ll want to give up your aspirations of self-determination.
You can complain about the unfairness of the IRS and tax code – the bureaucracy of it all, the confusion, the contradictions – and maybe even argue that it's "anti-business." Or you can do what almost everyone can but few bother to: play the IRS’s game. Only make sure that you're on the winning team.
In other words, if you own a real estate business, incorporate. Create an artificial entity that doesn’t eat, sleep or breathe. All it does is get tax breaks.
"Tax breaks" is a vague term, but for our purposes, we'll define it as taxes that a salaried worker pays that an entrepreneur doesn't.
Say your business loses a massive amount of money in a short time by incurring an unforeseen, uninsured expenditure, such as a civil suit. The sole proprietorship could end up owing more money than the business is worth. So where would the additional money come from? You, the owner. That’s called personal liability.
When you structure your business as a corporation, you're taking advantage of the legal principle of limited liability. In other words, your share of the business can’t be responsible for any more than what you put into it.
Two Ways to Incorporate
There are two common ways for your business to incorporate. The more common one is called an S Corporation; the other is as a limited liability company (LLC).
Under either an S corporation or an LLC, your private assets are protected. No one who feels slighted by your company can “sue you for all you’re worth,” as the invective goes. This isn’t the case when you’re a sole proprietor. In that case, for legal and tax purposes, you’re indistinguishable from the business itself.
An LLC doesn’t technically pay taxes. Instead, the government taxes the LLC’s taxable profits, which are distributed among the owners. Those profits get taxed at the same rate as regular income. Your LLC issues you a K-1 statement, which lists your share of the LLC’s income and expenses, to be transferred to your 1040.
An S corporation is a little more work but usually worth it. There are minutes, resolutions, the election of officers, formal financial statements and so on. You’re even supposed to hold an annual shareholder meeting, but that’s not difficult if you own all the shares.
From a tax standpoint, there’s virtually no difference between an LLC and an S corporation. The biggest difference between them is how the IRS treats excess profits. If you own and operate an S Corporation and pay yourself a “reasonable” salary, the remaining profit is “distributed” to you at the end of the year and isn’t subject to 15.3-percent self-employment tax. Not so with an LLC.
Other Reasons to Incorporate
Hopefully, your business gets so successful that you end up selling it, which for most of us is the ultimate goal. Take it from someone who’s been there; while a sole proprietorship is easy to create, it’s a pain to sell.
If you operate your real estate business as a sole proprietorship, you have to sell every single asset individually. If you incorporate, the entire business moves as a unit.
Besides, if your business is viable and the new owner halfway intelligent, the first thing he'll do is incorporate anyway. Save him the trouble and do the incorporating yourself. Then add the incorporation fee into the price.
Even if your business has multiple owners, and even if those owners are just you and a spouse or a sibling, selling your share will remain a snap if you’re incorporated.
Are you ready to play the game? If not, you could just keep filing your annual 1040s and try to figure out why you’re not getting rich.
Although most states allow a real estate licensee to operate under a single-member LLC, you should check with your state real estate division to be sure. Ask your attorney or accountant if an LLC or an S Corporation is the right choice for you.
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Take Your Web Content from Good to Great Betty Kincaid, PMN, served as president of the Women’s Council of REALTORS® in 2005. She's a national speaker acclaimed for her knowledge and experience as an investor and entrepreneur. Betty’s first book, Control Your Cash: Making Money Make Sense, is available online and at your local bookstore. Visit BettyKincaid.com for more information.
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