News

By: Eric P. Trost

With a new tax season approaching, it’s a good time to start thinking about how to take advantage of the many new tax laws and changing tax regulations for the self-employed. For 2011, Congress has opened the door with these changes for the self-employed to help stimulate the economy through small business growth. This article highlights possible tax advantages for the self-employed real estate professional.

New Tax Law

2010 was a contentious year politically, and from that contention came a whole wave of new tax laws. Focused first on the economy, the Hiring Incentives to Restore Employment (HIRE) Act was passed early in the year. Following the HIRE Act, the comprehensive health care reform package was passed in March, which included significant tax pieces. In fall, the Small Business
Jobs Act was passed, and finally—just in time for the holidays—the Tax Relief Act was passed, temporarily extending what are popularly known as the “Bush Tax Cuts.”

Within these new tax laws, there were several high points for the self-employed:

• A deduction for self-employed health insurance premiums when computing self-employment tax – As any self-employed person knows, it is not always the income tax that creates the most burden; it’s the self-employment tax. Self-employment tax is a whopping 15.3% of your earned income, and has surprised more than one REALTOR^® come tax time. This new deduction allows a self-employed person a deduction for health insurance premiums paid in computing the self-employment tax – and the savings could easily be four figures. Whether you prepare your own tax return or use a local accountant, don’t miss this opportunity.
• A reduction in the self-employment tax in 2011 – For one year only, the self-employment tax on the first $106,800 of self-employment income has been cut by 2%, decreasing the self-employment tax to 13.3% instead of 15.3%. Take this relief into account when calculating your estimated taxes for 2011. For a real estate broker earning $50,000 after expenses, this is a $1,000 tax savings. But don’t get too used to it – the law is only good for the 2011 tax year. In 2012, the selfemployment income tax rate hikes back to 15.3%.
• Tax rates extended – The final tax-related act by Congress this year was the extension of all of the so-called “Bush Tax Cuts.” With its passage at the end of December, the extension means that tax rates for everyone, regardless of income, will not go up in 2011. Keep in mind, however, that these tax rates are only extended through 2012; so planning for income and deductions between 2012 and 2013 should be a focus for next year.

Rollovers

One of the tax laws that significantly changed in 2010 was allowing an individual to roll over amounts held in pre-tax accounts (such as IRAs or 401ks) into Roth accounts. While this type of rollover had been allowed in the past, in 2010 income limitations were removed, opening the planning technique for everyone. In addition, amounts rolled over into Roth accounts in 2010 had the benefit of deferring tax on the rollover until 2011 and 2012.

Why is a Roth account better than an IRA? Because when distributions are eventually taken out of the Roth account (at retirement), they are not subject to income tax; whereas distributions from a regular IRA are subject to income tax. This can create a huge tax savings in your later years and leave you more money for grandkids education, travel, and other activities.

If you didn’t convert your pre-tax IRA’s into Roths in 2010, don’t worry; you can still do this in 2011. You just won’t get the deferral of income tax on the conversion.

There are many factors to consider when deciding whether or not a conversion will be worth it to you. These include your current tax rate situation, your age, and your expected retirement and lifestyle requirements. If you have not spoken to your accountant or financial adviser about a conversion, I’d suggest you make the inquiry this year.

In addition to the new tax law opportunities described above, there are several other tried and true methods an individual REALTOR^® can use to lower his orher tax burden.

Flipping

More and more REALTORS^® are tackling “flipping” (the purchase, renovation and quick sale of a property for profit) as a new business opportunity to enhance earnings.

REALTORS^® are in a unique position to take advantage of this market. They know the motivated sellers, the opportunity areas, and the market conditions on what will sell and for how much. In addition, they have easy access to a wide inventory of properties.

“Flipping” income has the potential to be classified as capital gain income, which is not subject to the self-employment tax, or as earned income from self-employment, which is subject to the self-employment tax. The rules for flip income can be complex, but in general they depend on how often flips are done, how long the flipped property is held, and the time and effort put into the fix-up by the seller. This is an area where you want to be particularly careful and consult your tax advisor in an effort to minimize the tax impact of your flip income.

Establish a Retirement Plan

One of the most effective tools of tax planning is to establish a retirement plan. Besides being good for your future, most retirement plans offer current year tax deductions that save on taxes right now. Here are some of the different retirement options that any self-employed broker may choose from:

• Individual Retirement Account (IRA) – The IRA is the easiest plan to administer – in trade for extensive limitations relative to other plans. The maximum deductible contribution to an IRA in 2010 was $5,000 (or $6,000 for those 50 and older). The deduction is potentially limited for individuals participating in another retirement plan, or whose spouse is participating in a retirement plan. The IRA is adopted by the individual, not the business, so other employees of the business do not participate in the contribution. Individuals have until April 18, 2011 to make contributions to an IRA for the 2010 year.
• As an alternative to the traditional IRA, a Roth IRA is also an option. The Roth IRA does not offer a current tax break, but earnings grow tax free, and later distributions at retirement are not subject to taxes.
• Simplified Employee Pension (SEP) Plan – The SEP is a type of IRA account that may allow for larger contributions than the traditional IRA. The maximum deduction amount for a selfemployed person is approximately 20% of self-employment income; up to a maximum of $49,000 in 2010. The same limit of $49,000 applies to 2011 as well. The decision to establish and contribute to a SEP for 2010 can be made up to the extended due date of your 2010 return.
• The Solo 401(k) Plan – The solo 401(k) plan is similar to a traditional SEP plan, but is only used when there are no other employees. The self-employed person may contribute an additional $16,500 ($22,000 if 50 or over) beyond the 20% limitation of the SEP Plan. However, the overall contribution is limited to $49,000 (or $54,500 if using the 50+ catch-up provision.) This type of plan has to be established before the end of the year.

Deduct Your Home Office Expense

If you are a REALTOR^® using your home as a main office, be sure to capture expenses related to the office portion of your home. Include such items as mortgage interest, real estate taxes, and utilities. Don’t forget your office computer, Internet connection and cell phone as well as hidden deductions for repairs and depreciation for the part of your home used as an office.

Maximize the Deductions for Your Health Related Expenses

There are several techniques to make sure you are spending pre-tax dollars on health care expenses.

Consider establishing a Health Savings Account (HSA). In addition to the premium saved under the required high deductible health plan, an HSA allows for tax-deductible contributions into an account that can be later used to pay for health care expenses. Unused amounts can grow tax deferred and used in a future year.

If health expenses are significant, consider employing your spouse, and then setting up a medical reimbursement account for your spouse and family. Not only will dollars spent for health expenses provide a deduction for income taxes, but they will provide a deduction for self-employment tax as well.

Business Loss

If your business has low income or a loss for the year, consideration may be given to the following:

• Roll over your pre-tax accounts into a Roth account
• Postpone deductions, such as real estate taxes or charitable contributions, into the next year if you expect more income in the next year
• Put off purchases until next year, such as for a computer or car, if the deduction for the next year will offset higher taxed income

Proper timing of income and loss items during a loss year will help you get the most out of your tax deductible items.

Entity Choice - LLC or S Corporation

Is your business currently a sole proprietorship or a Limited Liability Corporation (LLC)? Have you considered being taxed as an S Corporation? While wholly owned LLCs have become more fashionable, an S Corporation still provides the opportunity to save on your self-employment tax bill. An S Corporation generating $60,000 of taxable income can save upwards of $3,000 in self-employment taxes over an LLC generating the same taxable income. Careful planning is required to use an S-Corporation to ensure that a reasonable wage is set and all appropriate payroll tax forms are prepared.

Estimated Taxes

If you are self-employed, you know that taxes must be paid in quarterly in order to avoid costly penalties. There are two alternatives to determine the amount you need to pay in:

1. Pay in based on a percentage of your total tax for the last year; or
2. Pay in a percentage of your total tax for the current year.

By computing your estimated tax under the appropriate method, you will keep your money longer, and not end up giving Uncle Sam a tax-free loan by way of overpaid estimated taxes. Factors to keep in mind when estimating: Take into account your spouse’s income and withholding, and whether you are expecting a higher income in the current year.

So there you have it: a compelling selection of possible 2011 tax advantages for self-employed REALTORS^®. I hope you find them useful. Please speak to your accountant or financial adviser on how you can take advantage of these tax-saving opportunities.

Eric P. Trost, CPA, MST is a Principal and Co-leader of the tax department at SVA Certified Public Accountant, S.C. Eric provides expertise to the real estate and construction industry groups within SVA, and heads up the firm’s cost segregation practice. 

 

 

Published: February 18, 2011