LLC or PA for Realtors, Which One Is Better for Real Estate Agents?
In this video we discuss the advantages and disadvantages of an LLC and PA (Professional Association) for realtors or real estate agents. Many real estate agents do not know which business structure is better for them, and that is why we answer if an LLC or a PA is better for realtors.
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One of the most common questions that we get here at FreedomTax accounting is, I’m a realtor and a lot of people are telling me to open up an LLC and a lot of people are telling me that it’s better to open up a PA to manage my realtor business, so which one is better the PA or the LLC? That’s what we’re going to talk about in this video.
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Now, many real estate agents come to our firm because their realtor sales are growing and they are reading a lot in google, other real estate agents are telling them that it’s better for them to operate their real estate business via an LLC or a PA, and they have a lot of questions on determining which one is better for my realtor business, the LLC or the PA, so let’s go into the content once again that’s what we’re going to talk about the PA vs the LLC for realtors.
Now, remember that we at FreedomTax Accounting, we are tax professionals that we specialize for foreign national real estate inventors; we do provide tax services to any type of real estate investor but we specialize for foreign nationals since a lot of accounting firms they do not know the specifics on handling foreign national inventors because their tax situation is a little bit different.
So, how do we help these foreign national real estate investors? We can help them open up an LLC in any of the US’s states; we are experts at FIRPTA, many tax accounting firms they have no idea how to work the FIRPTA tax withholding certificate, here at FreedomTax accounting, we have been doing FIRPTA for many years; we can help these foreign investors get their ITIN numbers and we can help them with their personal and corporate tax preparation. So, if you are a realtor and you have a foreigner that is a seller or a buyer, then you can reach out to us so we can help them in any tax questions that they may have.
Realtors can work in different business structures, the most common one is that most realtors work as sole proprietors as self-employed where everything is under their name and their income is being reported under their social security number. Another way they can work is under a PA or Professional Association, the PA is a very old business structure in the US. The PA was founded back in the 1800’s, it’s a more traditional way where a lot of realtors think this is the best way to go because it’s a very traditional way of operating their real estate sales, but in this video, you’re going to see that we think that the LLC is better option, and we’re going to show you that. They can also work under LLC, the Limited Liability Company; the LLC is a business structure that started the late 80’s, so it’s a more modern or current business structure. And there’s also a corporation.
For real estate agents we really don’t recommend opening up a corporation for, the real estate business corporations are more for bigger businesses that someday they want to go public, like the Amazons; so most likely a realtor is going to either grow their business structure to a PA or an LLC.
Now, here FreedomTax Accounting we feel that the LLC is the better option and we’re going to show you why.
There are advantages on working under a PA or an LLC compared to working as a realtor as self-employed, there are legal advantages and their tax advantage.
let’s start with the legal advantages, when you work as a realtor as self-employed, meaning that it’s under your name, the income is reported under your social security number. Basically, you have no personal liability protection, so your personal assets are not protected from business debt or claims. What does that mean, that means that your personal assets are at risk. God forbid there’s an error in any real estate sale that you do and someone tries to sue you; the lawsuit is going to go against you as a person, that means that your personal assets, cash in the bank, your properties, your cars, your stocks, your cryptocurrency, all your assets are now at risk because you can lose them in a lawsuit, because you’re basically managing your business under you name.
In comparison when you work your real estate agent business under a PA or an LLC, you as the owner of the PA or you as the owner of the LC, you are protected from personal liability and it protects your personal assets, meaning that if there is a lawsuit against you for any type of error in your realtor business, your personal assets are protected, why? because you are basically providing your real estate agent service through an entity, even though you are the owner and you are the realtor, the PA or the LLC is the one providing the real estate agent service. So, in a lawsuit, your personal assets are protected, so far that alone is a big advantage of working under a PA or an LCC compared to working under your personal name as a real estate agent.
Now, there is a legal advantage of the LLC over the PA. Let me explain, when you open up a PA the owner is provided with stock, so you have stock on your PA. The LLC does not have stock, the LLC provides units of ownership, so you have a percentage or ownership in an LLC, if you’re the only owner then it’s 100% units towards you.
Now, what’s the difference legally between owning stock and owning units of ownership in an LLC? It’s basically that stock has monetary value, what does that mean? It means that if you have a PA and you as a realtor you go bankrupt under your personal name, when you go to bankruptcy court, the bankruptcy court is going to determine that you have stock in a business and they’re going to give that stock to the bank that you owe the money to, so under a PA if you go into bankruptcy under your personal name the bankruptcy court can go after your stock and you’re going to lose your business. So, under the LLC that cannot happen because under the LLC you don’t have stock, the units of ownership don’t have monetary value in bankruptcy court, so if you are working under an LLC and you go into bankruptcy on a personal level, the bankruptcy court cannot go after your LLC. So that’s another legal advantage of the LLC over the PA.
Now let’s talk about taxes. When you work your real estate realtor business as self-employed, under your name, not under an LLC not under a PA, the IRS sees you for tax purposes as a Sole Proprietor, basically you have to file your real estate sales income and expenses under a Schedule C that goes inside the form 1040, which is your personal tax return, and this is you only option; if you are working as a realtor under your name you will always have to file your business income and expenses under a Schedule C, you have no other option. And what happens? Schedule C you have to pay self-employment tax from your business net profit, and let me explain how that works.
So, this is the way taxes work if you are a Sole Proprietor, meaning that you are working your real estate business as self-employed, remember that you real estate sales you must report it under form schedule C, and the form schedule C is a form that goes inside the form 1040 which is your personal tax return.
The schedule C you report your sales, you have your expenses and then you have your net profit. This net profit is reported as additional income in your personal tax return, and you’re going to pay federal tax which starts at 10 % but it can go all the way up to 37%, and what will determine the tax rate is the household income. So, remember that the sale from your real estate business, the net profit is going to be added to your household income, and whatever the household income is then that will determine the tax rate on the different tax tables.
Additional to the federal tax, this income will also pay self-employment tax which is 15.3% tax, most of that is social security, the rest is Medicare; so minimum, as self-employed, minimum tax that you’re going to pay on your Schedule C net profit is going to be 25.3% in taxes, which is the minimum 10% federal tax and self-employment of 15.3%.
Note this is the tax rate with the current tax table, we are recording this video in 2021, this may change in the future, but this is with the current tax rate. So that’s the way taxes work under a sole proprietor. Now, this tax structure has advantages and disadvantages.
The advantages are the schedule C is the simplest tax form, meaning that it’s very economical, you don’t have to do any type of elaborate accounting, you can take a summary to your CPA at the end of the year, you can just tell your CPA these are my sale, these are my expenses and most probably your CPA will do the schedule C for you; you don’t have to pay yourself under payroll, you just take money from your real estate business account; so it’s very economical and it’s a very simple business tax structure; you do pay higher taxes, but it’s a very simple tax structure to manage during the year. So that’s the way taxes work for a sole proprietor or a self-employed realtor.
Now, what happens under an LLC? The LLC has tax flexibility. When you open up an LLC with one owner the IRS give this single member LLC an automatic designation for taxes, and the IRS says that that single member LLC for tax purposes it is considered a Sole Proprietorship and you file Schedule C. So, for tax purposes when you open up an LLC, for tax purposes you end up automatically in the same Sole Proprietorship tax structure that if you were self-employed, with the advantage that now you’re working under an LLC and you get the legal protection. But the advantage is, that once your sole proprietorship grows you can change the tax structure of the LLC; remember that if you’re working as self-employed, the only option you have is the schedule C, you have no other tax option. Under the LLC you can tell the IRS that you want your sole proprietorship or you LLC to file taxes as a S-Corp or as a C-Corp, which depending on the case then you can choose which one is better for you.
Now, how does taxes work for LLCs as a Sole Proprietor, meaning that you’re a realtor, you open up a single member LLC? Remember that the automatic designation is that that LLC is going to file taxes as a sole proprietor, that means that legally you are an LLC, but for taxes you are a sole proprietor; an it’s the same thing as if you were self-employed, you file schedule C inside your personal tax return, you have your sales, you have your expenses, you have your net profit, this net profit is reported under your personal tax return, and you pay the federal tax that starts at 10%, and you also pay the self-employment tax which is 15.3%; so it’s exactly the same as a sole proprietor.
This tax structure is good when your real estate business is small, but once your sale start growing and your net profit starts being $40.000 dollars or more in a year, then this tax structure is not good for you because this self-employment tax is going to hurt you at the end of the year; that’s when we recommend the LLC to chance the tax structure to an S-Corp or to a C-Corp; but if your sole proprietorship is not making $40.000 dollars or more in net profit in the year, then it’s better for you to keep yourself under the Schedule C for tax purposes. If your net profit is over $40.000 dollars in the year then your first option, which usually is the best option, is to change your LLC tax structure to an S-Corporation.
How does the S-Corporation work? Under the S-Corporation now you need to file form 1120-S, which is not the Schedule C, form 1120 is a separate corporate tax return, so it doesn’t go inside your personal tax return. How does the escort work for taxes? You have your sales, you deduct your expenses, and you have your net profit at the end of the year; this net profit also gets reported under your personal tax return, in this case the 1120-S, the S-Corp tax return, produces a form which is called the S-Corp K-1 form, that K-1 form has the net profit and you need to report that net profit in your personal tax return as additional income.
Now, this net income is also going to pay the federal tax which starts at 10%, but remember it can go all the way up to 37%; and remember the self-employment tax which is 15.3%. The advantage of the S-Corp is that you do not pay self-employment tax and you only pay the federal tax rate, so that automatically you’re saving 15.3% in taxes so that’s a lot.
Now, you may ask yourself if the S-Corporation gives me an automatic 15.3% tax advantage, why doesn’t everyone work under an escort? Let me show you why. Because the S-Corporation does give you a tax advantage, but it has more requirements during the year. Why? Because the 1120 form is not a simple form, compared to the Schedule C, so when tax time comes and you need to file your corporate tax for your escort the 1120-S is a more expensive tax return to fill out; the accounting is not that simple as the Schedule C, so most probably you are going to have to pay for bookkeeping services, because the accounting is more complex. Also, a major difference is that under an S-Corp, you as the owner of the S-Corp, from your real estate sales you have to pay yourself via payroll, meaning that you have to now pay a payroll service, sending payroll quarterly reports, sending quarterly payroll payments; so, as you can see the S-Corporation is more complex, during the year you have more expenses, but since at the end of the year you save so much in taxes that it makes sense to inquire in these extra operational expenses during the year and to save a lot in taxes at the end of the year. That is why we recommend that you only change from a sole proprietorship to an S-Corporation once your net profit if $40.000 dollars or more; because if your net profit is $40.000 dollars or less, than the extra expenses of the S-Corp there, you’re not going to save that much in taxes compared to the additional expenses that he S-Corp has; but once your LLC starts making $40.000 dollars or more in net profit, then at that point it does make sense that your LLC changed to an S-Corp, even though you have to pay additional services during the year, the amount of taxes you save at the end of the year is so much that is worth inquiring in these additional yearly expenses.
Now, what happens if you decide to change not for an S-Corp, but you decide that your LLC filed taxes as a C-Corporation? Under a C-Corporation you have to file form 1120, which is a corporate tax return; you report your sales, you have your expenses, and you have your net profit. Now, under a C-Corp that net profit does not flow into your personal tax return.
Right now, this net profit is going to have a flat corporate tax of 21%, (That is the current corporate tax rate, that corporate tax rate may change in the future; so, 2021 this is the corporate tax rate).
The disadvantage of the C-Corporation once again is similar to the S-Corporation. The 1120 form is a very complex form compared to the schedule C, the accounting is a little bit more elaborate, so you should hire a CPA or a bookkeeper to keep your C-Corporation bookkeeping up to date; if you’re the owner of a C-Corporation you do have to pay yourself in payroll as well; but the main disadvantage of the C-Corporation compared to the sole proprietorship and to the S-Corp is, that at some point from the net profit you as the owner have to take a dividend, and that dividend pays from 0% all the way to 20% tax; what does that mean? Let’s say that you take a dividend of $10.000 dollars, that $10.000 dollars pays taxes here, on the corporate side, and it pays also taxes here under your personal income, so it’s double taxation under the C-Corporation; but there are cases where a C corporation is the best option, but I would say like for 90% of the cases, the S-Corporation is better choice, but there are cases where C-Corporation is the better choice for the realtor.
Let’s go now to the PA, how does the professional association work for taxes? When you open up a PA the automatic designation for taxes is that you are a C-Corp, so there’s no sole proprietorship option, there’s no simple tax structure option. Once you open a PA, you’re automatically a C-Corporation, which means that automatically you are tied into a complex tax structure; but you can tell the IRS that you want your PA to be taxed as a C-Corporation. So, when you open up a PA you end up as a C-Corporation automatically, meaning that you have your sales, your expenses, your net profit, you pay corporate tax of 21%, you have to pay yourself in payroll, and you are subject to double taxation dividend tax. So, there’s no simple tax structure option, you are automatically a C-Corporation. But you can change your PA to be an S-Corporation, which files form is 1120-S, same thing as the LCC; your net profit is included to your net income, you’re only going to pay federal tax, and you don’t pay social security tax, but now you do have to pay yourself in payroll. So, those are the two options as a PA.
In summary, if you are working as a realtor you can work in three ways. You’re either going to be self-employed, which is everything under your name, and your only tax option is the Sole Proprietorship, which is the simple form. You can work under an LLC, you have three tax options, and the good thing is that you have the option of having the simple tax structure of a Sole Proprietorship, and then as you grow you can change to an S-Corporation or a C-Corporation. Or you can work under a PA, and you have these two; you can work as a C-Corp or as an S-Corp.
As you can see, we like the LLC better than the PA because basically you have more legal advantage and also the realtor can start small under the LLC and they can file taxes under a simple sole proprietorship tax structure, and they don’t have to pay themselves in payroll. Once their realtor sales grow and once their net profit reaches $40.000 dollars or more, then they can transition over to a more complex tax structure, which usually the best option is the S-Corp; there are some cases where a C corporation is better. If you work under a PA, you are automatically tied to any one of these two complex tax structures, there’s no simple sole proprietorship option.
Once again, what’s the advantage of the LLC over the PA? Is that the realtor can basically start small, get the legal protection, start with a simple tax structure, and as you grow then you can change your tax structure to a S-Corp or a C-Corp. So that’s why at least here at FreedomTax we like the LLC over the PA for realtors.
Now, remember that this is general information, every case can be different so we always advise that you have a consultation with an advisor, with a professional, so you know which tax structure or legal structure is better for your specific case. If you do want that type of consultation there is our contact information below and we will gladly provide a consultation, and depending on your case, we will design a legal and tax structure that’s better for your specific case.
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