In this episode we talk about many of the recent changes in tax law and how they affect Real Estate Agents and small businesses.
- Consult with your own tax advisor!
- Standard Deduction has doubled to $24,000 in 2019
- Look at your business structure. It can make a huge difference in the way and amount of taxes that you pay.
- Keep a detailed log of all your business activities.
- Meet with your accountant at least a few a times per year
It’s Tax Time with Mike Wright Podcast Transcript
Adam Small: Hello and welcome to the Real Estate Marketing Minute. I’m your host Adam Small, and with us today is Kimberly Small. Hi Kim.
Kimberly Small: Hi.
Adam Small: How are you doing today?
Kimberly Small: Can’t complain.
Adam Small: Great, great. So today we are in the offices of Taxwright with Mr. Mike Wright, an accountant. Hi Mike, how are you?
Mike Wright: I’m good. How are you all?
Adam Small: Doing well, thank you very much. Thank you so much for joining us on our podcast and having us here at your offices, we do appreciate it.
Mike Wright: It was my pleasure.
Adam Small: Great. So what we are gonna be doing today is kinda talk about some of the recent tax changes, tax law changes, and kinda talk about how they may or may not impact a real estate agent, depending on how their business is structured. So the first thing I’m gonna say is that this is not meant to be tax advice and you should always consult with your own tax advisor before taxing any step based on any of this information. So with that said, Mike, why don’t you tell us a little bit about yourself?
Mike Wright: Well, I got into the accounting business because for 30 years I was an insurance auditor, audited small business for a large insurance company all over Indiana and for a while in Texas, and as the requirements to drive around got to be a little bit more onerous, I started my own business in my basement doing taxes for folks. I did my first paid tax return in 1992 and I’ve been doing more and more every year since. My focus is on individual tax preparation because people that are in business for themselves have to file tax returns, then obviously my experience in doing business audits was helpful in bringing that about, and so now I function as a full business accountant, not just focusing on only taxes but also book keeping and profit building and business development and so forth.
Adam Small: And you must be doing something right. You’ve been doing it for a while.
Mike Wright: I have.
Adam Small: Great. So real estate agents are generally considered independent contractors that are affiliated with a company. So can you tell us a little bit about how that’s different from being a regular W2 employee as opposed to that independent contractor status?
Mike Wright: It’s important, this year particularly, because of the big changes that were made in the tax law in 2017, and this is the first year that those results are being seen. It’s particularly important to remember that a self-employed person has a broader range of ways to reduce their taxable income than an employed person does. W2 employees are pretty accustomed to the normal deductions for mortgage interest and charitable contributions and so forth, but with the new standard deductions for those people, in most cases those amounts of money will no longer be significant, ’cause for a married filing joint couple, we’re looking at a deduction, a standard deduction of 24000 dollars, which is pretty substantial for most folks.
Adam Small: And it used to be 12000, is that right?
Mike Wright: Yes.
Adam Small: So it’s doubled. That’s really a big difference.
Mike Wright: It is. It is, and however with someone that’s in business, as indicated by a 1099 report, they get to deduct all of the expenses that are related to their trade or business, in most cases, a 100 percent. There is a reduction for meals at 50 percent, but other than that, everything is 100 percent. But the key is that those deductions have to be ordinary and necessary expenses for that business and that can be a relative term, but that’s the standard there. So that’s the good side because it helps reduce your income by being able to take those business expenses off.
The downside is that by being self-employed, it’s necessary that you pay what’s called the self-employment tax, and what that is, is the social security and Medicare tax that everybody pays, and as an employee, you pay half out of your wages and your employer pays the other half. As a self-employed person, you’re obligated to pay both halves, and that runs about 15 and a half percent of the profits that you make in your business, in addition to whatever other income tax you may have to pay. And that’s probably the biggest shock that W2 employees get when they find that out.
Adam Small: When they switch from W2 to independent contractor.
Mike Wright: I wasn’t clear about that, but yes, that’s it.
Adam Small: Well, I just wanted to make sure in my head.
Kimberly Small: So some real estate agents are married couples that are working together, and sometimes both spouses are licensed real estate agents, and sometimes one is licensed and the other is considered a team member or performing in administrative functions or what not. What should they be considered? What should they consider when they are filing, depending on those situations?
Mike Wright: Well this is an item that I’m going to put a disclaimer on top of the disclaimer that Adam already gave, simply because this is something that you really want to attend to closely with whoever you rely on for tax advice, because there are a variety of things built into this kind of situation. One of the issues has to do with whether or not the couple is working as an organized LLC, which if they are both working as licensed agents and operating in the sales end of the business, they could be doing and they would both be reporting as partners, with a partnership return if it’s an LLC. If they aren’t an LLC and they’re both working in the real estate activity directly as sales people, then they can both get away with just filing a single schedule C for each of them. They don’t have to file the separate partnership return, which the IRS would require in the case on the LLC.
And then there’s also the possibility that if one of the spouses is the active licensed agent and the other spouse is the backroom support person that that agent relies on, then it makes sense for the spouse that’s doing the backroom work to be considered an employee because there are some advantages that can be had. For one thing, the employee wages that the active licensed spouse pays the other spouse is an expense, which lowers the self employment tax for the active agent spouse, although you do have to pay the taxes for the spouse that’s receiving wages. So, so many of these things are like a balancing act. You have to decide what the left hand is doing and what the right hand is doing and which one makes more sense for your situation, which is why, third time for this disclaimer, you have to talk to a tax professional about this.
Kimberly Small: And you talk about, you know we’ve talked, and like you said a couple times, about consulting with your tax advisor. How often should people in general be reaching out to their accountant or their tax advisor, and is it different for independent contractors or probably somebody that’s just getting started?
Mike Wright: The more often you can talk with the person that you rely upon for tax advice in general, the better it is. I always make sure that my clients that come to me, those that are not in business for themselves, I make sure that we have a conversation midyear, every year, so that we can make sure where they’re going, what their plans are, and we can make adjustment accordingly. It needs to be during the year, not at tax season, because you can only make changes during the year. For a person that’s self-employed or has other kinds of business concerns, then again, the more often they can meet and discuss these issues, the more important it is. And for my own clients that are in business, I have a variety of programs that let them choose whether they want to meet once a month or once a quarter as part of a subscription program, but whatever kinds of situation, your own tax advisor does. If they want to get together with you, I whole heartedly recommend it, because the more you know, they better actions you can take to minimize your tax bill.
Adam Small: So the more and earlier, the better, is what it sounds like.
Mike Wright: Absolutely. Although don’t get too early. I mean, we could do an estimate right now for the rest of the year, granted we’ve only got a month and a half into this year.
Adam Small: And it would probably be off, right?
Mike Wright: Exactly.
Adam Small: Yeah.
Mike Wright: So that’s why I recommend for the one time a year folks that we do it at midyear some time.
Adam Small: Okay, great. So there have been some tax changes as you mentioned earlier and we kinda touched on one, and they’re taking place this year. Can we talk a little bit about what impact they’re gonna have in general on people’s taxes?
Mike Wright: Sure. I mean, there’s a welter of them. We could spend a couple hours going over the different ones.
Adam Small: Well, we’ve got all day.
Mike Wright: Okay. Well me being a tax guy, I could go on and on, but let me focus on the ones that I get the most questions about.
Adam Small: Okay, that’d be great.
Mike Wright: Everybody, whether they’re in business or not on their individual tax return, does enjoy the newly increased standard deduction as we talked about before. That’s a really big thing, and because we’ve eliminated the personal exemptions, you know, you used to figure out how many kids you had and you’d get an exemption for each one, that no longer applies.
Adam Small: Okay.
Mike Wright: There are other cases where being able to demonstrate that a person is your dependent is still important in such areas, most probably for most people that are in business as real estate agents and have kids in college, the American Opportunity Credit is a really big deal and can be a substantial saving. That has not changed, but sometimes people get confused, what’s a dependent for and what’s not a dependent and so forth. So that’s still there. The other thing that has impacted people though is the elimination of what many employed people, people on a W2, used to be able to use to reduce their income, it’s called a miscellaneous deduction. Essentially they were unreimbursed employee expenses. So if your employee required you to drive or to have a home office or things of that sort, you got a deduction on your individual tax return for them. Those are gone.
Adam Small: So your mileage is all gone now?
Mike Wright: As an employee, yes. So that’s probably one of the biggest shocks for people who are W2 employees because this just … It was talked about when the law was passed, but now that people are doing their tax returns is when they’re really gonna see how much difference it makes. So that’s an important one. But I do want to shift mostly to business people, self-employed people, and I want to comment specifically on the whole issue of trader business, because what I’m gonna talk about next only applies if you are in a trader business, and a trader business is essentially some activity that you do with the intention of making a profit.
I want to underscore that I use the word intention because you don’t actually have to make a profit, you just have to be able to demonstrate that you’re doing the things that a business of your type would do to make a profit, and you also need to be able to demonstrate that you’re making an effort to improve your situation by a variety of means if you’re not making a profit. I always like to tell people, and I believe these facts are accurate, but Amazon.com did not make a profit for eight years and nobody ever considered that they were not a real trader business.
Adam Small: Right, right.
Mike Wright: That’s important. But as a trader business, then you are entitled to deduct all, and I underscore all, ordinary and necessary expenses that pertain to your business. So advertising pieces, business cards, mileage or other automobile expenses come in.
Adam Small: So as an independent contractor or a business owner it would come in, but as an employee it does not.
Mike Wright: Exactly.
Adam Small: So that’s really interesting and definitely very great for some people.
Mike Wright: It will, but again, I want to go back with everything I’ve seen, both in the estimates that we made last year when we knew what the law would be, and we were able to look at last year’s returns, and the returns I’ve actually done this year. It does seem to balance out okay.
Adam Small: Oh well, that’s good.
Mike Wright: Because of that standard deduction increase.
Adam Small: Right, right, right. Good.
Mike Wright: So that’s a good thing. The other thing that I do want to mention before we go onto our next question as far as the changes in business, have to do with the new 20 percent business, qualified business income deduction. It’s always a hard one to remember how to say. And what it does is provide those people who are in what we call pass through organizations, which would be partnerships, proprietorship, LLCs and S corps, the opportunity to deduct 20 percent of the qualified business income for their business from their personal tax return. There are some restrictions in there based upon the kind of business you have, specifically personal service businesses, and there’s also restrictions applying to how much wages you pay to other people, and what’s your total income is if you are a personal service business. So there are some gears and levers in that thing, but it’s close enough for most people that it likely would be about a 20 percent of your qualified business income that’s deducted.
Adam Small: That’s great! So you don’t get taxed on that is essentially what happens.
Mike Wright: Exactly.
Adam Small: Right.
Mike Wright: Because it’s reduced just like, just like the standard deduction on the other. I mean, the intent of this was to make it easier for people who are in, or to make compensation for people, who are in these pass-through organizations from the reduction of the corporate income tax for C corps, which went from like 35 percent and the 22 percent, and so that’s why they built this in.
Adam Small: Okay, great.
Kimberly Small: So you talked about an agent, or an independent contractor being able to show that it is their intent to make a profit. I know some real estate agents, they’re doing it on the side, they have something else that is their primary focus for their job, or there’s a lot of agents that are transitioning from another career, but it is their intent to go into real estate full time and make money doing so. So what are some considerations for those two types of scenarios.
Mike Wright: There is a list, and you can look it up online if you want, I’ve heard the list called nine points up to 19 points, I’m not sure what it is, but these are the things that the IRS looks for as characteristics of a business. There are things like having separate business bank accounts, there are things like doing the same kinds of things that other businesses in your realm do to be in business. It’s the kinds of things like how do you spend your time when you’re not physically doing the business itself, what do you do to promote your business, what is your intention with the business as far as how do you … Why do you want to make a profit? These are all issues that individually and collectively need to be present for someone to be able to withstand an audit approach that says they’re not a business.
This is very important because under the new law there is … The only way you can get the deductions for business expenses is to have a business, and so you need to keep logs of the time you spend, particularly if you’re a part-time person, in the real estate business itself. So you’d have a notebook somewhere or some kind of software on your smartphone that indicates the hours that you spent, and who you saw, and what you were doing that related to the real estate business as opposed to whatever your other business or other activities were. Like I said, the separate business bank accounts are a really important feature, and if you decide to organize in some way, create an entity like an LLC or an S corp to have those filings made appropriately and registered with the community or the Secretary of State or whatever the registration process is where you are.
And so those kinds of things are just the kinds of things that any business would do, and so that applies to you and that’s what you can say that works. I had an audit once, and it was not with a real estate person, it was a person that was dealing with drag racing, and as you might guess, most of those people, particularly someone like he that was starting out, they lose money. And so we had an audit, and so I sat in on the audit with him and the audit examiner was asking questions like, “Why do you take people out to lunch?” “Well I just, trying to get sponsor.” “Well, what do you do with the sponsorship money?” “Well, I use it on my cars.” But then as she got more detailed into those questions and it became obvious that he really had never though through the business aspects of what he was doing as, he just wanted to race cars fast, and he’d never really thought through what he had to do to be a business at that. And the audit … He had to pay back money that he had taken off.
Adam Small: That he deducted.
Mike Wright: That he deducted.
Adam Small: Yeah.
Mike Wright: And so-
Adam Small: Well that’s a shame.
Mike Wright: It is a shame but I mean, it shows the kinds of things that can happen. Yeah, you can lose money but you have to be, if you’re called to task on it, you need to be able to have your ducks in a row.
Adam Small: Right.
Mike Wright: And that’s the kinds of things that they’re looking for.
Adam Small: Alright. So there have been some rulings recently that are of particular interest to real estate agents. Mike, can you tell us a little bit about those?
Mike Wright: Yeah. There have been a couple that I’d like to highlight, and they relate to the fact that sometimes this law is not very clear, and so we all have to rely upon the IRS to tell us what the law means, which is their job.
Adam Small: So even though the law is written, they basically say, “This is how we’re interpreting it.”
Mike Wright: We call it guidance. We get guidance from the IRS on how to do things. And so one of the things that has to deal with, is the qualified business income deduction, and because of the limitation on that as a whether the person is in a trader business and they’ve provided us with some, or provided the real estate agents, with some regulations that make a little bit more sense about that. It simplifies the process that they, owners of rental real estate, and this doesn’t have to do with real estate agents that only trade in real estate, we’re talking about investors in real estate, and it simplifies the process that they have to use to show whether or not what they’re doing is in fact a trader business.
I like to use the example of, you inherited aunt Matilda’s house and just decide to rent it out to people and that’s all you do as a landlord, that is not a trader business. And so while you get the deductions that are appropriate to you having a rental property specifically, you don’t get the 20 percent business income deduction, you don’t get any of the other deductions that might go along with that.
Adam Small: Because you’re not really running a business.
Mike Wright: Exactly.
Adam Small: You’re just renting out the house as opposed to renting out 15 houses and maintaining them and all that.
Mike Wright: Exactly.
Adam Small: Okay.
Mike Wright: And so that’s an important distinction and this new ruling helps clarify that for people that maybe have five houses, not just one house. So it allows them to show what they need to do. And one of the things they instituted, which is something us tax payers like is something called a safe harbor. And a safe harbor simply means we’re not gonna ask you any more questions as long as you can qualify for these two things, and these two things are primarily 250 hours spent a year on maintenance of the property that you have as a safe harbor for that qualification. So that’s one of the things.
Another thing that is still kind of up in the air and you really need to talk with your advisor about, is the qualified improvement depreciation rules. As you all know, residential and commercial property both has to be depreciated over decades, not just years, but many improvements that are installed in certain kinds of properties qualify for a shorter depreciation period, and they also qualify for a different time of depreciation and I won’t go into the differences between MACRS and ACRS, but they’re different kinds of depreciation. Well congress and its wisdom took out the rules and promised to put them back in, but as far as I know, they were not put back in because they didn’t get included in any kind of reconciliation bill or one of the improvement bills that they’ve done. Now, if I’m wrong about that, I apologize, which is why you want to talk to your own tax advisor.
Adam Small: I knew that disclaimer was coming.
Mike Wright: But that’s a big thing because many real estate investors rely upon those special treatment items to make what they’re doing more profitable for them, and so that’s an important thing to remember. And those are probably the two biggest things that just specifically relate to real estate that’s come up.
Adam Small: Great. Thanks so much.
Kimberly Small: So we talked about a midyear meeting and obviously a meeting to get taxes done. An agent that is just getting started, who’s never been an independent contractor and that, I would imagine, that they would start out by meeting with their accountant to try to out what makes the most sense for their situation. For that midyear meeting and for when they come to you to get their taxes done, what are some of the things that they should have with them and what should they have planned to have in order to make it a good meeting?
Mike Wright: Okay. Well, there are a couple things. Remember I made a big point about having a business bank account, having recent statements of your business bank account would be important because, midyear particularly, you’re not gonna have a 1099 or anything like that to go. If they are doing the proper thing and keeping some kind of books, whether it’s something as elaborate as QuickBooks or just a nice Excel spreadsheet somewhere, they need to have that available for this conversation. It’s important when you’re doing an activity that requires certain number of hours to qualify to be in that activity, whether it’s the 250 hours safe harbor or the 750 hour professional real estate professional, real estate professional log. A log is a very important thing to have, and by a log I mean a listing of what you did on days that you were working, and if you’re … Always need to keep mileage information. So anything and everything that you have, receipts of expenses that you have or at least a record of those expenses, and by expenses I mean when you take people out and stop to buy lunch on the way for house showing, or when you take a trip up to a new community to seek out new investment properties, anything that’s business related that is also mileage related, you have to have your mileage log.
So all of those kinds of things are what you want to have available. If you’re starting out with your business or you’re doing a midyear thing, you want to talk with your tax advisor or your accountant or whatever that person actually is, and find out for sure what they want, if they have any particular need, but those are the general kind of documents you’ve got. And one of the biggest things to bring are questions that you have, and that’s always something that provided me with a lot of insight, and often times lets me either correct an issue or say, “Don’t worry about that.” Because if they have a question, then we can talk about why it’s important, why it isn’t important and how that applies, so don’t hesitate. I guess I should say, I always tell people it’s much more important that you bring too much stuff than that you don’t bring enough stuff.
Kimberly Small: That makes sense.
Adam Small: Yup, right. Alright Mike, so as we come toward winding this down, is there anything else that you want to put out there? Anything else that maybe we should’ve talked about that we didn’t?
Mike Wright: People should not be, this year particularly, we’re all kind of in the dark as to how it’s actually gonna turn out. We’re just getting started with the tax season, so I can’t really say, “We know the numbers have been run, we’ve seen things like that.” So people should not be upset when they get their taxes done and they found out either they owe more or they’re not getting a bigger refund or whatever. The important … I understand it’s upsetting, but the important thing is to find out why that happened and under the new regime, change what you need to change so it doesn’t happen again.
Adam Small: Right.
Mike Wright: I mean, that’s general advice, but taxes have not changed this much for 40 years, and so we’re all kind of starting from scratch if you’ll be … On the other hand, people should also recognize that there are things that have stayed exactly the same. The American Opportunity Credit for students that you have there in college is still one of the most valuable credits you can have. Over on the state side, we’re in Indiana of course, and Indiana has certain requirement or certain deductions that you can take that people don’t think about ’cause they don’t relate to the federal. I’m sure other states have similar things, so again, this is why it’s important to check out what’s going on for your particular situation, and don’t forget the importance of your state taxes as well as the federal.
Adam Small: Alright, great. Thanks. Kim, any final thoughts?
Kimberly Small: I just think, while we’re talking about taxes, it’s in the nature of real estate agents to be helpful for their clients, but they should never answer any questions regarding legal, legal instances or tax questions from their buyers or sellers. They should always refer them to a professional to give them the answers that they need, and it’s a good opportunity, if you do events, a home buyer’s event or a home seller’s event, you can invite a tax professional or a legal professional so that they can answer those questions too.
Adam Small: Alright, great. So Mike, thank you so much for joining us. If somebody wanted to get ahold of you and talk to you about their tax situation, how would they go about doing that?
Mike Wright: They can always contact me at my email address, probably the best way, which is firstname.lastname@example.org, that’s T-A-X-W-R-I-G-H-T .net, taxwright.net and I’ll be glad to respond and let them know. And if they’re local here, I always provide a chance to consult with folks, just to kind of answer their questions.
Adam Small: Alright, great. Thanks so much for joining us Mike. It’s been very informative, and if you guys like what you’re listening to, don’t forget to like or subscribe to us. Thanks so much and have a great day. We’ll see you next time.