If you earn a profit, the money is added to any other income you have for example, interest income or your spouses income if youre married and file a joint tax return and that total is taxed. 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 your business income and deductible expenses.
A corporation is a separate legal entity you can organize and conduct as a business and share in the profits or losses. It can hold title to property, sue and be sued, have bank accounts, borrow money, hire employees and do anything else in the business world that a human being can do.
In some states, real estate brokers and agents must form a special of corporation called a professional corporation. A professional corporation has the basic attributes of a regular corporation with certain restrictions about ownership and the of work it can do. Typically, a professional corporation must be organized for the sole purpose of performing professional services and all shareholders must be licensed to render that service. Thus, for example, in a real estate broker corporation, all the shareholders must be licensed brokers. A professional corporation is a state law classificationit has nothing to do with the IRS or taxes.
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LLCs owned by two or more people are ordinarily taxed the same as partnerships. LLCs with only one owner, are taxed like sole proprietorships.
For a real estate agent who works as an independent contractor for a real estate broker, the sole proprietorship form is a good choice due to its simplicity and inexpensiveness.
In many states, a corporation can obtain a real estate broker license in its own name. Most states require that some or all of the officers and/or directors of the corporation be licensed brokers.
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Thesole proprietorshipis by r the st and cheapest way to legally organize any business. You dont have to do anything special or file any s to set up a sole proprietorship other than the usual license, permit and other regulatory requirements your state or locality imposes on any business. Of course, you also need to comply with your states real estate licensing requirements.
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If your business doesnt have enough assets to pay a judgment obtained against you, your personal assets can be taken. Thus, your personal assets will always be on the line if you are sued for malpractice. This is why real estate sales professionals should always have errors and omissions insurance.
As a rule, a real estate broker is legally responsible for the actions of the real estate agents salespeople who work in his or her office. Forming a corporation or limited liability company may help limit the extent the broker can be held personally liable for malpractice committed by independent contractor agents or employees as long as the broker wasnt personally involved in the alleged wrongdoing.
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Stephen Fishman is a selfemployed tax expert and regular contributor to MileIQ. He has dedicated his career as an attorney and author to writing useful, authoritative and recognized guides on taxes and business law for entrepreneurs, independent contractors, freelancers and other selfemployed people. He is the author of over books and hundreds of articles, and has been quoted in The New York Times, Wall Street Journal, Chicago Tribune, and many other publications. VisitFishman Law and Tax Filesfor more information on his work.
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Moreover, the single greatest liability exposure most real estate agents and brokers ce is for malpracticelawsuits by dissatisfied buyers or sellers alleging things like fraud, misrepresentations, negligence, ilure to disclose and other violations of the agents or brokers legal and fiduciary duties. Forming a corporation will not protect you against personal liability for your own malpractice or other personal wrongdoing.
For tax purposes, there are two s of corporations S corporations and C corporations. S corporations are passthrough entities are taxed similar to partnerships. C corporations are separate taxpaying entities. C corporations must pay income taxes on their net income and file their own tax returns with the IRS. They also have their own income tax rates which are lower than inidual rates at some income levels.
The advantage the LLC provides over partnerships and sole proprietorships is that it provides its owners the same degree of limited liability for business debts and lawsuits as do corporations as described above. However, they are vored over corporations by many small business owners because they are easier to form and operate, requiring less legal formalities.
In most states, all the owners must be licensed to perform the professional services carried on by the LLC; and ownership cannot be transferred to unlicensed iniduals. Thus, all owners of an LLC formed to operate a real estate brokerage must be licensed brokers, and no owner may transfer his or her ownership in the LLC to a nonbroker.
In theory, every corporation consists of three groups those who direct the overall business, called directors; those who run the business daytoday, called officers and those who just invest in the business, called shareholders. However, in the case of a small corporation, these three groups can be and often are the same person; that is, a single person can direct and run the corporation and own all the corporate stock. So if you incorporate your oneperson real estate business, you dont have to go out and recruit and pay a board of directors or officers.
However, sole proprietorships do have one big drawback They offer no limited liability. A sole proprietor is personally liability for all debts and other liabilities. This means that a business creditora person or company to whom you owe money for items you use in your businesscan go after all your assets, both business and personal. This may include, for example, your personal bank accounts, your car and even your house.
The main reason real estate brokers choose the corporate form is to limit theirpersonal liabilityfor business debts and lawsuits. In theory, the owners of a corporationthe shareholdersare not personally liable for corporate debts. However, in realty, owners of small corporations are often required to personally guarantee their corporations debts, so such limited liability is often more mythical than real.
Because a partnership is a separate legal entity, property acquired by a partnership is property of the partnership and not of the partners inidually. This differs from a sole proprietorship where the proprietorowner inidually owns all the sole proprietorship property.
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A partnership is a form of shared ownership and management of a business. The partners contribute money, property and/or services to the partnership and in return receive a share of the profits the partnership earns. Unlike a sole proprietorship, a partnership has a legal existence distinct from its ownersthe partners. It can hold title to property, sue and be sued, have bank accounts, borrow money, hire employees and do anything else in the business world that a human being can do. Indeed, in some states, a partnership can obtain a real estate brokerage license in its own name.
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MileIQs blog does not constitute professional tax advice. You should contact your own tax professional to discuss your situation.
A partnership automatically comes into existence whenever two or more people enter into a venture together to earn a profit and dont choose to form some other business entity. As with sole proprietorships, it is not necessary to file any s to form a general partnership. However, its highly advisable to have a detailed written partnership agreement eslishing how the partnership will be financed and governed.
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To form an LLC, one or more people must file articles of organization with their states business filing office. Although not required, it is highly desirable to adopt a written LLC operating agreement laying out how the LLC will be governed. If you dont prepare an operating agreement, the deult provisions of the states LLC Act will apply.
Under partnership tax treatment, the business entity is a passthrough entity for tax purposesthat is, it ordinarily pays no taxes itself. Instead, the profits, losses, deductions and tax credits of the business are passed through the business to the owners inidual tax returns. If the business has a profit, the owners pay income tax on their share on their inidual returns at inidual income tax rates. If the business incurs a loss, it is likewise shared among the owners who may deduct it from other income on their inidual returns, subject to certain limitations.
The limited liability company, or LLC, is a unique hybrid a cross between a partnership and corporation. It provides the flexibility, informality and tax attributes of a partnership and the limited liability of a corporation. For many, this is the best of both worlds, and LLCs have become very popular in recent years. Many real estate professionals have formed LLCs. However, some statesCalifornia, for examplebar most real estate brokers from using them.
Because a C corporation is a separate taxpaying entity, it may provide its employees with taxfree fringe benefits, then deduct the entire cost of the benefits from the corporations income as a business expense. No other form of business entity can do this. When you form a corporation, it automatically becomes a C corporation for federal tax purposes. But you have the option of choosing S corporation taxation by filing an election with the IRS.
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As a general rule, all the partners in a partnership that operates a real estate brokerage must be licensed real estate brokers. Check your states real estate broker licensing rules for details.
As r as taxes are concerned, its an excellent choice because it provides passthrough taxation, which most agents prefer. You also wont have to file a separate tax return for your business, which saves time and money. When youre a sole proprietor, you and your business are one and the same for tax purposes. Sole proprietorships dont 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 .
Unlike a sole proprietorship, a partnership is considered to be separate from the partners for the purposes of computing income and deductions. The partnership files its own tax return on IRS Form . Form is not used to pay taxes; rather, it is an information return that informs the IRS of the partnerships income, deductions, profits, losses and tax credits for the year. Form also includes a separate part called Schedule K in which the partnership lists each partners share of the items listed on Form . A separate Schedule K must be provided to each partner. Each partner reports on his or her inidual tax return Form his or her share of the partnerships net profit or loss as shown on Schedule K.
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Similarly, a personal creditora person or company to whom you owe money for personal itemscan go after your business assets, such as business bank accounts and equipment. If youre a sole proprietor, youll also be personally liable for businessrelated lawsuits.
Mostreal estate agentsare independent contractorsselfemployed 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 brokers supervision. This post will help guide real estate agents and brokers on how to choose the correct real estate legal forms.
You create a corporation by filing the necessary forms with, and paying the required fees to, your appropriate state agencyusually the office of the secretary of state or corporations commissioner. Each state specifies the forms to use and the filing cost. Youll also need to choose a name for your corporation, adopt corporate bylaws, set up your corporate records, and capitalize your corporationissue stock in return for money, property and/or services provided to the corporation.
If you incorporate your real estate business, it becomes the owner of the businessthat is, it owns or leases all the necessary assets to run the business and hires employees and independent contractors to provide services to clients. It collects all the money clients pay, and pays all the bills including employee salaries and benefits. You own the corporation in the form of stock ownership. And you will ordinarily work as an employee of your corporation.
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Corporations and LLCs provide limited liability, which is the main reason why many small business owners use them. However, if youre running a oneperson operation, the limited liability youll obtain by forming a corporation or LLC is often more illusory than real. Thus, sticking with the unflashy, , and cheap sole proprietorship is a perfectly rational choice.
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The sole proprietorship and partnership are the deult entities they come into existence automatically unless a busine owners take the steps necessary to form one of the other entities.
Partnerships dont provide the inidual partners with any limited liability. Partners are personally liable for all partnership debts and lawsuits, just like sole proprietors. This means that youll be personally liable for business debts your partners incur, whether or not you know about them.
A sole proprietorship is a oneowner business. Unlike a corporation, LLC, 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. Most sole proprietors run small operations, but a sole proprietor can hire employees and nonemployees, too. Indeed, some sole proprietor brokers have large operations with many employees.
Many states require that real estate brokers have malpractice insurance to obtain this limited liability. Other states limit the amount of limited liability incorporating can provide a broker. The rules vary from state to stateyou should learn yours to determine if incorporating makes sense to limit your personal liability for others malpractice
If two or more brokers decide to coown a brokerage firm and split their income and expenses, they cannot be sole proprietors because they are not running a oneperson business. Instead, they automatically become partners in a general partnership unless they incorporate or form a limited liability company.
The great majority of real estate agents who work as independent contractors for a real estate brokerage are sole proprietors. Many oneowner brokerage firms are also sole proprietorships. Often, real estate professionals attain this legal status without even realizing it Quite simply, if you start in business by yourself and do not incorporate or form an LLC, you are automatically a sole proprietor.
Of course, real estate brokers are also running businessesthey, usually own a real estate brokerage firm, either themselves or with other brokers, for which one or more agents work. Every business has a legal form. If youre working as a broker or agent right now, you are almost certainly involved in one of the following s of business entities