Whether you are an new independent agent, or an experienced broker, the question of incorporation, is a valuable one to consider. The type of business entity which you own and operate can have an impact on taxation, and liability among other things. Below we discuss several of the most popular options and their individual pros and cons.
The sole proprietor is the simplest and most popular choice for agents. How does one become a sole proprietor? It is simple, they start running their business, there is no forms filed with the state, aside from the mandatory licenses related to being an agent and business tax licenses. But there is no special declaration needed to become a sole proprietor.
- All taxes pass through directly to the agent’s personal return. A Schedule C (1040) must be completed at tax time, but taxes are otherwise very simple.
- Sole proprietors may still enter into contracts and hire employees. From an operational standpoint, the sole proprietorship, can do the same things as any other business form, it is simply an extension of the owner.
- Liability. We want to emphasize that. If your business is not legally separated from the owner, then the risk and liability related to the business owner is wholly associated with that owner. Creditors of the business may seize personal assets, and lawsuits related to the business are made directly upon the owner without any level of protection.
A General Partnership is entered into when two individuals decide to form a business, or join in a joint venture. Similar to the Sole proprietorship, no paperwork must be filed with the state. Unlike a Sole proprietorship, however, the General Partnership does have a separate legal existence. This means property acquired, and income generated are owned by the partnership, to be distributed based upon the partnership agreement.
- For the purposes of taxation, a partnership is a pass through entity similar to the Sole proprietorship. The difference is the forms needed to be filed. A 1065 is necessary to inform the IRS of the individual income and expenses which can be attributable to each partner for their own personal returns. The 1065, which contains the famous Schedule K-1, is used to fill out the individual partner’s 1040.
- Liability remains a risk here. Although the partnership is a separate entity, the risk for debts and legal action remain with the partners.
Limited Liability Company (LLC):
The LLC, for an individual, or LLP (Limited Liability Partnership) are a means of incorporating which provides a limited liability barrier between the company and the owners. Incorporation is required with the state (not required to be state of residency, but that is a more advanced topic not to be covered here). This means paperwork must be filed, and additional levels of legal and financial expertise are required.
- A layer of legal protection between debtors and lawsuits between the owners and their business. Keep in mind that for most small businesses, banks often require personal guarantees on loans.
- Taxation is still pass through, and similar forms must be filed as with the partnership.
- Although the owners have a layer of protection from lawsuits and debtors, that isn’t an absolute protection. If a broker is involved in the wrongdoing of their agent, than they are still liable. Business entity protection is separate from licensure liability. If an owner did something wrong, than they are still liable.
- There are expenses and more administrative requirements related to a LLC/LLP compared with the previously mentioned entities. They can get expensive, several hundred dollars or more, dependent upon the state.
Corporations have a long history, and are seen as reliable, and consistent. Small businesses have the option of electing to be “S” corporations, which are able to take advantage of pass through taxation, as well as many corporate tax deductions. They are subject to very strict rules to maintain their “S” corp status.
Corporations file separate taxes, are subject to greater required documentation, and higher formation fees. They are considered to be a completely separate entity for legal purposes, as well.
In some states Real Estate Agents, as well as other professionals, including Doctors, Lawyers, and Accountants may file for a Professional Corporation or LLC/LLP, which require an additional level of approval through their licensing board.
- Corporations have greater flexibility and accessibility to funding, including the issuance of stock in exchange for cash or assets, and more comfort with lenders.
- Greater division between entity and owners for liability, but this does not eliminate the risk of licensure related to owner misconduct or misconduct of their employees if the broker, or agent is involved.
- Tax deduction for salary, and bonuses to employees, which the owners may be classified as.
- Corporations file a separate tax forms, and pay taxes separately, except with the “S” corp election.
- Unless the corporation is an “S” Corp than the there is a risk of double taxation, where the income of the corporation is taxed, and any distributions to owners are taxed on their personal returns as well.
- Greater levels of complexity, require more administrative forms, and fees related to them. Not just in incorporation, but with taxation and maintenance of the company.
As you can see, the decision whether or not to incorporate, and at what level is not an easy one, there are benefits and costs to each type of entity. We recommend doing more research and consulting with your financial as well as legal advisors to help you to make the best decision on what is right for you.
Disclaimer: The information contained in this document is provided for informational purposes only and should not be construed as financial or tax advice. It is not intended to be a substitute for obtaining legal, accounting, or other financial advice from an appropriate legal professional, financial adviser or for the purpose of avoiding U.S. Federal, state or local tax payments and penalties.