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Brokerage Firms and Their Unique Tax Situation: Understanding the Employment Tax Avoidance Opportunity for Brokerage Firms

Ohio provides a unique opportunity for real estate brokerage firm to treat their brokers and sales personnel as either an employee or an independent contractor. This creates a unique opportunity for brokerage firms to save a significant amount by eliminating the obligation to pay the employer-portion of Social Security tax (“FICA tax”), eliminating the requirement to pay State and Federal unemployment tax (“SUTA and FUTA tax”), and potentially eliminating the requirement to provide health insurance for other employees.

However, under Federal law the Internal Revenue Service (“IRS”) has set forth specific guidelines to determine whether a broker or sales professional can be treated as an independent contractor for federal tax purposes. The IRS has created a special statutory non-employee status for “qualified real estate agents” that allows a broker to treat them as an independent contractor, if certain conditions are met. In order for a “qualified real estate agent” to be treated as an independent contractor for federal tax purposes, they must:

1.       Be licensed as a real estate professional by an appropriate licensing authority,

2.       Substantially all of the real estate professional’s compensation must be directly related to the sale or other output of a home and not based upon hours worked, and

3.       The services of the real estate professional must be performed under a written contract providing that they will not be treated as an employee for federal tax purposes.

If the qualified real estate agent is able to satisfy the conditions set forth by the law then he/she will be treated as an independent contractor for federal tax purposes. If the conditions are met, the brokerage firm still has a responsibility for ensuring compliance with other applicable laws including obtaining Form W-9, Request for Identification Number and Certification from the qualified real estate agent and supplying to the qualified real estate agent, Form 1099-Misc, Miscellaneous Income no later than January 31st of the year following any payments if the amounts received were over $600.

If brokerage fails to meet the conditions set forth by statute then the default common-law rules are used to determine whether an employment relationship exists. The IRS looks to a three-factor test to determine whether an employment relationship exist between the parties. No factor is given more weight then the other but is determined based upon facts and circumstances. The three factors include:

1.       The Behavior of the Parties

a.       Does the broker control or have the right to control the work of the real estate agent or sales personnel?

b.       Are the hours worked set by the broker or is the real estate professional given flexibility?

c.       Is the real estate professional required to work at a certain location or certain times?

2.       The Financial Arrangement

a.       Is the real estate agent or sales personnel paid based upon hours worked or commissions on sale?

b.       Is training and/or equipment provided to the real estate professional in order to allow them to complete their job?

3.       The Relationship of the Parties

a.       Does the broker hold out, the real estate agent or sales personnel, as an employee to others?

b.       Does the broker provide benefits to the real estate agent?

c.       Is there any contractual relationship between the parties?

If a determination of an employment relationship is established, then the broker or sales professional would be treated as an employee for federal tax purposes. If an employment relationship exists then the brokerage firm would have additional duties and responsibilities to that employee that need to be considered including:

1.       Registering with the appropriate Federal, State, and Local jurisdiction for income tax withholding,

2.       Registering with the appropriate State agency for Unemployment and Worker’s Compensation, and

3.       Determining if you there may be penalties for not offering affordable health insurance coverage to your employees.

It is important to note that the IRS allows an individual who believes that they have been misclassified as a non-employee to file a document with the IRS requesting that the IRS make a determination of their employment status. The IRS allows both parties to provide documentation to assist in the determining if an employment relationship exists and will use a facts and circumstances methodology in making that determination. Therefore, it is important to ensure that the appropriate steps are taking at the beginning of the relationship in order to save time, resources, and money.

If you want to better understand your responsibilities as a broker, need assistance with navigating the complexities, or have questions about whether you are in compliance, let Robinson Legal help. We would be happy to discuss your unique situation and help you navigate the complexities. #robinsonltd