Real Estate Professionals and Taxes

Real estate professionals take a lot of training and pass a really tough exam to earn a license to conduct business. Buyers and sellers of real estate are depending on their knowledgeable agent or broker to locate properties, bring the parties together, and navigate transactions to the settlement table.

 

Unfortunately, all that training and exam-taking doesn’t cover the special IRS tax rules that real estate professionals need to know and understand. Real estate professionals who don’t know the rules could end up getting an unwelcome tax notice about underpaying or incorrect filing.

 

Real estate professionals can avoid tax headaches by knowing about and understanding these three areas:

 

  1. Business Type for Tax Purposes

Real estate professionals operate their business as a sole proprietorship, unless the she or he forms a partnership or incorporates. The IRS considers licensed real estate professional as statutory nonemployees and treated as self-employed. This is because substantially all payments for their services are directly related to sales or other output, rather than to the number of hours worked. Real estate services are often performed under a written service contract providing that they will not be treated as employees.

 

  1. Tax Responsibilities

Real estate professionals are individually responsible for filing and paying all taxes, including federal, state, and local income, as applicable. Business income and expenses are reported on Schedule C, “Profit or Loss from Business,” and filed with the individual income tax return. Net business profits are also subject to the employer and employee portions of the Medicare and Social Security taxes (i.e., FICA), totaling 15.3% of net profit. FICA is paid to the IRS with the individual business owner’s income tax return.

 

  1. Deduction for Business Expenses

Expenses incurred to run a business as a sole proprietorship are deductible. The IRS does not publish an exhaustive list of eligible business deductions. The rules state that the business can deduct expenses that are “reasonable and customary” for that business. Common deductible expenses for real estate professionals include marketing, education, business licenses, and payroll taxes. Keep track of business expenses throughout the year; they really add up and reduce your taxable income.

 

Special IRS tax rules that real estate professionals need to know and understand aren’t included in the licensing test materials. Don’t know the rules? Consult www.irs.gov or with a qualified tax professional. You’ll be very glad that you did.

Vendor Risk and Your Reputation

Recent news about Facebook and user data highlights the need to understand how your organization’s confidential data is protected. As if we needed another reminder! Sure, it’s a big, extreme and public example most of us cannot relate to. Splashy news stories are an opportunity for you to think about your own organization’s risk exposure related to data protection, without the splashy headlines.

 

These days, many businesses outsource services to third party vendors. Those vendors could have access to or be responsible for your organization’s confidential data. How can you make sure that those vendors are protecting your data as well as, if not better, than you would? How do you prevent your organization from being the victim of a data breach and avoid the negative on your reputation and operations?

 

Organizations should, at minimum, take three simple steps to protect their data and reputation from vendor risk:

 

  1. Written Agreement

Data protection responsibilities and expectations must be clearly delineated in a written agreement signed by both parties. Sufficient details should be included to clearly describe what controls and precautions are in place, who is responsible, how controls and precautions are validated, and when validations are performed. The agreement should also address the assumptions and performance expectations for your operations and controls.

 

  1. Vendor Monitoring

Use the data protection responsibilities and expectations in the written agreement to determine the vendor activities for you to monitor. Monitoring can take many forms, such as system or management reports and performance test results. Don’t hesitate to ask the vendor for documented evidence. Taking the vendor’s word without proof can backfire later.

 

  1. Hold Up your End

Vendors with access to or responsibility for your confidential data are depending on your organization and your workers to fulfill certain responsibilities. If a data breach or other performance issue occurs and you have not held up your end, the vendor could escape taking the appropriate responsibility – or liability. Remember, outsourcing doesn’t mean a total hand-off.

 

Data breaches, splashy headline or not, can be expensive and damaging to your organization. A vendor you depended on could be the cause. Outsourcing can be great but it comes with risks. Protect your organization’s reputation by managing vendor risk using the three simple steps above.

 

Am I Running a Business?

This week’s blog was inspired by conversations I’ve had recently with a few new tax clients. Part of my job as a tax professional is to learn about clients’ circumstances and activities so I can help them be aware of and comply with federal, state, and local tax rules for operating a business.

 

Clients who engage in business activities sometimes need my help to understand the rules that are not related to income taxes. One of those rules is about registering a business with the state, county and local jurisdiction where it operates. Individuals who do freelance or other non-employee work may not realize that they are running a business, albeit a small one.

 

Individuals engaging in business activities, freelance or otherwise, should get clear and accurate answers to these three questions:

 

  1. Is my activity a business?

Generally, an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit. Profits are often not made in the early stages, but the business activity starts when goods or services are offered in exchange for funds. In other words, even a small freelancer is engaged in a business activity.

 

  1. What does my jurisdiction require?

States, counties, and cities want to know about business activities that operate in their jurisdictions. One reason is to enforce safety and zoning laws, but another big reason is to get their fair share of business tax revenue. Businesses are required to register in every jurisdiction where they are located. License fees, registration fees and taxes vary.

 

  1. Where do I get help?

Being a business owner in the 21st century means that you have Internet access to every resource you need. State, county and city websites are a goldmine of information about registering a business and other requirements. Government websites usually have pages dedicated to new businesses with checklists and links.

 

Business activities, freelance or otherwise, must be registered with the applicable state, county and local jurisdictions. Figuring out the requirements is easier than it’s ever been with all the online resources and links. Do a little homework to ensure that your business is aware of and complies with the rules.

Your Organization’s Financial Health

Your personal health and your organization’s financial health are the same in at least one way — serious problems could exist that you cannot see or feel. A sudden loss of income or an unexpected expense can stop the heart of your organization just like a medical crisis can stop your body. For your organization, like your body, monitoring a few key areas can alert you to problems on the horizon.

 

At a minimum, organizations should monitor financial health in these three essential areas:

 

  1. Actual vs. Expected Financial Activity

Financial performance information should be compared to planned, or budgeted, performance to determine how actual events compare to what you thought would happen. Focus on variances in significant income and expense categories. Obtain explanations for why the budget or plan was not met. Did conditions change?  Were projections unrealistic? Focus on “why” and use that information to refine budgets and plans.

 

  1. Cash Flow

Project your cash inflows and outflows for at least three months, preferably for six or more. Assess whether income that you expect to take in is going to cover the amounts you need to pay. Sounds easy, but this analysis takes some thought and effort. You need to know your payments receivable and payable, regular payments that are required no matter what, such as payroll and rent, and your reconciled bank account balances. Be realistic about payment timing and what it really costs to sustain your organization.

 

  1. Expenses

Maintaining control over spending is the most important and most difficult part of running an organization. Demands to fund day-to-day operations, in addition to investing in technology and infrastructure, are constant. Prioritizing essential expenses and growth investments is a challenge that requires regular attention. This is particularly true in newer organizations where infrastructure investments are most crucial.

 

Maintaining your organization’s health is a lot like managing your personal health. Monitoring a few key health areas can alert you to problems on the horizon, and give you an opportunity to act before it’s too late.

 

 

 

 

Basic IT Controls Still Reduce Cyber Fraud

Last week’s Institute of Internal Auditors (IIA) cyber fraud webinar was a great reminder. Basic IT controls that we learned years ago are still valuable to follow. Sales reps may promise that their product is the “silver bullet” for preventing cyber fraud, but those apps don’t replace good old fashioned IT controls and training.

 

Fraud has existed for a long, long time. Technology gives criminals new opportunities to perpetrate bigger frauds more quickly than ever before. Many data breaches occur because basic IT controls are neglected, leaving systems vulnerable to hacks and malware. Purchasing advanced solutions doesn’t replace basic IT controls.

 

Four basic IT controls that reduce cyber fraud are:

 

  1. Update and Patch Management

Skipping system updates and patches create vulnerabilities, such as those that were exploited by hackers in some recent cyber fraud events (e.g., Equifax and Home Depot). Excuses for skipping updates and patches include lack of time and concern about impacts on other systems. Updates and patches are crucial — they protect systems with up-to-date security processes.

 

  1. Monitoring

System logs and periodic monitoring should be established to detect operating activities or conditions that should not occur. Anomalies, such as after-hours transaction volume spikes and data transmitted to an unauthorized IP address, should be monitored and acted on. Automated alerts and error reports require follow-up and action to be effective.

 

  1. Password Management

Passwords are the key to the front door of an organization’s systems. Sharing passwords and keeping factory-issued passwords are like hanging the keys on the door knob. One example is when a system administrator fails to change the manufacturer’s default password, leaving the door to that system wide open to unauthorized access.

 

  1. Fraud Risk Training

Traditional methods, like training and documentation, make people aware of cyber threats and vulnerabilities. Real life examples of the risks and costs of a data breach, and techniques used by hackers to manipulate people and data, help workers to recognize risks and how to avoid them.

 

Even after investing in silver bullet applications, organizations can still fall victim to cyber fraud due to a breakdown in basic IT controls. Following these four basic IT controls help organizations reduce their vulnerability to expensive cyber fraud.

Ethical Culture Drives Financial Success

We grew up thinking that good behavior is rewarded. Current events can really rock that thinking. But it’s been proven that good organizational behavior, also known as an ethical culture, can result in financial success. Yes, the Good Guy really can win by running an organization in an ethical manner.

 

In fact, a February 2016, Forbes.com article, The Profit Potential in Running An Ethical Business by @SteveParrish4, says that an ethical business is easier to manage than an organization with disdain for rules and disrespect for accountability. As Mr. Parrish says, keeping a second set of accounting records is time consuming and expensive. Fraud losses and prosecutions can get expensive, too. Just ask the former employees and shareholders of Enron, WorldCom, etc., etc.

 

An ethical culture starts with that proverbial “tone at the top” set by leadership – the Board, CEO, and CFO. Tone at the top sets the organization’s guiding values. So how does ethical culture happen?

 

Leadership takes four actions to establish the right tone at the top to promote an ethical culture and drive financial success:

 

  1. Communicate expectations.Organizations must make it clear that unethical conduct will not be tolerated. Clear and convincing policies should convey the organization’s values and expected behaviors. A first step is to establish a written code of ethics and ethics training.

 

  1. Lead by example.Leadership must set an example through its actions. Observing leadership actively following the organization’s code of ethics increases the likelihood that it will be followed by others. Leadership must also be mindful of perception, and understand how their actions could be interpreted.

 

  1. Recognize integrity.Support an ethical culture by recognizing individuals for ethical behavior. Recognition could be a monetary incentive program, or some other special acknowledgement from leadership. Whatever the reward, publicly celebrate the behavior and clearly communicate the link between ethical behavior and the reward.

 

  1. Establish confidential reporting.No matter what leadership does to promote an ethical culture, some individuals will still engage in unethical, or even illegal, activities. Establish a confidential tip line or other mechanism for reporting real or suspected fraudulent behavior or ethical violations without fear of retaliation. Set up a mechanism to follow-up on tips.

 

These actions alone do not guarantee that everyone in the organization will act in an ethical manner, but they can go a long way to setting an ethical culture and driving financial success.

Business Financial Records

More than 500,000 small businesses are born every year, according to the Small Business Administration (SBA). Every year, a few of those small businesses find their way to me and ask questions like: How do I keep my business finances straight? When should I start keeping financial records? What tools should I use to manage it all?

 

Every business is different but they all have one thing in common – they can’t make good decisions without getting control over and understanding their finances. Establishing financial systems and processes is essential. Hiring a qualified bookkeeper or accountant is one way to get started, but many new businesses don’t have the budget.

 

I only have the capacity to help a few new businesses every year. For those I can’t get to, here are three steps that business owners and entrepreneurs can take to get control over and understand their finances, and to make good financial decisions:

 

  1. Separate Business and Personal Finances

Open a separate business account to avoid commingling personal and business funds. Don’t wait – open the account as soon as possible. If you can, do it before incurring any business expenses. Apply for a business credit card to avoid putting business expenses on your personal credit card. Separating personal and business finances allows for a transparent view of your business progress. It also helps to establish that you are operating real business, not a hobby.

 

  1. Track All Financial Activity

Maintain a record of all business income and expenses. Expenses should be tracked by category, such as rent and advertising, so you know where your funds are going. The IRS does not specify a particular system or format for business records. The only requirement is that your records are accurate, complete, and provide enough detail to identify the underlying source documents. Source documents may be kept electronically. Computer software packages purchased online or in retail stores can be very helpful, easy to use, and require very little knowledge of bookkeeping and accounting.

 

  1. Plan and Monitor

Even without a formal budget, you need to plan for monthly and annual income and expenses. Having a plan for your finances helps to prioritize your business activities and provides a baseline to monitor your progress. Didn’t meet your plan? Don’t see it as a failure; it’s an opportunity to assess your plan and adjust your activities.

 

Paying a qualified and experienced professional to help set-up sufficient record keeping is a great option. But if that’s not in your budget, taking these three steps will help you feel confident that your records can help you to make good decisions for your business and to satisfy the IRS.

Tax Scam Calls Still Happening

It’s still happening. It happened to me just last week. I came home to a voicemail telling me that four warrants are out for my arrest and I need to pay up or turn myself in. Of course, the caller conveniently provided a callback number. The caller also sounded automated. Who would fall for that? You might be surprised…

 

Hundreds of unsuspecting taxpayers are still being defrauded of thousands of dollars. Otherwise, the scam callers would stop. It wouldn’t be worth their time. Taxpayers should not take the bait and fall for this trick. But it can be really intimidating to get a threatening call about what is already a scary topic – your taxes.

 

Four tips to help taxpayers avoid getting scared enough to become a scam victim:

 

  1. The IRS initiates most contacts through regular mail delivered by the United States Postal Service.

 

  1. The real IRS will not:
  • Call to demand immediate payment
  • Call someone who owes taxes without first sending a bill in the mail
  • Demand tax payment without allowing the taxpayer to appeal the amount owed
  • Require a taxpayer to pay in a certain way, such as with a prepaid debit card
  • Ask for credit or debit card numbers over the phone
  • Threaten to bring in law enforcement to arrest a taxpayer who doesn’t pay
  • Threaten a lawsuit

 

  1. Special circumstances when the IRS will come to a home or business include:
  • When a taxpayer has an overdue tax bill
  • When the IRS needs to secure a delinquent tax return or a delinquent employment tax payment
  • To tour a business as part of an audit
  • As part of a criminal investigation

 

  1. IRS Revenue Agents who may conduct a visit to a taxpayers home or business carry two forms of official identification that have serial numbers. Taxpayers can check both IDs. Revenue Agents conducting audits may call taxpayers to set up appointments, after having first notified them by mail. By the time the IRS visits a taxpayer at home, the taxpayer would be well aware of the audit.

 

Have you been called or visited by someone impersonating the IRS? Don’t be scared or intimidated. Hang up the phone and visit IRS.gov for information about how to detect and report tax scams.