Properly completing a tax return has two primary components: The first is knowing what is deductible. The second is understanding where to report the deduction on your tax return. In this article, we will continue our line-by-line Schedule C discussion, with three more deductions: Commissions and Fees, Contract Labor, and Depletion. Commissions and Fees and Contract Labor are a little more complicated than they may seem. These deductions may require additional reporting by the business owner claiming them. Depletion is very rare for most business owners, including real Estate Agents, so we will limit our discussion to explaining what depletion is.
Commissions and Fees (Line 10)
Although the title, Commissions and Fees, may seem straight-forward; it’s not. For that reason, we’ll take a few moments to explain each.
Commissions: A commission is paid to help your business generate income. The most common commissions are amounts paid for referrals as a percentage of generated earnings. For example, a real Estate Agent pays a 1% commission for leads that results in a sale (be careful - state law may require an individual receiving a commission on real estate sales be licensed).
These commissions can take many forms that combine different expenses. For example, an agent rents a booth at a week-long home show. The agent pays $350 for the booth and promises to pay 3% of any income earned from leads obtained during the week. The 3% is deductible as a commission when paid by the agent. The $350, however, is not deductible as a commission or a fee; its deducted as an Advertising Expense on Line 8 of Schedule C (2018).
If, on the other hand, the agent pays for a sign at the home show and the sign includes a phone number and lead code (telling the agent the sign generated the lead), the sign would be an advertising expense. The 3% is still a Commission and Fee.
Commissions may also include payments to other Real Estate Agents, such as when you share your sales commission. Be careful, however, to make sure the split commission is included in your income. If paid at closing, the commission may not appear on the 1099-MISC received from your broker. If not first included in income on your Schedule C, the commission is not deductible as an expense.
Fees: The term Fees, like a great deal of IRS-speak, is a misnomer. The more descriptive title for this line would be Commissions and Fees (Fees Not Deductible Elsewhere on Schedule C).
Fees paid to generate sales for your business are deductible. For example, instead of paying a telemarketer a percentage commission, you pay them a $10 flat fee for each scheduled appointment. Each $10 payment can be considered a fee. Technically, as I mention in our Real Estate Agent Tax-Cut Library, this $10 fee could also be viewed as a commission. The distinction, however, is irrelevant since its deducted on the same line either way.
The only deductible fee mentioned in IRS instructions is the cost of credit reports for customers, suppliers, employees, and yourself (if for a business purpose). I also venture to say that fees for background checks for business are also deductible fees.
As discussed in our tax-cut library, an easy way to determine where an item is deductible is to ask why the item or service was purchased. Fees are deducted in a variety of locations, depending on the nature of the purchase. Here are a few examples:
- Fees for a Telemarketer (not including any commission): Advertising
- Multi Listing Service Fees: Other expenses
- Accounting, Tax Preparation or Legal Fees: Legal and Professional Services
- HOA Fees: If you have a home office, this is an indirect expense for business use of your home.
- Investment Fees: If related to the purchase of an asset, these fees are capitalized (added to the cost of the property purchased).
- Fees to repair your car: Auto Expense (if deducting actual expenses)
- Commissions paid to employees: Wages.
- Fee for real estate license or business license: Taxes and Licenses.
- Shipping fees are added to the cost of the item(s) purchased.
Contract Labor (Line 11)
Contract Labor is fees paid for services to individuals who are not employees. Like Fees, Contract labor is another IRS misnomer. A more accurate title may be Contract Labor Not Reported Elsewhere on Schedule C. Contract labor, by definition, provides a service. As mentioned above, to properly categorize a particular service, ask why the service was purchased. The answer will tell you where it goes on the tax return. For instance, paying a web designer to create a business-promoting website is Advertising. Contracting an attorney to draft lease agreements or an accountant to prepare taxes are Legal and Professional Fees. Hiring a self-employed groundskeeper to mow properties is Repairs and Maintenance.
The challenge (and potential problem) arrives when you have a difficult time placing the service in a particular category or when the service provided is constant and integrated into your day-to-day operations. When this difficulty occurs, the individual providing the service may not be an independent contractor. They may be an employee. For this reason, the most common form of correctly reported contract labor is general labor provided by temporary employment agencies. They are the employees of someone else providing employee-like services to you.
The likelihood that amounts reported as contract labor are payments to common-law employees may be why the IRS Contract Labor instructions is mostly a lesson on the difference between employees and independent contractors. This distinction can be subtle and is based on three, subjective, common-law control tests: 1) Financial Control, 2) Behavioral Control, and 3) Nature of the Relationships.
The cost of misclassifying an employee can devastate a business. Being an employee is not a choice based on agreement. It is a question of law as interpreted by the IRS. If a misclassification occurs and the IRS reclassifies the contractor as an employee (or worse, a group of contractors as employees), an avalanche of tax filings, back-taxes, penalties, and interest will often follow.
For more information on the danger of employee misclassification, check out our article, Contractor or Employee? A Confusing & Dangerous Question. If you are interested in learning more about employee/contractor classification, take our course Employee vs Independent Contractor. We also have a training version to help teach your employees.
Form 1099-MISC Reporting
Like many lines reported on Schedule C, payments made to Commissions & Fees and Contract Labor will often require sending Form 1099-MISC to payees. Form 1099-MISC is a reporting form that tells the IRS and recipient that they earned income during the year. The recipient uses Form 1099-MISC to complete their tax return. The IRS uses Form 1099-MISC to make sure the recipients include that income on their tax return. With certain exceptions, Form 1099-MISC is required when the business or organization pays a non-incorporated individual or business $600 or more for services during the year. To learn more about Form 1099-MISC, read our article, Form 1099-MISC Noncompliance (Can Literally Destroy Your Business). We also have a class on Completing Form 1099-MISC as well as a training version for employees.
Depletion (Line 12)
Depletion is a deduction that represents the removal of a natural resource through mining, well extraction, and timbering. In certain parts of the country, the removal of natural gas through wells and fracking has made the depletion deduction more common. Generally, depletion is a percentage (often 15%) of revenues generated by the natural resource. Most individuals who take this deduction report it on part one of Schedule E, Supplemental Income and Loss not Schedule C. Depletion is a specialty area in taxation that can be highly complex. For that reason, a consult a professional when taking this deduction.
As may be obvious, depletion has nothing to do with the business of being a Real Estate Agent.
Take Away: Commission and Fees, and Contract Labor are two deductions that, except revenue-based commissions and finders fees, include a surprisingly narrow scope of expenses for real estate agents. Each is a reminder, however, of the importance of tracking and reporting payments that require Form 1099-MISC. Depletion is a deduction for the removal of natural resources that does not impact Real Estate Agents.
Summary and Invite: We hope this article helped you to understand Commission and Fees, Contract Labor, and Depletion as it applies to Real Estate Agents. If you’d like to learn more about cutting your most significant expense, TAXES, check out our Real Estate Agent Tax Cut Library. The Real Estate Agent Tax Cut Library includes over eight hours of video broken into twenty-nine searchable volumes and covers every possible deduction a Real Estate Agent can take on their tax return. Our Broker Version will help your entire agency cut their taxes! We also invite you to browse our courses.
Photo Credit: https://flic.kr/p/hR42oj