Gilmer Ferretti Blog

Navigating Payroll as a Real Estate Entrepreneur: Tips to Avoid IRS Penalties

Written by Chris Ferretti | Dec 15, 2024 4:01:17 AM

As a real estate entrepreneur, you’ve mastered the art of closing deals, managing properties, and navigating market trends. But let’s talk about a part of the business that doesn’t get the same spotlight: payroll.

When it comes to managing payroll, the stakes are high. The IRS watches closely, and the consequences for missteps can be severe: audits, penalties, and even legal trouble. Yet, for many entrepreneurs, payroll feels like a maze of rules, deadlines, and risks.

The good news? Navigating payroll doesn’t have to be a headache. With the right strategies, you can stay compliant, optimize your tax efficiency, and keep the IRS happy. Let’s break it down.

What Payroll Compliance Means for Real Estate Entrepreneurs

Payroll compliance isn’t just about cutting checks. It’s about getting the details right:

  • Worker Classification: Worker classification determines whether someone working for your business is an employee or an independent contractor. It’s not just a label—it directly impacts your payroll tax obligations, legal responsibilities, and the way you report to the IRS.

    • Employees: Require you to withhold and pay federal income tax, Social Security, and Medicare taxes, as well as unemployment taxes.
    • Independent Contractors: Are responsible for their own taxes, and you only need to provide them with a Form 1099-NEC for payments over $600.

    Misclassifying a worker can lead to significant fines, back taxes, and interest charges. The IRS looks closely at classification, especially in industries like real estate, where short-term projects and flexible roles are common.

    Example of Misclassification

    Imagine you hire a property manager to oversee renovations on a development project. You provide specific hours, control how they perform their duties, and supply the tools they need. However, instead of classifying them as an employee, you issue them a 1099 as a contractor to avoid payroll taxes.

    If the IRS audits your business, they’ll likely determine that this property manager is an employee because:

    1. You control their work schedule and methods.
    2. You provide the tools and materials.
    3. The work they perform is integral to your business.

    The result? You could be liable for unpaid payroll taxes, penalties, and interest, which could amount to thousands of dollars.

    How to Avoid Misclassification

    1. Understand the Key Factors:

      • Behavioral Control: Do you control what, when, and how the worker performs their tasks? More control typically indicates an employee.
      • Financial Control: Are you reimbursing expenses or controlling how the worker gets paid? Employees usually have less financial independence.
      • Relationship Type: Does your contract specify benefits, like paid leave or ongoing work expectations? Employees typically have these guarantees, whereas contractors do not.
    2. Use IRS Tools: The IRS provides a Form SS-8 to help you determine a worker's status if you’re unsure.

    3. Consult Experts: Payroll providers like Gusto can help ensure proper classification, automating processes to minimize risk.

    By correctly classifying workers, you avoid costly fines and maintain a compliant, professional operation.

  • Accurate Tax Withholding: Ensuring the correct amount of federal, state, Social Security, and Medicare taxes are withheld. This task can easily be managed by a payroll provider like Gusto.

  • Timely Tax Filing: Filing payroll taxes on time is crucial. A service like Gusto can handle this for you, minimizing the risk of penalties.

The IRS doesn’t take payroll mistakes lightly, especially for real estate entrepreneurs operating S-Corps or managing multiple entities. The key to avoiding penalties? Understanding the rules and using the right tools.

S-Corp Elections: The Payroll Game-Changer

Operating as an S-Corp is one of the most effective ways for real estate entrepreneurs to reduce self-employment taxes. Here’s how it works:

  • Why It Works: S-Corps allow you to split your income into two categories: salary and distributions. While salary is subject to payroll taxes, distributions are not, resulting in significant tax savings.

  • The Reasonable Compensation Rule:

    • The IRS requires you to pay yourself a reasonable salary for the work you perform. This ensures you’re not avoiding payroll taxes entirely.

    • Example 1: If you’re a developer managing multiple projects and your company is netting $250,000 in profits, a reasonable salary might be $70,000 to reflect your role in planning and oversight, as well as the business’s overall profitability.

    • Example 2: If you’re an interior designer working part-time on staging properties and your business profits are $100,000, $40,000 might align with industry standards for your responsibilities, time spent, and the profit margins of the business.

Set your salary too low, and the IRS could reclassify your distributions as wages, triggering back taxes and penalties. Set it appropriately, and you’ll enjoy the tax advantages of the S-Corp structure.

How to Pay Yourself the Right Way

Here’s the million-dollar question: How do you pay yourself in a way that keeps both your bank account and the IRS happy?

  • Salary vs. Distributions:

    • Salary: Must meet the reasonable compensation threshold and is subject to payroll taxes.

    • Distributions: Taxed at a lower rate but cannot replace your salary entirely.

  • Step-by-Step Guide:

    1. Determine your reasonable salary using industry benchmarks and the time spent in your role.

    2. Use a payroll provider like Gusto to process your wages, withhold taxes, and file payroll taxes on time.

    3. Pay yourself a mix of salary and distributions to maximize tax efficiency while staying compliant.

This isn’t just about following rules; it’s about creating a system that works for you and your business.

Why Gusto Stands Out for Payroll Management

Managing payroll doesn’t have to be stressful, especially with a tool like Gusto:

  • Automated Compliance: Gusto handles tax withholding, payroll tax filings, and even reminders for deadlines, ensuring you stay on track.

  • Time-Saving Features: From automated calculations to direct deposit, Gusto streamlines payroll processes so you can focus on growing your business.

  • Built for Small Businesses: Affordable and user-friendly, Gusto is designed to meet the needs of entrepreneurs without sacrificing functionality.

Other payroll tools like QuickBooks Payroll and ADP also offer robust features, but Gusto’s simplicity and real estate-friendly pricing make it a top choice.

Red Flags to Avoid

Not all payroll mistakes are created equal, but these are the ones that can cost you the most:

  • Skipping Payroll Taxes: Ignoring payroll taxes or underreporting income is a direct route to IRS trouble.

  • Misclassifying Workers: Labeling employees as contractors to save on taxes might seem clever, but it’s a red flag for auditors.

  • Paying Yourself Too Little: Setting an unreasonably low salary to avoid payroll taxes is a surefire way to draw IRS scrutiny.

  • Overusing Distributions: Excessive distributions without proper salary payments can trigger reclassification and penalties.

The devil is in the details, and so are the penalties.

Real Estate-Specific Payroll Scenarios

Real estate entrepreneurs face unique payroll challenges. Here’s how to navigate them:

  • Managing Multiple Entities: If you’re running several LLCs or an S-Corp within your portfolio, coordinate payroll carefully to avoid double-dipping or confusion.

  • Seasonal Workers and Contractors: Fluctuating workforce? Make sure you’re classifying and paying short-term employees correctly. Compliance here is key.

Real estate isn’t a one-size-fits-all business, and neither is payroll.

Conclusion

Payroll might not be the most glamorous part of running a real estate business, but it’s one of the most important. Compliance isn’t just about avoiding penalties; it’s about building a business that’s efficient, trustworthy, and scalable.

If you’re ready to streamline your payroll processes, avoid IRS penalties, and keep more of what you earn, let’s talk. At Gilmer Ferretti, we specialize in helping real estate entrepreneurs like you navigate the complexities of payroll and tax compliance.

Book a free consultation today, and let’s make payroll the easiest part of your business.