Worker classification errors can cause big problems for brokerages—and the industry at large
By Andrew Conner
Working as an independent contractor in a brokerage has long been the industry standard for real estate professionals. While state laws and regulations vary, the federal government, by way of the IRS, has even carved out a special statutory rule for the industry, making the independent contractor test simpler for licensed real estate professionals.
The usual test for determining independent contractor status involves a number of factors that include the level of behavioral and financial control a company has over a worker, as well as their contractual relationship. However, according to the National Association for REALTORS®, for real estate professionals that test is simpler and consists of three requirements:
– The worker must have a real estate license;
– Their pay must substantially relate to their sales or other output, rather than amount of time worked; and
– They must have a contract with their company that states they will not be treated as an employee for federal tax purposes.
This special status is advantageous for real estate professionals because firms are often made up of independent contractors. In fact, for many real estate firms, particularly smaller ones, keeping agents as independent contractors is necessary to stay in business.
“When I opened my brokerage it was just myself and my husband,” says Monique Higginson, principal broker at Market Source Real Estate in Salt Lake City, Utah. “When you’re a small company, it’s difficult to float payroll and pay those extra taxes if your agents are treated as employees rather than independent contractors.”
Because of this, changes to federal and state laws regarding independent contractors can pose an existential threat to brokerages. While the IRS exception for real estate professionals seems to be holding strong and some recent California court cases that brought the independent contractor test into the spotlight aren’t expected to impact real estate professionals, the more control a brokerage tries to exert, the more likely they are to be legally tested. And that could have repercussions for the entire industry.
Toeing the line
Deirdre Felgar, GRI, CRS, CCIM, principal/broker at Avenues Realty America in Las Vegas, Nevada, thinks many brokerages are potentially going over the line.
“More and more, we have these [brokerage] teams where the leader or supervisor is assigning the other team members specific jobs—I’m the buyer’s agent, you’re the seller’s agent, you handle the paperwork, someone else will handle prospecting—and then they expect the team to show up during certain hours,” Felgar says. “Even though they all share in the commission and they’re all independent contractors, I think that’s an issue as they are treated as employees.”
Felgar says she sees teams built like this almost exclusively and it’s up to the broker or owner to pay attention to what is going on and ensure that they aren’t crossing any legal lines. She supervises 14 agents, and at any given time two or three are employees who receive W-2s for tax purposes while the rest are independent contractors who receive 1099 forms. Her employees often also work as independent contractors in an agent role—for which they also fill out a 1099—but when they are in their employee role, they have well-defined duties.
“I won’t cross that line,” she says. “I even give them a different desk when they’re an agent so mentally that line doesn’t get crossed.”
Proactive policies
Both Higginson and Felgar recommend speaking with a local expert, such as an attorney or accountant, when setting up a new brokerage, to ensure that you understand your state’s independent contractor laws. Higginson explains that as long as you have a strong plan from the outset, staying within the legal boundaries is not difficult.
“When you begin to open a brokerage, you should determine if you want to have a team structure with employees because you’ll need to set it up differently and you’ll need a lot more capital and bandwidth to bring people on,” Higginson says. “In my brokerage, as a competing broker, I really don’t have the capital or the time to be supervising and training agents, so they truly need to be independent and out there on their own as contractors.”
Although she acknowledges that any changes to worker classification rules that adversely affect the special status of real estate professionals could potentially “wipe out a lot of small brokerages,” Higginson doesn’t expect to see any shakeups in Utah any time soon. Felgar also doesn’t necessarily see a day of reckoning for the independent contractor versus employee debate happening in the near future, but she is wary as more brokerages trend toward team-based approaches that could one day turn independent contractors into employees.
“If you’re the broker of a company of 50 independent contractors and all of a sudden that was 50 employees with potential incomes of several hundred thousand, you will be looking at a lot of money you’re expected to pay,” says Felgar. “If you have any suspicions about how you operate, I would take action now. The rules aren’t hard to follow.”
Going It Alone
Whether you’re part of a larger brokerage or a true sole proprietor, if you are currently working as an independent contractor, you may want to consider self-incorporating. Creating a corporation for your real estate business has a number of advantages, such as liability protection and easier tax management. Nancy King, associate broker at Long & Foster Real Estate in Virginia Beach, Virginia, has done just that and it has simplified her life greatly.
“The best advice I ever got in real estate was to concentrate on what you do best and hire other people to do the rest,” she says. “Incorporating frees me to pursue real estate with a more streamlined method of tracking expenses and assuring my taxes are paid.”
King worked with an attorney who filed the incorporation papers and also takes care of the required annual report, which goes to the state commission. She also hired a payroll company to handle her accounting and pay her taxes.
“In the four years since I incorporated, I have grown my business by 25 percent each year,” says King. “I also see a lot of agents starting their new year with a $10,000–$15,000 tax burden due to large end-of-year sales not accounted for in quarterly paid tax payments through the year. That can throw off your whole business.”
For more legal insight, join us for a FREE member-benefit webinar, “Legal Issues in Real Estate Every Agent Should Know” with Dale Carlton, CRS, at 1 p.m. Central on April 10.
