How Tax and Brokerage Rules Restrict Realtors

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Ontario based realtors are under a significant tax disadvantage due to some confusing combination of the rules related to their professional body (The Real Estate Council of Ontario also known as RECO) and the provincial government.

In contrast to other provinces, realtors in Ontario are effectively prevented from operating their professional activities through a corporation despite many years of discussions and lobbying. There is no reason to believe that “the powers that be” will change their views anytime soon. Perhaps insignificant for the 80% majority of the realtors (that old 80/20 rule), however, for the remainder and those who wish to be part of the roughly top 20%, this is or will be an enormous tax issue restricting growth and ultimately restricting the choices available to realtors to deploy after-tax funds to their businesses, families, and charities for example.

This frustration has resulted in some of the larger brokerages allowing their top realtors to create a sub-brokerage and thus incorporate, but this strategy to date has been met with a great deal of hesitation from our observations on the part of both brokers and realtors. Consideration now to creating one’s own brokerage which would meet the professional and provincial requirements for incorporation may gain momentum for those refusing to wait any longer.

Economically, what are we talking about? In Ontario, with the last provincial budget lowering the threshold where maximum tax brackets are met, it takes relatively little to reach practically maximum tax brackets. With a taxable income of only $220,000 and up, an Ontario realtor can pay tax at just under 50% (to keep the numbers simple). At roughly $44,000 the tax rate is approximately 31% while at approximately $88,000 one is in the 43% area for a tax rate in 2014. Contrast this with a rate of 15.5% in a corporation for the first $500,000 of taxable income. You don’t need to be much of an accountant to figure out that at relatively low amounts of net income there is room for significant tax savings at even modest amounts of income, let alone those who are or will be more robust performers. While we must appreciate that a certain level of income is typically needed for the family to pay for household expenses, we haven’t even talked about the advantages of income splitting and long-term planning.

Let’s put this in a different way. For someone who is able to retain or split income with $100,000, their tax savings in using a corporation as compared to conducting their realtor activities as an individual could be approximately $35,000. This is $35,000 annually. Not once, not twice, but every year where the profits allow. A risk-free rate of return (ignoring changes to tax rules and rates). Said another way, practically a risk-free rate of return of 35%, yes 35%, less the cost of compliance if you can set up a brokerage for your professional activities. Well, at 35%, you can afford a fair bit in compliance costs. And if someone else is taking care of most of the compliance, from a tax perspective if you can maintain your revenues, this seems like a no-brainer.

OK, maybe you’re not yet at the maximum tax bracket. So, does a corporation still make sense? It depends!!!
Even at the relatively low tax bracket of a little over 31%, we have savings at the corporate level of basically half of these taxes given the corporate rate of 15.5%. Yes, someone could cut their tax bill in half at a relatively low-level of income. Considering the tax brackets, the savings would be even more, but let’s keep this simple. At the very least, someone can cut their tax bill in half at modest amounts of profits.

Practically speaking, someone who has a net profit, and no other source of income, of say $40,000 or less has no tax need of a corporation unless they expect profit increases over the next few years. Further, let’s be realistic, there are additional costs to run your corporation which must be factored into the equation. Between low personal tax brackets at low to modest amounts of taxable income, business costs and the small amount of additional complexity involved in operating your own corporation, most realtors will find that once they are grossing approximately $100,000 in earnings, serious attention should be given to setting up a corporation, particularly where they are expecting to grow beyond this. This is not to say that a realtor grossing $100,000 must incorporate, it is to say that a discussion with qualified advisors to help you determine the specific pros and cons in your situation will be well worthwhile. Even if this is to say implementation should not be quite yet, but to establish a realistic time frame based on income projections, your specific situation, and your future plans.

How do the tax and brokerage rules restrict realtors as per our opening comments? Consider the funds available to a realtor on an after-tax basis as compared to gross income or net income. A high performing realtor, or one who will shortly be a top producer, will have roughly speaking an 85 cent dollar to work with if they are incorporated as compared to a 50 cent dollar if they operated as an unincorporated proprietor.

Let’s say that another way. If the realtor was to invest in real estate, a business, their own business, paying for the post-secondary education of their children or grandchildren, or certain remuneration to family members, as examples, they have a lot more money to make these investments and expenditures. Clearly using an 85 cent dollar to invest with is far easier than using a 50 cent dollar. Someone stuck using a 50 cent dollar to live life with is clearly at a disadvantage and restricted in what they are able to do for themselves, their families and charities.

Article Contributor
George E. Dube, CPA, CA
Partner, BDO Canada LLP | @georgeEdube
Dube & Cuttini Chartered Accountants LLP