The XBroker: February 2008

This is the second post in a four part series focusing on business and incorporation strategies for Real Estate Professionals.

If an employer offered you a 5% raise tomorrow, I imagine that you’d be pretty tickled. If that’s the case, the advice I’m going to give in this post will be the equivalent of a feather in your ear or a finger in your side... Sometimes the fastest route to increasing your income is to decrease your tax liability. Since I can’t recall ever encountering a taxpayer who thought they were under-taxed, I imagine this topic will have universal appeal.

There has been a lot of Washingtonian hoopla regarding the tax cuts over the last several years. However, there has been a silent tax increase that has far-reaching impact and has gone relatively unnoticed (my partner, Garrett Sutton, posted on this very topic last week).

The silent tax increase is the payroll tax, which is the tax collected to fund the bankrupt Social Security program and Medicare. If you are under 40, you probably already realize that this ponzi scheme has very little chance of yielding a return on your contributions when you retire. Many of you may discover that you pay more of this tax than any other.

If you receive a W-2 as an employee, you’ll notice that your total contribution amounts to 7.65% of your gross income (you don’t get to see that your employer is paying a matching contribution – if only your employer was as generous with your 401(k) you’d be retired already!). If you are an independent contractor – operating as a sole proprietor, you have the privilege of paying 15.3% of your income. Hefty indeed. So let’s talk about how you can take advantage of a legal remedy to this income sucker.

In my last post, I discussed the importance of setting up a corporation. I recommended an S-Corporation, which is a pass-through entity, meaning that at the end of the year all profits from the business pass through to your individual tax return as a distribution – where you will pay income taxes only. You only pay the welfare tax on your wages.

So assume you earn $100,000 this year. Operating as a sole proprietor you will pay $15,300 in payroll taxes. Now let's assume you have set-up an S-Corp set-up and you feel a salary of $30,000/yr is reasonable.[The operative word here is "reasonable" - you don't need to pay yourself at the top of the pay scale, but the IRS requires the salary to be reasonable. PayScale.com will give you and your tax planner an idea of what is a reasonable amount for you.]

The $30,000 is subject to the 15.3% tax, meaning that you will pay $4,590 in payroll taxes. The $70,000 that remains in the business will flow through to you as a distribution – taxed at your income tax rate.

This simple strategy would save you $10,710 ($15,300 - $4,590) and leave you more money to grow your business or to reward yourself for your efforts.

Now that we’ve covered off on the tax benefits of incorporating, in my next post I’ll turn the attention to accessing capital for your business.

-The XBanker 

Allow me to introduce myself; I’m the XBanker – a business-financing insider, shedding some light on the murky world of small business lending and business credit. This is the first post in a 4 part series focusing on business strategies for Real Estate Professionals.

Tom Peters’ article in Fast Company several years ago: The Brand Called You, had a drastic impact on my life and career. I quit looking at myself as an employee and instead as an independent business and brand. I highly recommend this article to everyone, regardless of career. Since branding isn’t my bag – I’m not going to pretend that it is by discussing it here.

If you invoice for your services or receive a 1099 from an “employer” – chances are that you pay too much in taxes, unduly burden your personal credit and are missing out on a huge opportunity to access cash and credit for growing your business.

Last year I invited a handful of listing agents into my home to win my business. Each conversation turned to the very topics that I’m going to address in this series. One of the agents in particular was walking the razor’s edge. His family-run real estate team was making close to $1m/year in commissions. This was on top of a number of income-generating investment properties. After 15 years in business, this professional was still operating as a Sole Proprietor. Not only was he paying way too much of his income in taxes, he was literally a car accident away from losing everything. If that wasn’t enough, he needed float to cover his team in a slowdown and reserves to jump on investment opportunities – without drawing upon the equity in his home. My advice for him is the same that I extend to you.

The first thing that you need to do is to incorporate. I’ll keep this really simple: form an S Corporation. My simple rule is: corporations for business activities, LLCs for holding assets (such as real estate); if you have a business partners that you aren’t married or related to, form an LLC for your business (but still form an S Corporation for your interest and income). Your tax advisor should be able to adequately address the advantages of these structures. I’ll address tax benefits in my next post, but please keep in mind that tax savings is just one component of what I’m addressing; obtaining capital is my primary focus.

Forming a corporation is the first step of separating you from your business activities. Once the separation is complete, you can build a credit profile for the business and begin to obtain business loans and lines of credit. I’ll provide some tactical strategies for optimal positioning for your corporation to obtain financing. In my next post, I’ll focus on the tax benefits of creating this separation.

According to a report from MortgageDaily.com, H.U.D. spokesman Lemar Wooley states that FHA loan limits may rise by March 1st 2008.

Amidst the quagmire of explanations regarding new conforming and FHA loan limit interpretations and implementation schedules, Mr. Wooley offers the most succinct language yet:

"In areas where the median home price is above $583,800, the maximum FHA loan limit will be $729,750, HUD indicated. In areas where the median price is below $216,840, the FHA limit will be $271,050."

"Look at it this way, all FHA loans will fall in between $271,050 and $729,750."

So, it appears there will be 9 months of increased FHA loan limits since they're set to expire December 31, 2008.

Alas, this is but one piece in a thousand piece puzzle.

To check where your county's median home price resides, visit HUD's site.

For Dustin...

Not because he asked, but because I admire him and his work.

If you're a real estate or mortgage professional and looking for top internet marketing advice in a 'Web 2.0' world, one may now receive it from one of its founding fathers.

Project Lifeline, increasing Conforming and FHA loan limits, rate freezing...*Yack*

The parables are mounting up in the face of Congress' threat to move H.R. 3609, The Emergency Home Ownership and Mortgage Equity Protection Act of 2007, and Senate (S. 2136, The Helping Families Save Their Homes in Bankruptcy Act of 2007), crafted to inoculate homeowners against the U.S. mortgage foreclosure epidemic by allowing modifications while in bankruptcy proceedings, into legislation.

What's going down behind the scenes amounts to little more than clever posturing by the banking industry and/or their government agencies infected by cash infused lobbyists, IMHO. None of the above 'solutions' provides anything new and/or unique to the floundering homeowner, instead representing pleas and/or diversions by the banking industry for Congress not to interfere with their business.

Project lifeline may be handy for borrowers in arrears with the bank, on a case by case basis, essentially (and solely) at the banks discretion. The Bill that was passed the loan limits is an exercise in voodoo math, only benefiting a small piece of the most over inflated (yet still valuable) areas of the country.

Rate Freezing appears to be the most potent foreclosure countermeasure, then you read classic tidbits like:

On Capitol Hill yesterday, some Republican lawmakers and their aides expressed concern that the plan would anger homeowners and others who stayed out of the subprime mortgage mess.. These all sound like good ideas until you take the time to read the fine print.

Darren McKinney, 48, a renter in the District, said he has been waiting for housing prices to fall so he can buy a condo without resorting to a dubious loan. He turned down an opportunity to buy his 600-square-foot apartment for $310,000 in late 2004 because he thought it was "absurdly overpriced."

Now the government is rewarding people who made irresponsible decisions and bought homes beyond their means, he said.

"There are those of us who purposely sat on the sidelines during the course of the last three years while the senseless frenzy was going on, and we presumed the free market would be allowed to correct itself," McKinney said. "The government is now meddling in the market and looking to prop up lenders and borrowers alike, and those of us who wisely bided our time get screwed."

-Washington Post

What-Huh? Something tells me this is the same guy who would be 1st in line to sue the bank for 'selling him on the wrong loan'. Rate freezing is a far better proposition than say, ummm, imminent value draining short sales and foreclosures that would penalize good borrowers who had the balls to buy a home. Sorry the entire real estate market didn't depress for your personal gain. I understand being 'bearish', but WTF?

There seems to be a divide between the White House and Congress on what could, should and needs to be done. The Bush Administration sanctions and ratifies the psuedo-benefit programs like Project Lifeline and rate freezing, yet Congress seems intent on taking things one step further, beyond the banks acceptable tolerance for control of modification. There's some serious spinnin on Capitol hill as Democrats are pushing for more tangible consumer aide while the Republicans are incentivized to pursue solutions that give big business the ability to save face, on their terms, IMO.

Banks feasted when they could, now it's time to reap whats been sowed. Bulls and Bears make money, Pigs get slaughtered. Banks are pigs, lying pigs at that. A new study by Georgetown professor Adam Levitin suggests recent claims by the Mortgage Bankers Association that Bankruptcy facilitated mortgage modifications would result in substantial interest rate spikes, to the tune of 200 basis points, are a complete fallacy. Keep in mind that these are the same bankers who fight for preferential cost disclosure requirements when compared to the broker community, so Prof. Levitins findings seem entirely plausible.

While these Bills will probably add to the limited assistance Project Lifeline, rate freezing, and new loan limits shall offer, there are still some shortcomings:

Relief is limited to mortgages originated January 1, 2007 going forward. Most of the 'damage' was done well prior to this date, leaving a bulk of the neediest borrowers out to flail in the wind. I don't understand this provision at all.

Only sub-prime (non-conforming) borrowers qualify. My guess is finagling with Fannie and Freddie backed loans is a little to close to home, even for Congress. Thats a shame because I've heard from plenty of people who have/had adjustable Conforming loans and are in a world of hurt. These are supposed to be PRIME borrowers..?

The modified rate will be equivalent to the market rate for 30-year conforming mortgages plus a risk-premium. Plus a risk premium is pretty ambiguous.

I'm about tired of these half baked 'solutions', there are so many of them rolling out with few making real sense or a real difference. Maybe the whole will be greater than sum of these parts...until then it's a bunch of the same people talking to each other saying the same things, while patting each other on the back and allowing us to listen in...