Can I charge clients by the hour for brokerage services?
QUESTION: I’m trying to find new ways to represent buyers and sellers while continuing to offer all the same services I do in my current commission-based practice. I would like to offer brokerage services at an hourly rate, but my firm informed me that I cannot do this based on tax laws. Why can’t I charge an hourly fee like a plumber or lawyer?
ANSWER: There is no law that prohibits you from providing real estate brokerage services by the hour. However, there are significant tax consequences to both you and your firm if you charge by the hour instead of receiving compensation based on sales or other output.
Section 3508 of the Internal Revenue Code, found here, states that a qualified real estate agent is considered an independent contractor, and not an employee, if: (1) the agent is licensed to perform brokerage services; (2) the agent performs services pursuant to a written contract stating that the agent is not an employee for Federal tax purposes; and (3) substantially all of the compensation for real estate services performed by the agent is “directly related to sales or other output (including the performance of services) rather than to the number of hours worked.”
Proposed guidance from the IRS suggests that a qualified real estate agent should have at least 90% of their total compensation received during the calendar year from services directly related to sales or other output, rather than the number of hours worked. If an agent is misclassified as an independent contractor when they should be an employee, a firm may have to pay penalties and back taxes. The back taxes to be paid include at least FICA (Federal Insurance Contributions Act) and FUTA (Federal Unemployment Tax Act) taxes, which otherwise do not apply when agents qualify as independent contractors under section 3508. Independent contractors are instead subject to self-employment income tax (SECA) instead of FICA or FUTA under federal law. Similar North Carolina state tax laws also may apply.
Given this framework, it may be possible for both you and your firm, in consultation with a CPA or tax lawyer, to create a strategy that both fits the tax law and is mutually beneficial. This might mean that if you do charge by the hour, any hourly compensation received is limited to comply with Section 3508 of the IRS Code. Or, you and your firm may decide that it is more beneficial for you to work as an employee on an hourly basis rather than as an independent contractor, even if only on a part-time basis.
Whatever you and your firm decide, both the Exclusive Right to Sell Listing Agreement (Form 101) and the Exclusive Buyer Agency Agreement (Form 201) provide blanks for firms to specify compensation. The forms already provide the flexibility for you and your firm to specify many ways to be paid, including, but not limited to, the following:
1. A commission based on a percentage of the gross sales price of a property;
2. A flat fee commission that is not based on a property’s gross sales price;
3. A non-refundable retainer; and
4. A mixed fee comprised of 1-3.
Other methods of compensation to consider may include, but are not limited to, charging by the number of homes shown to a buyer, charging by the number of showings or open houses provided to a seller, or other methods where services are sold a la carte or in a tiered system (for example, platinum, gold, or silver service offerings). So long as you and your firm, after consulting with a tax professional, are confident that at least 90% of your compensation is “directly related to sales or other output (including the performance of services),” then you should continue to qualify for the safe harbor offered in Section 3508 of the IRS Code and be considered an independent contractor for tax purposes.
All that said, even if you do not meet the statutory safe harbor of section 3508 of the IRS Code, you may still qualify as an independent contractor under common law principles. The common law focuses on the amount of control the firm has over your practice and other considerations. NAR has compiled a list here. A CPA or tax lawyer may be able to help you find a solution via this method as well.
Obviously, your firm’s choices regarding commissions and your independent contractor status are important. Improper categorization of your employment status with the firm could lead violation of workers’ compensation and unemployment compensation laws in addition to the tax laws discussed above. You should understand that your firm is entitled to have policies in this arena, and they do not have to provide an hourly rate option for you. However, REALTORS® are known for their ingenuity and problem-solving. If you and your firm, after consulting with a tax professional, can agree on a compensation structure that accommodates charging by the hour, then the law permits you to do so.
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