IRS RULES MORTGAGE BROKERS ARE EMPLOYEES

This Article is designed to be of general interest. The specific techniques and information discussed may not apply to you. Before acting on any matter contained herein, you should consult with your personal legal adviser.

LOAN OFFICERS ARE EMPLOYEES: NEW IRS TECHNICAL ADVICE

Most brokers treat their salespersons as independent contractors. The standard CAR and Professional Publishing forms so provide. However, if a real estate licensee is engaged in mortgage lending, classification as an independent contractor is improper. Mortgage Agents typically solicit, service and participate in the funding of residential loan applications.

Mortgage Agents of California mortgage brokers are required to possess a real estate salesperson or broker license issued by the California Department of Real Estate (DRE). As licensees, a written employment agreement is required by the DRE.

The usual agreement between a mortgage broker and a loan officer provides that the mortgage broker has no right to supervise the agent's activities other than required by the DRE. Mortgage Agents are not required to adhere to any set schedule of hours or work, although they typically work during normal business hours. Mortgage Agents may use the facilities and support staff of their brokers but they must furnish their own cars. Mortgage Agents are paid on a commission based on the successful funding of a loan. The written agreement usually provides that the Mortgage Agent's services are to be provided as an independent contractor and that the Mortgage Agent agrees that there will be no provision for federal or state taxes. The Mortgage Agent generally receives his or her earnings either as each transaction closes or on a periodic basis. The mortgage broker issues an IRS Form 1099 to the Mortgage Agent at the end of each year.

In the TAM, the IRS reviewed the longstanding recognized practice of treating loan officers as independent contractors for employment tax issues. The National Office of the IRS considered Internal Revenue Code section 3508 which provides that a qualified real estate agent is a statutory nonemployee for purposes of FUTA (unemployment taxes), FICA (social security), and federal income tax withholding. The IRS concluded that the placing of loans for residential real estate sales or refinancing existing loans are not activities customarily performed by a real estate agent, as explained in its Proposed Regulations section 31.3508-1(a)(2).

This means that Mortgage Agents are not independent contractors but are, instead, employees. Therefore mortgage brokers have potential liability for their failure to withhold payroll taxes, including FUTA, FICA, and federal income taxes for each of their Mortgage Agents. This could amount to more than $10,000 per mortgage agent per year. In addition, interest and penalties may be imposed. Also, the failure to collect and pay employment taxes can result in the imposition of the "100% penalty," which may be imposed personally on the individuals responsible for the payments or the decision not to pay rather than the business entity.

Relief from liability may be available to mortgage brokers who meet the reasonable basis, reporting consistency, and substantive consistency requirements of section 530 of the Revenue Act of 1978, as amended. However, no relief is open to the loan officer who must suffer the consequences of being an employee, such as the inability to report income and expenses on Schedule C and being subjected to the 2% limitation on employee business expenses.

Even if a mortgage broker is exonerated from past practices, the issuance of this TAM will affect how loan officers are treated in the future. Both mortgage brokers and loan officers should consult their tax accountant or tax attorney as to the applicability of this TAM to their individual situations.

Alan R. Seher is an attorney with the firm of Weiss & Weissman, Inc. He is a Certified Tax Specialist by the California Bar Association, Board of Legal Specialization. Mr. Seher is also a licensed real estate broker. He concentrates his practice in real estate and tax related matters.