Tax advice can be one of the most difficult areas for financial advisors to add value for their clients. The intricate body of tax law governs how much money state, local and federal governments can charge taxpayers each year for items such as goods, services, property and income. While most people understand that taxes are a necessary part of life, few know how to minimize their tax burden and maximize their refund at the end of each year. With the help of a good advisor, however, you can make wise choices that can benefit you and your family in many ways.
The key to reducing your tax bill is understanding how the tax code works. That involves knowing the difference between deductions and credits. Deductions allow you to subtract expenses from your taxable income, while credits give you a dollar-for-dollar reduction in your tax bill. The difference between the two can make a significant impact on your tax liability.
In addition to deductions and credits, the tax code also includes several other types of taxes. There are direct taxes, which are assessed against products and services directly by the government, and indirect taxes, which are levied against goods and services through an intermediary such as a retailer or distributor. Some common indirect taxes include sales and excise taxes, property taxes, and value-added taxes.
While some types of strategies that are commonly employed by financial advisors fall into the category of “tax avoidance,” which the IRS says is only practiced by designated tax professionals like attorneys, CPAs and EAs and therefore requires their approval before a client can receive them, others simply seek to optimize the timing or nature of income to reduce the overall tax burden (e.g., Roth conversion strategies that restructure how a client recognizes pre-tax assets to ensure they are taxed at the lowest rate).
For advisors who haven’t yet developed their own tax expertise, making recommendations around these types of strategies can be a tricky proposition. Straying too far into the realm of ‘tax advice’ can expose an advisor to additional legal liability, not to mention the risk of their firm’s compliance department taking them to task over a recommendation that violates internal guidance.
To minimize this risk, a good advisor should have a clear process in place to evaluate the potential impact of any new strategy before recommending it to a client. This could involve considering the strategy in detail and creating a visualization of its impact on the client’s financial picture using powerful planning software.
It could also include a brief discussion with the client to highlight the benefits and risks of following the strategy, including demonstrating how it would be implemented in practice, or it might just involve running a hypothetical projection through the software to show the results of the strategy without going so far as to recommend that the client implement it. The more detailed the analysis, the greater the need for an advisor to be cautious not to cross into the territory of ‘tax advice’.Steuerberatung