February 28, 2024

When it comes to creating value for clients, minimizing taxes is one of the most important areas where financial advisors can contribute. But when it comes to providing advice on strategies designed to do so, there is a fine line between giving formal tax advice and simply helping clients understand how different strategies may impact their own unique situation. Crossing that line can expose advisors to substantial liability – not only in the eyes of the IRS (which could potentially prosecute them for practicing before them) but also from their own firms’ compliance departments, which might refuse to reimburse them for any taxes owed by their client as a result of the advice they provided.

Ultimately, the difference between what constitutes formal tax advice and just helping clients understand how different strategies might impact their own unique situation comes down to whether the strategy involves interpreting existing rules in some way or not. Interpretation is a practice that should really be left to attorneys and CPAs, or at least done in collaboration with those professionals. But many strategies that help reduce a client’s tax burden simply involve optimizing the timing or type of income that is recognized so that it creates the lowest overall tax liability for them.

These types of strategies might include converting pre-tax assets into Roth accounts, deferring income into future years when they expect to be in a lower tax bracket, or postponing the recognition of investment income until the year after the year that it is earned so that they can maximize the deductions they are eligible for. For example, if you have invested in municipal bonds and earn interest from those investments, then the tax you will pay on that income may be less if you collect it this year rather than next.

As such, these types of strategies might not be considered tax avoidance but rather tax optimization. However, the more specific and detailed an advisor gets in their consideration of a particular strategy (and in how they communicate that strategy to their clients), the closer it might get to being considered formal tax advice – which is something that would likely trigger a need for a designated professional to sign off on.

Given the potential for significant liability from such recommendations – both in terms of taxes owed and from their own firm’s compliance department – many advisors shy away from discussing tax-related matters with their clients. But having a clear framework for the difference between formal tax advice and simply analyzing and communicating tax-related strategies can allow advisors to more confidently engage with their clients on these issues without running afoul of their own firm’s rules around what constitutes tax advice. And that can benefit them both in terms of the amount of value they are able to create for their clients.  Steuerberatung

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