Taxes are one of the few financial costs that every person is legally obligated to pay, no matter their income level or how they invest their money. As such, they’re a vital part of our financial system and the foundation of how we pay for necessities like food and housing. But despite the fact that everyone has to pay taxes, there are still plenty of ways for individuals and businesses to minimize their tax burden – and many strategies are available to help clients do so.
Often, these types of strategies aren’t a form of “tax avoidance” that would be scrutinized by the IRS and thus considered to constitute ‘Tax Advice’ (though there are certainly many examples that might fall into this category). Instead, they simply aim to optimize either the timing or nature of income being recognized based on established rules. These types of strategies may be a bit more complex than simple “tax deductions” and can include things such as Roth conversions, asset location recommendations, or moving income between different entities.
Advisors have a real need to create value for their clients around the area of taxes, given that it represents an important component of their overall financial plan. But they also need to do this in a way that is compliant with Federal regulations and the compliance departments of their firms. This presents a significant challenge for advisors, since straying too far into the area of “tax advice” can create significant legal liability for them and their firm.
As a result, many advisors choose to steer clear of offering any type of tax advice at all, or only offer advice that is very broad and general in nature (e.g., recommending that clients consider using a traditional IRA instead of a Roth IRA). While this approach is understandable in some cases, it can limit an advisor’s ability to add value for their client.
Another option is to rely heavily on illustrations to communicate a strategy, but this can often cross the line into “tax advice” as well. The best way to navigate this issue is to use ranges in place of specific numbers when illustrating a particular strategy. This makes it clear to clients that there isn’t a single, perfect answer and that they will need to consult with their tax professional to determine if the strategy is appropriate for them.
Finally, a third option is to make sure that any advice an advisor provides is documented in writing. This may mean having a meeting with the client, their tax professional, and the advisor to discuss the strategy and how it will be implemented, or it may simply involve an advisor writing a letter to the client outlining the recommendation. Either way, it is critical that the advice be documented clearly so that no confusion arises regarding whether or not it has crossed the line into tax advice. It is this clarity that will help prevent a misstep that could lead to serious legal trouble for an advisor or their firm down the road. Steuerberatung