Taxes Are a Central Component of Financial Planning

Taxes are a central component of financial planning. Advisors can create a lot of value for clients by helping them minimize their taxes. However, it’s important to understand what constitutes formal “Tax Advice” and how to communicate tax-related strategies with clients while protecting them and their firms.

Some forms of tax advice entail the kind of tax avoidance schemes that would be scrutinized by the IRS and require the involvement of a designated professional. Other strategies involve optimizing the timing or type of income that is recognized based on clear, established rules.
It’s a necessity

Taxes are a crucial component of financial planning. Almost every strategy that an advisor creates for their clients has some kind of tax implication. However, many advisors are told by their (generally well-intentioned) compliance departments to avoid giving recommendations on tax-related issues – because they may end up creating legal liability for the firm in the event that something goes wrong.

The problem is that defining what constitutes “tax advice” can be difficult. It’s not just about advising clients on the types of tax avoidance strategies that are scrutinized by the IRS and require the involvement of an attorney, CPA, or EA; it also includes interpreting rules and analyzing the impact of certain activities.

One possible solution would be to create a regulated profession of tax advisors, similar to a notary, and establish that only these professionals can give specific tax advice. This will maintain the competitiveness of rival professions while setting quality standards. However, this approach has drawbacks, including the fact that it can be difficult to establish a monopoly for tax advice in the absence of clear rules and adequate enforcement of those rules.
It’s complicated

Tax advice is not only complicated, but it can be difficult to know where the line between giving good advice and bad tax advice even exists. Many financial advisors find themselves navigating the cliff’s edge between these two things on a regular basis when discussing strategies with clients. This is because a lot of firms have not developed policies on how to safely give such recommendations without crossing the line into tax advice (which creates legal and financial liability for both the firm and the advisor).

For example, if the strategy involves some sort of tax avoidance that is scrutinized by the IRS and requires a designated professional like an attorney, CPA, or EA, then it definitely constitutes tax advice. But if the strategy is more benign, such as using a certain type of entity or tax-efficient way to schedule income, then it’s probably just tax planning. This is something that a financial planner could do in a meeting with their client and their tax professional, or by writing the recommendation to the client.
It’s important

Financial advisors can easily get caught up in the grey areas of taxation. There are certain types of strategies that, by any other definition, would be considered ‘tax advice’ (like recommending an investment in a particular type of income or entity designed to defer taxes) and others that simply aren’t allowed from a regulatory standpoint (like advising on the timing and structure of Roth conversions).

Despite this, there are many ways that advisors can safely provide value to their clients by discussing these topics, and even offer specific recommendations in a general context. But it’s important for advisors to understand how to walk the fine line between giving good tax advice and crossing over into Tax Advice – which can create legal and financial liability for the advisor and their firm. This is why it’s important to follow the 3-step process of Consideration, Consultation, and Recommendation. This helps to ensure that the advisor is not stepping over the line into Tax Advice without the support of a designated tax professional.
It’s actionable

A central part of financial planning is understanding taxation and how it affects a client’s finances. But even though advisors often have a great deal of expertise in this area, they are often told by their firms’ compliance departments to avoid giving any advice on the subject. This is not because there’s anything illegal or immoral about making recommendations on tax-related subjects, but because firms want to protect their advisors and clients from possible legal and financial liability.

The solution to this issue is to establish a clear framework for what does and doesn’t constitute formal “Tax Advice” that can help advisors be more confident in communicating strategies with their clients without violating the unique rules set by their compliance departments. This can be done by defining what kinds of things could be considered to cross the line into Tax Advice, such as creating detailed projections for clients and comparing outcomes from different strategies. It is also important to use ranges instead of exact numbers when describing the effects of various strategies.Steuerberatung

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