Some financial advisors may be tempted to wash their hands of taxes and leave them to the accountants. But that approach doesn’t ensure the best outcome for their clients. Great financial advisors know that, while the calendar has turned over on 2022, there is still work to be done before it is left behind. And that work is around taxes.
Every financial decision has a tax implication, and sufficient planning is not done until the taxes have been considered and reported correctly to the IRS. With that said, here are seven pitfalls financial advisors can avoid as they work their way through the tax-filing season.
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Letting Clients Jump Ahead on SECURE 2.0
A point of confusion for many taxpayers is the fact that the provisions of the SECURE 2.0 Act are not focused on 2022. As the news cycle has already shifted to planning opportunities from this bill, it’s important to help clients avoid trying to apply these future changes to their current tax returns.
Make sure that you are clear on which tax year you are referencing when discussing these matters with clients.
Neglecting Final 2022 Tax Moves
Although the calendar has turned to 2023, there are still actions to take for the 2022 tax year. Those are commonly related to contributions to tax-advantaged accounts such as individual retirement accounts (IRAs) and health savings accounts (HSAs). Waiting until the beginning of the next year (for example, early 2023 for the 2022 tax year) can be a great strategy to make sure certain account contributions are maximized but proceed with caution.
Whether you’re communicating with the client, custodian or tax preparer, make sure it is clear which tax year the contributions relate to. Getting this wrong or leaving it vague can create confusion that may not even be identified until the client is trying to make contributions later in the year or, even worse, when the client receives a letter from the IRS pointing out the discrepancies.
Not Following Up on Recommendations
As a financial advisor, you are responsible for the tax consequences of any recommendations you make. The tax forms that custodians and other reporting agencies send do not always have all the necessary information. Qualified charitable distributions (QCDs) and backdoor Roth contributions are two examples of planning strategies that commonly get misreported. Not taking the time to make sure these activities are reported correctly can result in a client paying taxes twice on the same income.
Make sure you are reminding your clients of the planning you did together throughout the year. Having a process for annually sending a year-end tax letter to each of your clients is a great strategy.
Getting Blamed for ‘High’ Taxes
Advisors must clearly communicate the tax impacts of their recommendations, then remind the clients at tax time why the higher tax bill makes sense. (Think: Roth conversions or capital-gains harvesting.) If that step is neglected, the advisor may be blamed when the CPA tells the client how much he owes the IRS. Proactive communication is the best way to avoid this. Use that same year-end tax letter to reinforce the planning value behind recommendations that increase a client’s tax bill in the current year.
Making Mistakes With Form 8606
This form reports Roth conversions and backdoor Roth contributions, including the calculation of the pro-rata rule when applicable.
Whether a client prepares his own taxes or works with a tax professional, this form is routinely done incorrectly. At a minimum, advisors should be bringing these activities to the attention of the tax preparer, so the preparer looks out for them. In situations where there are delays between nondeductible contributions being made (that’s the first step of a backdoor Roth contribution) and the funds being converted to Roth, it becomes especially important to actively communicate. That’s because the contributions and earnings are not treated the same for tax purposes.
Not Waiting for Amended Tax Forms
Advisors can provide a great service to their clients by monitoring their accounts for amended tax forms and notifying the client if any are issued. This is also a reason to encourage your clients to not rush out and file their returns as fast as possible. Updating a draft return because an amended form 1099 was issued is a less painful process than needing to go back and amend the entire return because new information arrived after filing with the IRS. Not only can that be time-consuming and frustrating, but it’s also possible it can cost the client hundreds or even thousands of dollars in avoidable tax preparation fees.
Not Pushing Back on Do-It-Yourselfers
There is nothing inherently wrong with a client preparing her own taxes. But there are limitations. Often, clients who work with a financial advisor are at a point where they should be working with a tax professional. In reality, many of those clients continue to do their own taxes until something goes terribly wrong. When an advisor is working with a self-preparer, it’s critical that the tax impacts of decisions are shared and reinforced to help the client avoid creating tax problems through inaccurate reporting.
Bottom Line
Advisors should be getting their clients’ tax returns every year and reviewing them. That review should include ensuring that work that was done together was reported together, along with looking for future planning opportunities. An easy win for reviewing tax returns is to specifically look at how much the client is paying at tax time or how big of a refund the client is receiving. A common myth among taxpayers is that there is nothing they can do throughout the year to affect that outcome at tax time. Being the person in a client’s life who helps them adjust their withholdings or estimated tax payments can seem like a simple thing, but clients love it.
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Photo credit: ©iStock.com/fizkes, ©iStock.com/ Jirapong Manustrong, ©iStock.com/Anchiy
Steven Jarvis, CPA, is a columnist for SmartAsset and has been compensated for this article. Taxpayer resources from the author can be found at retirementtaxpodcast.com. Financial Advisor resources from the author are available at retirementtaxservices.com.