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.
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. Steuerberatung