Kitces has made available for download their article, “Tax Advice Restrictions For Financial Advisors: How To Offer Tax Planning And Remain In Compliance”, published on Kitces. The Executive Summary is as follows:
Taxes are a central component of financial planning. Almost every financial planning issue – whether it is retirement, investments, cash flow, insurance, or estate planning – has tax considerations, and advisors provide a great deal of value in helping clients minimize their overall tax burden. And yet, despite the prominent role of taxes in financial planning, advisors are often prohibited by their compliance departments from making recommendations for a specific course of action on a certain tax strategy. Which means that advisors are often left to figure out on their own how to guide their clients on tax-related matters without crossing the line into ‘Tax Advice’, which can potentially create certain liability issues for the advisor and their firm.
This is not because of any blanket regulation against financial advisors making tax recommendations. Although the IRS states that only designated tax professionals like attorneys, CPAs, and EAs can give advice on certain strategies (e.g., those that are designed to avoid taxation, such as tax shelters, that have a high potential for abusing tax laws), many of the tax strategies that financial advisors recommend are not meant to shelter income to avoid taxation altogether, but are instead designed to ensure that income is simply taxed more efficiently, such as by optimizing the timing or nature of income when it is taxed (e.g., Roth conversion strategies involve recognizing taxable income via the conversion to ensure funds are taxed at the lowest possible rate). From the IRS’s perspective, there is no requirement to be a designated tax professional in order to give advice on such strategies that optimize taxation.
For many advisors, engaging in tax advice is often prohibited because of the potential legal and financial liabilities that are opened up for advisors and their firms. Unlike investment advice, advisory firms are usually not required to create policies and procedures around properly given tax advice (unless they specifically employ designated tax practitioners), so there is often no clear-cut way to ensure tax advice is given correctly. And the consequences for incorrect tax advice can include legal and financial penalties if a client were to be harmed by the wrong advice – which is often not covered by the firm’s E&O insurance –creating an expensive liability when tax advice goes wrong.
For advisors who are prohibited from giving tax advice, tax planning can be an alternative approach for discussing tax matters with clients. Tax planning can range from giving general, nonspecific information on tax laws and regulations to creating detailed projections for clients and comparing the outcomes of potential tax strategies – so long as the planning does not also include a recommendation of a specific course of action that would constitute tax advice. Generally, the more detailed the analysis, the likelier it could be construed by the client as a recommendation – which is what ultimately matters, since a presentation that the client understands to be tax advice is as good as actually giving tax advice. In these circumstances, safeguards such as upfront disclosures and collaboration with the client’s tax professional may be necessary to ensure that the tax professional – and not the advisor – is the one making the actual recommendation.
The key point is that understanding what constitutes tax advice versus tax planning that doesn’t go so far as to make a recommendation can help advisors more confidently engage with their clients on tax matters without violating the unique rules set in place by their compliance departments. Having a framework for the types of advice to give and for the language to use when communicating strategies to clients can reduce the confusion of being obliged to provide guidance on taxes while being prohibited from giving actual tax advice. Because ultimately, the question around tax planning (if not outright advice) isn’t whether it should be offered, but how it can be delivered to provide the most value to clients while protecting the client, advisor, and firm!
To read the full report, click: “Tax Advice Restrictions For Financial Advisors: How To Offer Tax Planning And Remain In Compliance”
Posted by Marin Larkin, Associate Editor, Wealth Strategies Journal.