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Forget April, Taxing Tasks Should Be Year-Round Effort

By Tamika Cody April 11, 2016

Tax season is in its final throes but for advisors there’s plenty they should be doing year-round to curtail their client’s tax bite.

To start with, advisors should be generally aware of each client’s tax bracket and regularly include conversations about tax in interactions with clients. Many life-changing events – such as retirement or inheritances – can easily knock an individual out of their usual bracket.

Such events are an “opportune time to harvest gains if a client’s tax situation changes,” says Frank Pape, director of consulting services at Russell Investments private client services group.

Pape says for smaller investors, advisors can check in quarterly with a phone call asking if there have been any life-changing events. For larger investors, he says it’s ideal to discuss during face-to-face meetings throughout the year.

Investment line items

Dean Mioli, director of investment planning at SEI Advisor Network, recommends that by midyear advisors go over their clients' investment line items. Once advisors know an investor’s marginal tax bracket, they can take a look at the interest, dividend and capital gain line items.

For example, if the investor is in the 28% tax bracket or higher, owning corporate bonds in a brokerage account may be tax inefficient.

“Municipals are more tax efficient than corporates in a taxable account and also provide a diversification benefit,” says Mioli.

Also, when reviewing income from dividends, Mioli says advisors should know if dividends are being considered as ordinary income, which would mean they are likely being taxed at the investor’s marginal tax bracket, rather than a tax-favored rate.

He says advisors should determine where those tax-inefficient dividends are coming from. Given that some asset classes – like emerging market debt, high yield bonds and commodities – are inherently tax-inefficient, Mioli says these investments should ideally be located in tax-deferred accounts.

Mioli says advisors can also periodically examine capital gains with a view to keeping them as low as possible – ideally at zero or less.

Tax-loss harvesting can also help reduce taxes, Mioli says. As an example, if the capital gains line showed $4,000 in long gains but in reviewing the year-end brokerage statement there were $6,000 in long losses, by harvesting the losses before year end, the tax savings would be $1,160.

Although tax-loss harvesting can minimize taxes, Mioli says most investors don’t even consider it. He says most investors likely don’t know where to begin. It is an area where advisors can substantially help their clients.

Leiha Macauley

Keep beneficiaries in check

Throughout the year it’s natural for advisors to focus on asset allocation and investment strategies, but Leiha Macauley, a partner at Day Pitney, says it’s imperative to also check the beneficiary designation in estate plans and in existing trusts.

Even in a well put together estate plan, she says advisors sometimes miss the name of an ex-spouse still listed on an IRA. Macauley recommends financial planners have clients review beneficiaries to be sure there’s no change in circumstances: “If you get that wrong, there will be a problem on the estate taxes.”

For clients who are the beneficiary of a trust, Macauley says financial advisors should look at the trust’s income to compare whether or not the trust is paying a higher income tax. The distributing income from the trust could qualify to be in a lower tax bracket.

Macauley says the latter might be challenging for personal advisors to pin down because often a completely different advisor is managing the trust account.

Review your client’s tax returns

Pape suggests advisors and CPAs meet shortly after taxes are filed, to review their client’s tax return. He says oftentimes CPAs aren’t aware of the chain of events that may have led up to a tax hit, if there is one.

The annual advisor-CPA meeting should work in each professional’s favor, says Pape: “This is a great retention strategy for both.”

Pape suggests advisors focus on the top 30 investors, or the top 10% of their books.

Mioli recommends client, advisor and CPA all meet together to analyze how the investment plan fits with the tax plan.

Mioli says advisors should inquire about what investors have in mind for the future. Are they contemplating a stock option exercise? Do they have plans to purchase another home, and if so, how are they financing the down payment?

“You may have to help them figure out how to raise the cash in the most tax-efficient manner,” he says.