Tax Planning and Tax Advice: What Is and Isn’t Tax Advice?

Tax season is a hectic time for many people, and when it ends, most forget about it until the next year comes around. Nevertheless, tax planning is an important aspect of financial advice for clients that can help mitigate some of the dread associated with taxes and reduce a client’s overall tax burden. Yet, some advisors may be confused about what constitutes tax advice and how to communicate strategies that will minimize legal liability for themselves, their firm, and their clients.

The main distinction between tax planning and tax advice is that while tax planning does involve consideration, analysis, or projection of strategies without going so far as to make a recommendation, giving actual advice typically involves making that recommendation. As a result, the nuances of this distinction can lead to confusion about what is and isn’t tax advice and, in turn, discourage some advisors from engaging with their clients on this topic.

To avoid a conflict of interest, it is often best for the advisor to hand off any recommendations related to tax-related matters to the client’s tax professional. This is especially important if the strategy could potentially be considered tax sheltering (e.g., a Roth conversion strategy) or other strategies that have the potential to violate IRS rules by abusing deductions.

Additionally, advisors should be careful to ensure they communicate that their advice reflects the law and authorities existing as of the date that they provide it and that subsequent developments may change the effect of the advice. Some E&O insurance policies exclude coverage for any taxes or penalties that a client might incur as a result of an advisor’s advice, so it is vital to understand the limits of a policy and be aware of the risks involved.

There are many common strategies that a financial advisor might consider when working with a client on his or her taxes. These strategies might include maximizing the timing or nature of income to ensure that it is taxed at the lowest rate possible or taking advantage of the fact that certain types of income are taxed at different rates (i.e., deductible interest versus ordinary income).

While these are just some examples of common tax optimization strategies that advisors might use with their clients, the bottom line is that there are many ways that advisors can add value to their clients by helping them reduce their tax exposure. By understanding what kinds of strategies may require a CPA or tax attorney’s sign-off, and by creating a framework for how to talk about these with clients, advisors can create an efficient process for addressing their clients’ tax-related needs.

In addition, by developing a strong understanding of tax regulations and rules, advisors can better recognize the types of strategies that could be considered “tax sheltering” and may therefore require the involvement of a designated professional and avoid running into conflicts with their firms’ compliance departments. This will allow advisors to confidently engage with their clients on this important subject and minimize the risk of liability for themselves, their firms, and their clients. Steuerberatung

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