Tax season can be a stressful time for many individuals, especially when they are unsure about how their financial situation will affect their taxes. While the process of filing and paying taxes is inevitable, there are strategies that can help reduce the overall tax burden. Financial advisors often use tax planning to help clients legally minimize their tax liability. This can include helping them claim the right deductions and credits, identifying taxable events, or finding ways to optimize their investment portfolios.
But when it comes to advising on specific tax-related strategies, the line between what constitutes tax advice and what doesn’t can become blurry. For example, a strategy like the backdoor Roth conversion could be considered tax advice by the IRS — but this type of recommendation is not what most advisors would consider to be part of their core competency.
There are some types of tax advice that are clearly off limits for most advisors, such as tax shelter strategies that have a high potential for abusing tax laws. But many advisors find themselves in a tricky position of being both obligated to provide guidance on taxes and prohibited from giving advice on specific strategies due to unique rules set out by their compliance departments.
Having a clear definition of what constitutes tax advice versus tax planning that doesn’t go so far as to make a recommendation can give advisors the confidence they need to engage with their clients on tax matters without violating these unique rules. In addition, having a framework for the types of advice to offer and for the language that should be used when communicating these strategies with clients can help to minimize confusion over whether a strategy is acceptable or not.
As financial advisors develop their tax expertise and take advantage of increasingly powerful software that can create detailed projections of the impact of specific strategies, they may be eager to engage with their clients in more detailed discussions about these topics. However, the more detailed these conversations get, the closer they will likely come to crossing the line into a formal recommendation that could be subject to legal liability.
In the past, this has left many advisors struggling to balance their desire to bring value to their clients by utilizing tax-related strategies and a lack of clear guidelines on what they can and cannot recommend. This struggle was exacerbated by the fact that most firms did not have policies and procedures in place to assist their advisors in creating appropriate tax recommendations or ensuring that they are adhering to regulatory requirements (or, in some cases, even the firm’s own policies).
Fortunately, there is a solution. By leveraging the power of Carta’s Equity Tax Advisor platform, financial advisors can now easily model and discuss a wide range of potential tax scenarios with their clients – including backdoor Roth conversions – without risking their compliance status or creating significant liability exposure for themselves or their firms. Steuerberatung