Tax deductions

Tax deductions for financial advisor fees | Financial advisers


The Tax Cuts and Jobs Act of 2017, commonly known as the TCJA, removed the deductibility of financial advisor fees from 2018 to 2025.

And while advisers and clients have had a few years to get used to the change, they may be looking at it with renewed interest after the long bull market that has persisted even during the coronavirus pandemic.

“Investment returns have been so high in 2021 that many fees are rising enough for clients to notice,” says Ken Robinson, certified financial planner and founder of Practical Financial Planning in Rocky River, Ohio, and member of Alliance of Comprehensive Planners. “Whether the markets are up or down, clients can truly benefit by paying with pre-tax dollars by having their fees withdrawn appropriate amounts from their IRAs.”

Although the TCJA limits the tax saving options available to investors, there are always ways to increase the tax deductibility of your clients’ fees, such as using commission-based and billing-based investments. direct from traditional individual retirement accounts, trusts and corporate accounts.

Deductibility of section 212 eliminated, but some advantages remain

Prior to the TCJA, Section 212 of the Internal Revenue Code allowed individuals to deduct expenses incurred in the production of income, including fees paid for investment advice.

“These expenses were available as deductions when you itemized whether they exceeded 2% of your adjusted gross income,” says Kevin Martin, senior tax research analyst at the H&R Block Tax Institute in Kansas City, Missouri. “The TCJA has eliminated all of these ‘subject to 2%’ expenses for tax years up to 2025.”

Some deductions remain: Investors can still deduct the interest they pay on investment assets, for example, says Martin.

What is perhaps more beneficial is that investment costs such as mutual fund expense ratios are technically calculated on a pre-tax basis. The expense ratio is deducted from a fund’s income before that income is distributed to shareholders. Since shareholders only pay taxes on the income they receive, their expense ratios are always established with pre-tax funds. The same goes for any sales or commission fees to the advisor.

“For people who currently pay large investment management fees and are really obsessed with finding a way to make investment fees tax deductible, one should consider investing in mutual funds again. Loaded, commission-based and actively managed investments, ”says Michael Zovistoski, managing director of UHY Advisors in Albany, New York.

“When the mutual fund is finally sold, the commission is included in the cost base, which in turn reduces the gain on the sale, again indirectly making the sales commission deductible,” he says.

Bill traditional IRAs separately

“The benefit to the client is that a limited and appropriate portion of the fee could be taken directly from the IRA,” says Robinson. This allows them to pay at least a portion of their consulting fees in pre-tax dollars.

However, direct billing of clients’ IRAs should be done with care.

“There may be issues with the levy of fees from IRAs if the fees do not represent the actual time spent advising on the IRA,” says Chris Wentzien, Chartered Accountant and Certified Financial Planner at Natural Bridges Financial Advisors and member of the board of directors of the Alliance of Complete Planners.

Sometimes clients want all of their fees taken from an IRA, but that could result in disqualification from the IRA if you provide comprehensive financial planning services and manage all fees through the IRA, he says.

Be sure to only charge the IRA for the number of hours spent advising specifically on the IRA account, the advisers say.

Other experts advise against the practice of direct IRA billing.

“We always recommend that you do not use retirement account assets to pay for fees for other accounts,” said financial advisor Ken Van Leeuwen, managing director and founder of Van Leeuwen & Co. based in Princeton, New Jersey. “One of the most powerful retirement tools is a tax-deferred growth account, and we wouldn’t want to interfere with that compound growth.”

Trusts and business accounts retain some deductibility

While an individual cannot take various itemized deductions like those in IRC 212, trusts still can to some extent.

The tax code has a special rule that allows trusts to deduct these expenses in full, provided the expenses are unique to the trust and are not routinely or usually incurred by an individual, says Sean Weissbart, partner at Blank Rome and assistant professor. Law at New York University Law School.

If an advisor provides specialist advice to the trust that goes beyond what is traditionally provided to individuals, that additional portion may be deductible for the trust, he says.

“For example, if a trustee can articulate an unusual investment objective or a specialized need to balance certain interests of the parties, it may be possible to deduct this excess expense even before the current law expires,” he says. However, the regulations make it clear that balancing must be about services “beyond the usual balancing of the variable interests of beneficiaries and current remainders”, to the point that it would make no sense to compare them to the needs of ‘an individual investor.

In such cases, if you charge an individual a $ 10 fee but charge the trust $ 15, the trust can deduct the $ 5 difference, Martin says.

To do this, you need to make sure the trust is treated as a non-grantor trust, which means it is treated as a separate tax entity, Weissbart says. With transferor trusts, the creator of the trust is responsible for paying taxes on the trust’s annual income and the special rule would no longer apply.

“It is possible that a trust that is currently classified as a grantor trust could be reclassified as a non-grantor trust by removing the powers in the trust document that caused the initial classification of the grantor trust,” he says.

Then, as with an IRA, carefully divide your fees and identify the portion that is more than what an individual would be charged.

“Trustees who take these positions must keep meticulous records in the event that it becomes necessary to justify that these expenses are outside of those that would be incurred by an individual investor,” Weissbart said.

“To the extent that the investment costs relate to business assets or a business purpose and are paid by the company, these costs remain deductible by the company,” Zovistoski said.

Likewise, if you are assisting a business owner with specific business issues, such as succession planning, “those fees may be billed separately and paid for by the business,” which may be deducting the fees, says. he.

Wentzien offers a similar advantage to its independent clients.

“As we are full financial planners, and not just investment advisers, part of our fees may be taken from Schedule C (self-employed) and Schedule E (rental properties) for advice given in these areas. He said.

As with IRA advice, it carefully tracks the time it allocates to these areas and bills them separately.

Don’t change your billing practices for tax reasons

The section 212 expense deductibility was a nice benefit, but it shouldn’t define how you bill customers.

Rather than changing your billing practices, it is better to focus on “ways to minimize taxes on overall client investments by selecting investments that offer tax-free income, long-term capital gains or eligible dividend income, which is taxed more favorably than usual such as interest income, ordinary dividends or short-term capital gains, ”says James Beam, chief investment officer, brokerage, planning, retirement and strategy for US Wealth at TD Bank.

For your clients, it’s more important that their investments match their goals and that the recommendations you provide match those goals.

If the deductibility of your expenses becomes a deciding factor for a client, adds Wentzien, that client is probably not someone you would want to keep for the long term anyway.