Midyear Tax Planning for Financial Advisors

Even though the filing deadline for 2022 tax returns is in April of 2023, there are deadlines that come earlier that sometimes go forgotten. The tax industry has done taxpayers a huge disservice by referring to February to April of each year as “tax season.” That period has essentially turned into the only time of year that people tend to think about taxes. Great advisors set themselves apart by expanding the conversion into a year-round topic, proactively reaching out to clients to talk taxes beyond tax season. And the good news is that there are plenty of things that can be done to add value to a client through midyear tax planning.

— Getting ready for year-end.

— Getting ahead of changes.

— Planning for the future.

— Setting expectations to avoid surprises.

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Getting Ready for Year-End

Midyear is a great time to work with clients to make sure they are on track for estimated payments (third-quarter payments are due September 15, and fourth-quarter payments are due January 15) or to make adjustments to withholdings from wages — only taxes withheld during the calendar year count toward the current-year tax bill.

Many tax professionals only review their clients’ taxes during tax season, which means there is a fantastic opportunity for advisors to add value for their clients by checking in midyear and reviewing a pay stub to make sure their clients are on track. With the most recent change to the form W-4, which is used to adjust withholdings, many taxpayers end up confused and unsure about how to better align their withholdings with how much they actually owe for the year.

For retired taxpayers and those approaching retirement, discussing withholdings on social security benefits and retirement plan distributions also delivers a tremendous amount of value. Many taxpayers are unaware that social security benefits are taxed, and even fewer are aware that they can have taxes withheld, which can be done with form W-4V.

Similarly, with retirement plan distributions, advisors can get ahead of potential issues by making sure that clients understand that withdrawing money from a 401(k) or IRA is not the same as taking money out of a savings account.

Getting Ahead of Changes

Waiting for tax season to talk about taxes especially creates headaches in years where there are changes in a client’s life. Proactively reaching out during the year to learn about changes in jobs, unexpected sources of income, out-of-state moves, home sales, or change to marital status or number of dependent children, among other things, can give clients time to make choices and not simply be reactive at the filing deadline. For financial professionals, it may feel obvious that these things all have tax implications, but for most taxpayers that simply isn’t the case.

A typical tax preparer is going to reach out to clients in January and ask a long list of questions about things that happened “last year,” meaning the opportunity to do something with that information has passed. Advisors who have an intentional approach to learning about these changes, then responding to them during the year in question, are setting their clients up for success.

Planning for the Future

After making sure that the current year is taken care of, advisors can move on to helping clients plan for the future. Seeing account balances go down is never going to be fun, but incorporating tax planning gives advisors and clients concrete action to take to still be intentional about their long-term plans. Roth conversions can be advantageous regardless of current market conditions, but during a market downturn, savvy advisors are essentially helping their clients make a conversion while the account is “on sale.” The IRS only asks the client to pay taxes on the balance at the time of the conversion, not based on what the account might grow to.

Advisors committed to tax planning should be evaluating all of their clients for Roth conversions during the year, and many do. The piece that often gets forgotten is communicating your assessment to the client when the ultimate decision is to not convert to a Roth. Commonly known as “the dishwasher rule” — the client only gets value from the actions advisors take behind the scenes, if they know those actions were taken. Evaluating a strategy and deciding it’s not a good fit is still valuable, if the advisor communicates it to the client.

This same approach can be used with other tax-planning strategies. Whether an advisor is evaluating capital gain harvesting, capital loss harvesting, gifting appreciated stocks, contributing to a donor-advised fund or any number of other tax-planning strategies, effective communication is a critical piece of the puzzle.

Just as it’s important to be having tax conversations midyear and not strictly during tax season, setting the stage early for tax planning can help improve outcomes. Age-dependent strategies make good examples of this. Qualified charitable distributions — the ability to give tax-free directly from an IRA to a qualified charity — only become an option for taxpayers once they reach the age of 70 1/2. The best advisors are starting the conversation on this topic when a client is 67 or 68, not the year they turn 70. Even if there is no specific action to take in the current year, advisors can set a plan for the future and demonstrate to their clients the range of value they can deliver.

Setting Expectations to Avoid Surprises

Advisors often hesitate to commit to tax planning because “what if there is nothing I can recommend?” The dishwasher rule can always be applied for taking the actions already described in this article. Communication is key, and the emphasis needs to be on the value to the client.

In addition, there are plenty of areas where advisors can include tax education, even without specific actions, in their communications to clients. One common area of frustration for investors is year-end capital gains distributions from their investment accounts. This is an often-misunderstood area, and when it creates an unexpected tax liability, a lack of understanding quickly turns into frustration and even anger. Midyear is a perfect time to include a piece in a client newsletter explaining what causes capital gains distributions to appear on a 1099 and what a taxpayer should know if they do appear.

Another great example of proactive tax education for clients is including information on the expiration of the Tax Cuts and Jobs Act. Everyone wants to know what tax rates will be in the future. Advisors, of course, should never try to predict the future, but it can be a value-add for clients to remind them of what we already know. In this case, we already know that after 2025, certain provisions of the Tax Cuts and Jobs Act will expire and some tax rates will increase.

For advisors serious about helping with tax planning, picking even one topic from this article to work on will be a huge win for the client. Bringing up taxes in the summer and fall may feel like a small thing, but taxes are emotional. This small step can lead to a completely different experience for taxpayers this next “tax season.”

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Midyear Tax Planning for Financial Advisors originally appeared on usnews.com

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