Prior to 2018, investors could deduct some or all of their investment advisory fees on their federal tax returns. The Tax Cuts and Jobs Act (TCJA) of 2017, effective for tax years 2018 to 2025, eliminated the deductibility for “miscellaneous items,” such as fees for financial advice, IRA custodial fees and accounting fees.
How big of an impact did the Tax Cuts and Jobs Act have on U.S. taxpayers? Data from the IRS estimates that 46.2 million taxpayers itemized their deductions in 2017, followed by only 16.7 households in 2018, a plummet of nearly 64%. Only 11.4% of individual filers in 2018 claimed itemized deductions of some kind, according to the IRS.
Many tax filers do not itemize their deductions because they can use the standard deductions to reduce their overall tax liabilities, and the IRS steadily increase the standard-deduction thresholds for taxpayers each year to keep up with inflation. For example, in 2017, the standard deduction amount for single taxpayers was $6,350, and was $12,700 for joint filers. When the IRS released its inflation-adjusted tax brackets for 2024 on Nov. 9, the standard deductions were increased to $14,600 for single filers and $29,200 for joint filers.
Since standard deductions are fixed dollar amounts, many taxpayers use them to offset their taxable income, rather than keep track of their receipts, especially if they do not exceed the standard deduction amounts, anyway.
Still, it’s hard to pinpoint exactly how many investors itemized their financial advisory fees prior to 2018. Some investors in the top tax brackets were likely unaffected by the legislation because the financial advisory fees often did not exceed 2% of their adjusted gross income.
So, are there any tax breaks for investors? While financial advisory fees are not currently tax deductible, there are some other ways to get some tax relief from engaging a financial planner and benefiting from their services. Here are four tax-break strategies to consider:
— Financial advisory fees.
— Investment interest expenses.
— Qualified dividends.
— Tax-loss harvesting.
Financial Advisory Fees
Let’s revisit this topic again in a different context. If you own an IRA, you can elect to have your financial advisory fees (related to this account only) taken from your IRA balance. This would essentially provide you with a tax break because the fees are extracted on a pretax basis.
Investment Interest Expenses
If you itemize your tax return and have an outstanding loan used to purchase income-producing investments, some of the incurred interest on that loan may be eligible for a tax deduction. Some special rules apply for this opportunity, though. For starters, the deduction is limited to net taxable investment income, which typically includes non-qualified stock dividends and interest income, less any investment interest expenses. Qualified stock dividends and municipal-bond income are not included.
If the investment interest expenses are greater than the net investment income, then you can deduct the expenses up to the income amount; the remaining investment interest expenses can be carried forward to the next year.
Qualified Dividends
Qualified dividends are typically subject to the favorable, long-term capital gains rate relative to taxes, ranging from as little as 0% to 15% or 20%, depending on an investor’s income in 2023. Higher wage earners, such as individuals who have a modified adjusted gross income of more than $200,000 or joint filers with income more than $250,000, are subject to an additional 3.8% net investment income tax. Still, long-term capital gains rates are quite a bit lower than ordinary income tax rates, which can reach as high as 37% in 2023.
But did you know that you can choose to have your qualified dividends treated as ordinary income? And when might that option make sense for an investor?
Let’s take Bert, for example, who has $10,500 in investment interest expenses, $8,000 in net investment income and $2,000 in qualified dividend income. If Bert chose to have his qualified dividends treated as ordinary income, he could potentially claim more of the investment interest expenses as a deduction (in this case, $10,000) and possibly pay no tax on the qualified dividends.
Tax-loss Harvesting
Tax-loss harvesting is commonly known as the “lemonade approach.” In a year like 2022, when the stock and bond markets dipped into double-digit territory for an extended period, this strategy helped some investors make proverbial lemonade out of their sour circumstances. Here’s how the strategy works:
— An investor sells an underperforming investment, like an exchange-traded fund (ETF) or an individual stock, in a taxable investment account.
— Any realized loss can be used to reduce realized capital gains and potentially offset up to $3,000 in ordinary income.
— The deadline for realized, reportable gains and losses is Dec. 31 of each year.
— Next, an investor can reinvest the proceeds into a different investment that is better aligned with his or her financial objectives.
The key guardrail investors must keep in mind for this strategy is the “wash-sale rule.” To avoid running afoul of the wash-sale rule, an investor must not sell a security at a loss and buy the same or substantially similar security within 30 calendar days before or after the sale.
If you would like to look into these strategies a bit further, check out these publications from the IRS website: Publication 550, Publication 529, and Schedule A. Because these strategies may have taxable implications, consult with your qualified tax professional, like a CPA or tax attorney, and your financial planner to determine if they are a good fit for your own financial interests.
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Tax Breaks for Investors Who Engage Financial Planners originally appeared on usnews.com
