Many financial advisors are eager to help clients with tax-related strategies, but compliance departments at their firms are often adamant about not letting them cross the line into formal “Tax Advice” (which would create legal and/or financial liability for both the firm and the advisor). So what does it mean to safely give good (tax-related) advice without crossing that dangerous line?
Most of us know that a “tax recommendation” is advice that involves an interpretation of existing tax rules to find an effective way for a client to legally reduce their tax liability, compute taxes on diverse investment portfolios, find the right deductions and credits applicable, etc. Most of these recommendations, whether or not they are considered Tax Advice, are fairly benign and should be well within the scope of most advisors.
But there is a much broader category of tax strategy that, in the eyes of the IRS, is likely to be considered Tax Advice and therefore outside of the scope of most financial advisors, including those who are designated tax professionals like CPAs, attorneys, and EAs. These are strategies that involve a loose interpretation of the tax rules, and they can include structures that have the potential to abuse the law by sheltering income from taxation or by minimizing taxes owed (e.g., Roth conversion strategies that optimize the timing of recognizing taxable income so it is taxed at the lowest marginal rate).
Fortunately, most of these types of strategies are not considered to be “tax avoidance” — which is the type of activity that is strictly forbidden by the IRS under Treasury Department Circular 230 and should only be offered by designated tax professionals. Instead, they are often referred to as “tax optimization” because they simply aim to minimize the amount of tax that is owed.
In general, financial advisors can offer a lot of good advice about tax-related strategies, but there is no bright line that defines the border between merely discussing a tax-related strategy and offering formal Tax Advice. Most advisors will need to work with their own tax professional on a case-by-case basis to decide what level of discussion or recommendation might be appropriate for them.
Consideration – where the advisor sketches out a plan for the strategy and discusses it with their client as long as it is made clear that they are not yet offering a recommendation. Consultation – where the advisor and tax professional discuss the details of how the strategy will be implemented in practice, including the impact it may have on the client’s broader circumstances and the impact any changes to the strategy might have on those broader circumstances. Recommendation – where the advisor and tax professional jointly propose the plan of action to the client. This might happen in a meeting with the advisor, tax professional, and client together or it might occur in a meeting with only the advisor and the client with the recommendation written out in a letter from the tax professional. Steuerberatung