Tax reform introduced a lot of provisions that can confuse wealthy taxpayers—and sometimes their financial advisors. But it doesn't have to be, according to tax preparers.
"Tax advice is planning carefully to legally pay as little federal and state income tax [as possible] currently and in the future. Financial planning and advice treat tax as another line item in the list of expenses when planning for retirement and cash flow,” said Alan M. Rothstein, a CPA/PFS and president of Asset Strategies in Avon, Conn. “Financial advisors should be knowledgeable about the highlights of the Tax Cuts and Jobs Act, but not necessarily be an expert.”
The key is aligning financial and tax planning advice, another tax preparer said.
“The biggest conflict between tax advice and financial advice is when dealing with whether to recognize a capital gain,” said Gary Chan, a CPA/J.D. and director of tax and estate planning at EP Wealth Advisors. “The financial advice for selling a position may be to reduce the risk. The financial advisor may advise to sell to bring the position in line with the asset allocation, but this [could] also cause the client to incur a large tax when the gain is recognized. The client may hesitate to do anything due to this conflict. The ideal is for tax to be a factor in the decision-making, not the sole factor.”
Preparers said advisors remain confused about a few key new points of reform:
• The qualified business income (QBI) deduction. This has confused financial advisors due to the complexities of this law and from the subsequent IRS guidance, according to Chan. The benefit is a 20% deduction for the taxpayer who has a qualifying trade or business. “There were questions as to whether rental real estate qualifies,” he said. “Not all rental real estate qualifies under the safe harbor approach. ... Some financial advisors are not aware of this technical limitation.”
Another confusing detail involves eligible trades or businesses, he said. Business services ineligible for the full deduction can include consulting, health, accounting, law, actuarial science, performing arts, financial services and athletics.
• Qualified Opportunity Fund (QOF) investments, or opportunity zones. Tax reform set up the qualified opportunity zone program of incentives for long-term investments in certain communities. An investor can defer recognized capital gains by investing these gains into an Opportunity Fund, which is designed to invest in businesses in lower-income areas.
In this area, though, “it’s difficult to advise taxpayers with any certainty,” Chan said. “More questions are raised each time new guidance is issued. For example, the tax provision provides that a ‘sale or exchange’ may accelerate gain recognition prior to the mandatory date. This raises the question, ‘What other transactions could trigger the gain?’ [From] new guidance, we now know that property distributions from a QOF, gifting a QOF or terminating/liquidating a QOF owner would cause gain recognition. But what about inheriting a QOF at death?”
• The business interest limitation. “There’s a misperception that all small businesses are exempt from the limitation,” Chan said. “The misperception deals with whether the small business qualifies as a ‘small business’ according to the IRS rules.” Under the rules, a small business does not include a ‘tax shelter,’ Chan added, which is defined as any business where more than 35% of the losses are allocated to partners and S corp shareholders.
With so many unsettled questions, preparers and advisors should work closely, but “the client should be the one nurturing the relationship,” Rothstein said. “In many instances, there’s a conflict of interest because the tax preparer might also be a financial advisor [and] have strong connections with a tax preparer. It’s becoming clear that all sectors of the financial community are stepping into areas that were separate and distinct even 10 years ago.”