An individual income tax return can be a treasure trove of planning opportunities and practice development opportunities for practitioners. Many practitioners are concerned about cost issues. Clients will negotiate prices, or complain about a modest increase in tax prep fees every few years, so it seems incongruous that the same client would be willing to spend much more for consultative services, but a meaningful percentage will. Consider some of the planning ideas and suggestions following.
____ 1. Filing Status
A taxpayer’s filing status is the first window into planning possibilities. Some taxpayers filing as single may be divorced and subject to a Property Settlement Agreement with a former spouse, which might dictate certain planning. A would-be planner should check lines 21 and 31a of the first page of the 1040 to determine whether the taxpayer is receiving or paying alimony. A planner should consider the effect of any alimony arrangement on the taxpayer’s present and future income stream and incorporate it into the planning. If you communicate with this particular client, or a group of clients via a templated letter, some of the questions to ask about the post-divorce situation might include:
a. Have you updated your beneficiary designation? The divorce may not preempt that and if you don’t change the beneficiary designation (unless the settlement restricts that) your ex may well inherit. Lots of people forget this as evidenced by the cases fighting over this each year that make it to court.
b. When is the last time you have reviewed the agreement to be certain you and your ex are complying? While CPAs are not likely to review legal issues there are often plenty of tax and economic issues they can address.
c. Was life insurance required under the agreement? Is it in force? How do you know? Might it be handled better?
____ 2. Head of Household Status
Taxpayers who file as head of household may also be subject to a Property Settlement Agreement with a former spouse and may also have the same concerns as a single taxpayer. Since this client has a child, other issues arise.
a. Has the client updated his or her will to name a guardian?
b. Who is the account owner on any 529 college savings plans? Many clients don’t realize that an ex-spouse (if named account owner) can pull out all the funds.
____ 3. Married Filing Separate Liability Considerations
If the taxpayer and spouse are filing separately might this be because one of them is in the midst of a substantial lawsuit? If so there may be a host of things that can be done (and that should not be done). Discuss asset protection issues, and if advisable recommend the client consult with an estate planning or bankruptcy attorney. The litigator may have little expertise with these matters and while handling the litigation may not be focused on broader issues. The most important advice, which many clients do not understand or imagine, is that if subject to suit, that spouse may not be permitted to change the title to assets (e.g., deed the house from joint to solely the spouse not being sued). Inappropriate transfers might subject the spouse being sued to worse results. Perhaps any parent or other benefactor can revise their wills to assure any assets bequeathed to the client being sued are to be held in appropriately protective trusts.
____ 4. Married Filing Separate Medical Considerations
Where the taxpayer and spouse have chosen to file separately in order to take advantage of one spouse’s large medical deductions and lower AGI, a planner should recommend that the taxpayers meet with their estate planning and review existing, or execute new, durable powers of attorney and health proxies. Review planning for medical expense deductions.
a. Is the client able to qualify for a full or partial payment under a disability policy?
____ 5. Married Filing Separate Matrimonial Considerations
A preparer should determine why a taxpayer is filing as married filing separately. If the taxpayer is separated, the preparer should coordinate with matrimonial counsel to provide such assistance as may be required for the taxpayer’s benefit.
a. Some taxpayers file separately because they were advised long ago before they entered the marriage to do so to keep assets separate.
b. Does that still make sense?
c. What is the penalty in terms of tax cost from this decision? Are there other options?
____ 6. Married Taxpayers Matrimonial Considerations
In the case where the taxpayer is married but subject to a prenuptial or postnuptial agreement governing their financial arrangements, a preparer should obtain a copy of the agreement. The preparer should review the agreement to determine the following:
a. What financial obligations does the agreement create?
b. Are there specific insurance requirements?
c. Is there a better tax method to achieve the goals of the prenuptial or postnuptial agreement?
If the taxpayer intends to keep certain assets separate, then, instead of filing separately and potentially having a greater tax liability, proper recordkeeping may be a solution. By way of example, assume that a prenuptial agreement provides that certain investment assets are separate property but the income earned is applicable to marital expenses. Arranging for automatic transfer of the income from the separate accounts to a joint checking account keeps the assets separate while making the income available.
All taxpayers regardless of filing status should also consider asset protection planning in order to protect assets from future creditors and predators. There may be simple changes, e.g., owning the marital home jointly to provide a measure of protection. Many states provide that a residence owned by husband and wife receives some measure of protection from either spouse’s claimants. The house may have been held as tenants in common to fund a bypass trust. That decision may have been made before the advent of portability (or repeal of the estate tax) and may never have been revisited.
____ 7. Exemptions – Dependents
Many taxpayers have the additional concern of providing for their dependents. A planner should determine whether the taxpayer ought to consider one or more of the following:
a. Has the taxpayer established 529 plans?
b. Should the taxpayer consider this?
c. If a section 529 plan is established, have successor account owners designated?
d. Has anyone reviewed the selection of the 529 plan and its investment performance?
e. Consider trusts for minor beneficiaries. Does the client’s will provide for trusts for heirs?
f. When do those trusts end?
g. Most trusts are drafted very simplistically and distribute all assets to the child/beneficiary at some age, e.g. 30. Is that really advisable?
h. What if the child divorces at age 31? There are better approaches.
i. Do the parents have significant funds in custodial accounts for the children? It might be feasible to invest in a family partnership. The parent may also be able to spend custodial money down in order to reduce risk and use funds freed up in the process to fund a new trust that is more secure.
j. If the dependents are 18 or older, they should complete powers of attorney and living wills to protect themselves. Children heading off to college should sign these documents to permit their parents to help them as a routine prerequisite to heading off to college.
____ 8. Employer-Provided Benefits
a. Wage information often lends insight into other issues that may be relevant to planning for a client.
b. The planner should determine whether life insurance, long- or short-term disability benefits are being provided by the employer and discuss with the client whether the client should obtain additional insurance. The planner should help the client determine whether the disability insurance is adequate.
c. A key issue to consider is whether the waiting period before benefits may be paid is reasonable relative to the client’s and the client’s family’s needs and liquidity.
d. Too often clients assume that if they have coverage at work they are “fine.” But what if they change employment? What if after they change employment they have a health issue and cannot then obtain new coverage?
e. If they have both personal and work coverage are they coordinated?
f. If the client is contributing towards a qualified retirement savings plan, such as a 401K, the planner should obtain copies of the beneficiary designation forms and confirm that the beneficiaries have been properly designated.
g. If the client is not contributing to a qualified plan, the planner should determine why not. If the client is eligible for a pension upon retirement, the planner should help the client to confirm that resources generated by the pension will be sufficient to address the client’s needs.
h. In the event that the client has received or is expected to receive stock options, the planner should discuss whether and when the client should consider exercising the options in order to maximize the benefit. Perhaps it would be advantageous for the client to wait to exercise the stock options until after retiring to a lower cost state, e.g., Florida in order to reduce state tax liability. The planner and client should weigh the tax implications against the Company’s growth potential, possibly in consultation with a certified financial planner.
____ 9. Special Considerations for Principals of Closely Held Businesses
For planners servicing clients who are principals of closely held businesses, a planner should evaluate whether the compensation paid by the business is reasonable.
a. The IRS has become increasingly proactive in challenging arbitrary allocations between salary and distributions for owner-employees. Examiners are scrutinizing C corporation deductions to determine whether part of the deduction for salaries paid to shareholder-employees should be recast as a disguised dividend. IRS auditors have become keenly aware that some S corporation shareholders take artificially lower salaries in order to avoid employment taxes. If any of these payments are modified on audit, the taxpayer could be subject to interest and penalties on the underreporting. A planner should make clients aware of these issues and seek to insulate them from such challenges by the Service.
b. Be mindful that the tax changes proposed by President Trump may change the dynamic of how planning for business structures (e.g., form of entity) and owners (e.g., salary) may change. Too often clients retain whatever structure was in place without changing to adapt to new tax developments.
c. Whatever form of entity when was the last time the client/business owner met with his or her attorney to create minutes or other entity documents? Failure to observe entity formalities could lead to a piercing of the entity veil in the case of a suit and thereby reach the client’s personal assets.
____ 10. Interest and Dividend Income
Planners should confirm that clients are appropriately diversified and have sufficient liquidity to meet their needs.
a. A client who has moved recently may need to restructure their bond holdings to a new state. Further, while municipal bonds typically provide a degree of safety, excessive concentration of bonds from a particular state or issuer could pose unintended risk of inflation. Home equity lines of credit, margin accounts and other mechanisms may be considered to provide a client with sufficient liquidity to meet unanticipated costs.
b. Some clients may have fallen into the trap of diversifying investment advisors instead of their investments. A CPA/planner should be able to identify such a client just by reviewing the sources of interest and dividend income as reported on the Schedule B to the Form 1040. Upon discovery of this issue, a planner should advise the client to consolidate accounts with one investment advisor in order to ensure that the client’s investments are meeting the client’s financial goals.
c. Too often clients have not reconsidered their investment approach in decades and their circumstances and needs may be quite different now. The objectivity and independence a CPA practitioner can bring to this discussion, even if not well versed in investment details, can be invaluable to the client.
____ 11. Business, Rental, and Royalty Income
a. A client with business income reported on a Schedule C may need to consider restructuring the business as a limited liability company.
b. To the extent that the client is reporting business income on Schedule E, a planner should review the choice of entity and assess with the client whether the current choice is still optimal by evaluating the liability risk for business claims to reach personal assets.
c. The CPA/planner should also evaluate with the client whether the client ought to consider obtaining additional business insurance or riders to an existing homeowners’ insurance policy.
d. To the extent that the client owns S corporation stock, the planner should review trusts established by the client to confirm that they contain the appropriate language necessary to permit the trusts to hold S corporation interests. With the high estate tax exemption and even more so the possibility of repeal, more wills are being prepared by general practice attorneys that may have no tax sensitivity. It is more important than it ever has been for CPAs to identify these issues.
____ 12. Capital Gain or Loss
A planner should evaluate whether and to what extent a client may be able to maximize tax benefits by harvesting gains or losses. To the extent that the client has only one investment advisor, it could be helpful for a planner to reach out to that professional in order to determine the opportunities available. A planner may be able to help the reluctant client to consolidate accounts under one or two investment advisors by pointing out that an advisor can create more tax-effective strategies if s/he has all of the information about the client’s investments at her/his disposal.
____ 13. IRA Distributions
Whether or not a taxpayer is actually receiving IRA distributions, a planner should have a discussion with a client about the designated beneficiary of the retirement plan. It would be best for the planner to obtain a copy of the actual designated beneficiary clause and confirm that it is properly completed and identifies the appropriate beneficiaries. Clients often have various accounts from which to withdraw funds to cover living expenses. These might include a by-pass trust from a late spouse, an inheritor’s trust that may be Generation Skipping Trust (GST) exempt, a pension or IRA and other regular non-trust taxable accounts. Often, helping the client prioritize which accounts to access, to what extent, and with which priority, can provide substantial income tax, estate and GST tax and asset protection benefits.
____ 14. Age and Disability
a. Clients over age 65 may have a need for a revocable living trust for the proper management of assets.
b. A planner should ensure that both a durable power of attorney and a health care proxy are adequate and in place.
c. For the disabled client, a planner should explore whether necessary home improvements may qualify as a medical expense deduction. Specifically, a client may be able to deduct the cost of special equipment and home improvements if the main purpose is medical care. These can include: adding an accessible entrance ramp, installing a lift, widening doorways, building handrails, modifying cabinets, etc. While the opportunity exists, the planner must exercise great care to help the client corroborate the medical need and ensure that the expenses are not deducted to the extent they increase the value of the home.
d. For clients who report large medical expenses on their tax returns, the planner should evaluate whether the client has adequate insurance and whether the client is maximizing health savings accounts or other tax-favorable plans to pay deductibles and non-covered costs.
____ 15. Real Estate Taxes
a. A planner should consider the location of all of the client’s real property and the effect of state estate tax laws when putting together an estate plan. The client may wish to consider changing domicile to a state without an estate tax, such as Florida. Only about 18 states still have an estate tax. If the federal government repeals the federal estate tax more states may eliminate their taxes as well.
b. To the extent that a client is paying substantial real estate taxes, a Qualified Personal Residence Trust may be an advantageous, if an estate tax issue remains (but consider the loss of basis step up).
____ 16. Charitable Gifts
Large donations may indicate the client is charitably inclined so that charitable estate and gift tax planning may be appropriate. With the recent drop in interest rates, a client may be able to maximize estate planning goals with the Charitable Lead Trust and a private foundation may enable the client to create a legacy of giving that will extend beyond their natural lives.
Change the Conversation
Few clients understand the scope of assistance a CPA can provide beyond tax compliance. They need to be educated and that will take a proactive effort and investment by the practitioner or firm. Here are a few thoughts:
• Identify 20-50 better clients and call them during less busy times and discuss a few planning ideas from an “eyeball” of their return. Don’t make a sales pitch but rather share some thoughts. Clients will well understand you can do more for them if you only whet their appetite. All will appreciate the input. By self-selecting clients you believe are the most likely candidates for more work (and see the ideas below before you limit your perspective on what more work can entail) you’ll enhance the potential for further work, whether from that client or referrals from them. We call these “A” clients.
• Develop simple templates of emails or letters to categories of clients, e.g. trust clients. Have a simple but tailorable list of points that can quickly be tailored to the particular client or return mostly by deleting points that are not applicable so that you have a succinct list of planning points. For example, every trustee should keep trust records to minimize the risk of violating fiduciary duty, enhance the benefits of the trust (e.g. coordination of distributions with beneficiary income tax status), assure that the trust is current (is it an old bypass/credit shelter trust set up when the estate tax exemption was $1 million that is now useless)? Clients rarely note boilerplate emails since they have proliferated to the point of becoming a nuisance. However, a real letter or email addressed to them noting something relevant to their situation may well command real attention and stand out from the “static” of pre-packaged email newsletters.
• Enclose a short tailored planning letter or memo with each return package. We enclose an article of new planning ideas with each month’s billing. Clients appreciate getting more than just a bill. Every practitioner knows their client base. Invest some time and tailor a memo or letter to that. A practitioner in New York City likely does not have too many clients with farm or ranch interests. A practitioner in Missouri may have a lot of clients with those concerns. Some practitioners have a lot of physicians in their client base, some don’t. Prepare something relevant and just enclose it in mailings you are doing anyhow. Here’s a simple and really practical idea that should not be difficult for any practitioner to create: “5 Planning Mistakes We’ve Seen Clients Make in the Past Year.” Tailor it to your client base. Write short actionable steps clients can get their hands around. Skip the usual ending “Please call our office to make an appointment to discuss these and other issues that might concern your file.” If clients are smart enough to hire you they don’t need trite sales pitches. Just offer good information that works for the majority of your clients.
If you can start the conversation, and the points below will give you more ideas, you can generate new work. It’s really easy for a client to ask her golf buddies how much they paid for their 1040 and then give you a hard time if your fee is $100 greater. But if you are working in more of an advisory capacity that comparison and cost sensitivity follows a different litmus test. It becomes “Was that advice worth the cost.” In many cases it will be worth more.
Maximizing the potentials of tax planning requires more regular conversations between adviser and client. Start the conversation.
This article is intended to provide a useful roadmap that highlights the planning opportunities apparent in typical federal income tax returns. We hope that we have offered helpful insight that will guide your conversations with your clients and help you to transform from tax preparer to overall adviser and planning strategist.
Martin M. Shenkman is the author of 35 books and 700 tax related articles. He has been quoted in The Wall Street Journal, Fortune, and The New York Times. He received his BS from the Wharton School of Pennsylvania, his MBA from the University of Michigan, and his law degree from Fordham University.
Joy Matak, JD, LLM is the CohnReznick Trusts and Estates National Practice Co-Leader and provides wealth transfer strategies to assist high net-worth families accomplish asset protection, tax planning and business succession goals.