The markets go up and the markets go down, but “the tax man cometh,” no matter what. Each year, as you prepare for your annual reckoning with the IRS, it’s more important than ever that your financial advisor and your tax advisor have open lines of communication. The more these two financial professionals can be on the same page as you prepare your return and other documents, the better you’ll fare, not only in tax savings but also in the long-term growth of your financial resources.
Here are a few of the ways that good, clear communication between your wealth advisor and your tax expert can directly benefit you when tax filing time comes around.
1. Tax-loss harvesting
Even in a good market year, you’ll probably have some assets in your portfolio that haven’t made money. In consultation with your tax professional, your financial advisor can review your holdings and identify positions that could be sold at a loss. Why take a loss, you ask? Because such strategic harvesting of capital losses can help you offset gains in other areas. Your financial advisor can help you make smart choices for which losses to take, and your tax expert can provide the big-picture assessment of how much is needed. And speaking of capital gains, another point that bears mentioning is establishing a “capital gains budget” for your portfolio. This is especially helpful for clients who tend to let the tax “tail” wag the portfolio “dog”: they are reluctant to sell appreciated assets, since this will generate gains that might result in a taxable event. This is an area where discussions among the client, the financial advisor, and the tax expert can be especially beneficial. By setting an annual “budget” for capital gains, the tax advisor and the financial advisor can work to increase tax efficiency for the long term, while keeping taxable gains at a level the client can feel comfortable with. Here’s an analogy that might be helpful for understanding this process: By “mowing the lawn” each year (i.e., taking measured gains in the portfolio and paying the taxes due), we can avoid having the portfolio become “overgrown” (i.e., containing years’ worth of unrecognized gains that could represent a large and less-avoidable tax event or, even more likely, a source of over-concentration in a single asset that undercuts proper diversification and asset allocation). In fact, our tax planning department at JFS Wealth Advisors can work hand-in-hand with JFS advisors to keep client portfolios “trimmed and edged” throughout the year.
2. Help with required minimum distributions (RMDs)
Retirees who are withdrawing money from traditional 401(k)s, IRAs, and other tax-favored plans must be conscious of the required amount of funds they must pull out each year, beginning at age 73 (for taxpayers born in 1959 or earlier). While your accountant is probably familiar with these requirements, they may not have an encyclopedic knowledge of your asset mix within these accounts or what other income you have that should be taken into consideration. On the other hand, your financial advisor can look at the range of investments in your portfolio and recommend withdrawal strategies that take into account both tax requirements and the particular characteristics of your assets. It may make sense, for example, to take the withdrawal from one mutual fund held in an IRA account as opposed to another mutual fund in the same account. Because your financial advisor is familiar with your asset mix and its place in your financial strategy, they can help your accountant make the best, most tax-savvy choices for handling your RMDs.
3. Strategies for optimal taxable–tax-exempt income mix
Though this is something you should wait until tax time to think about, it’s important to know whether or how much you should be incorporating tax-exempt income streams into your asset mix, with regard to your fixed-income (interest-bearing) investments. Interest from sources like municipal bonds is free from federal taxation for most individuals, and even though the coupon rate (interest) is usually lower than a taxable bond, the tax-equivalent yield can be higher for those in elevated tax brackets, because of not having to pay income tax on the earnings. Your financial advisor and your accountant need to have a shared understanding of your tax bracket so that your ratio of taxable and tax-exempt income is optimal for your unique situation. And by the way, this becomes even more important as you approach retirement; in some cases, you can expect to be in a lower tax bracket during retirement, and the tax-exempt investments that made sense before may be less advantageous.
4. Help with alternative minimum tax (AMT)
For taxpayers with higher incomes, the AMT is an ever-present consideration. Many of the tax breaks and deductions enjoyed by those in lower brackets are unavailable if you are subject to the AMT. While there’s not much you can do once you find out you’re subject to the AMT in a given year, you can plan ahead for the next year to reduce the chances of being caught by it in the future. Reducing your adjusted gross income (AGI) by such tactics as increasing contributions to IRAs, 401(k)s, 403(b)s, and health savings accounts (HSAs) is one way of reducing your AMT liability. You can also help yourself by controlling your capital gains as much as possible (see “tax-loss harvesting,” above). Your accountant will be the one who tells you if you’re subject to AMT, and your financial advisor can help put you in a more advantageous situation for future years.
5. Minimizing taxes on Social Security
You’ve worked long years and paid thousands into the system, and in retirement, it’s time to start receiving the benefits in the form of Social Security income payments. For some retirees receiving Social Security, benefits are either non-taxable or taxed at a relatively low rate. But for those with sources of income such as IRAs, 401(k)s, or even part-time work (increasingly common for retirees), a portion of Social Security benefits will probably be taxable. For single individuals with income between $25,000 and $34,000, half of your Social Security income is taxable ($32,000–$44,000 for married couples filing jointly). If you file individually and your income is above $34,000, 85% of your Social Security income is taxable ($44,000 for married filing jointly). If you are close to one of these thresholds, your financial advisor and accountant should work together to keep you in a lower bracket for taxable Social Security income.
In good times and bad, taxes are a constant—unfortunately. But careful coordination between your financial advisor and your tax professional can take some of the bite out of the process. If your investment and tax experts don’t know each other, there’s no time like the present to provide an introduction. Especially during this time of year, you need to be talking to them. But even more important, they need to be talking to each other.
At JFS Wealth Advisors, we understand the importance of professional teamwork for managing client accounts in a tax-efficient manner. When CPAs and financial advisors coordinate, everyone wins. If you’d like to find out more about better coordination for your financial team, please let us know.
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Disclosure: This content is provided for informational and educational purposes only and should not be construed as tax or legal advice. JFS Wealth Advisors is not a CPA firm or Law firm. You should consult with a qualified tax professional regarding your individual situation before making any tax-related decisions.
