Tax pitfalls are something everyone tries to avoid, especially high net worth clients. Investing can bring on excess tax burdens if your clients are not aware of things they should be on the lookout for to avoid potential problems.
Here, I'll discuss the top four tax pitfalls that are an issue for high net worth clients:
1. Lack of Collaboration: It is key to have clients introduce you, their tax advisor, to their financial advisors and/or wealth managers. Many times, the advice provided by these professionals will have tax consequences, so it is important to have everyone on the same page. The last thing you want is to find out that your client made a bad move the prior year when sitting down to do their taxes. Maybe they have received a 1099, K-1 or other tax document you were not aware of before beginning the return. Ideally, you want your clients to feel comfortable bringing their team together when they are considering financial decisions that may impact them tax-wise. This will allow the client to get the best advice and ensure there are no surprises, as well as provide you with an introduction to the financial advisor. This introduction may lead to additional business and future collaboration with other clients.
2. Tax Shelters: I have not met many people who enjoy paying taxes, and I am sure you haven't either. There are always new tax shelters being created and marketed to high net worth individuals as a way to avoid, defer or mitigate taxes. It is important that you work with your clients to do the due diligence needed to assure they are not being enticed into a tax trap or some type of investment that may have more risk they would like. It may also make sense to bring a tax attorney into the conversation to ensure the vehicle is not violating any law that would reverse the tax benefits being granted. Tax shelters are typically complicated and, in certain cases, with more risk than they may appear on the surface. For those of you in the business a while, I am sure you recall the Oil & Gas Limited Partnerships that were around in the 1980s and hurt many investors.
3. Mutual Funds: Depending on the client's tax bracket and what type of account the mutual funds are held in, they may not be a wise investment. Mutual funds held in a qualified account are not an issue, as you know, because the capital gains will not be taxable. However, your client could incur large capital gains, in non-qualified accounts, if the funds they own decide to distribute significant short- or long-term capital gains distributions. Your clients do not have control over this and could be in for a large tax bill if they do not plan properly. It would be more prudent for these types of clients to hold Exchange Traded Funds (ETFs) or individual securities in non-qualified accounts to provide them with more control over the capital gains they would incur for the year.
4. Estate and Gift Tax: Under the Tax Cuts and Jobs Act, the estate and gift tax exemption has risen to $11.2 million (or $22.4 million for married couples). This essentially doubled the previous exemptions and is set to sunset December 31, 2025. High net worth clients will want to review these new thresholds with their financial team. They may need to update or change their estate plans to take advantage of these new levels while they are in place. Clients may want to amend their plans in order to benefit from these increased limits. Some will argue that these changes only apply to the Ultra High Net Worth, while others still feel this applies to the High Net Worth. I decided to include this to make sure it was addressed for your clients if your definition includes the wealth level of this group. In addition, helping your client with this process could lead to introductions to estate planning attorneys and other advisors that could be potential referral sources for your practice.
Taxes are something everyone has to deal with, and they affect the high net worth segment in a greater way. Since they are typically impacted by larger tax bills, they are looking for ways to minimize them too. In the search to lessen their tax burdens, your clients can also stumble upon pitfalls that may cause them greater harm than good. It is important to review with them, on a regular basis, what their tax plan is currently and what, if anything, they should be considering to do differently. It is a constant planning and review process, at which you and their financial team are the center.
Lawrence Sprung CFP® is the President and Founder of Mitlin Financial, Inc. He entered the financial industry in 1996 and continues to be inspired and energized by the challenge of helping his clients achieve and even surpass their financial goals.
Mitlin Financial, Inc. is an SEC Registered Investment Advisor (RIA) that prides itself on...