As we approach tax season, many of us are thinking about how we can minimize the amount of money we owe to the IRS. Whether it’s claiming the right deductions, optimizing the timing of income or choosing the best types of investments to avoid taxes, there are a number of strategies that can help make sure we don’t get hit with an unexpected bill come filing time.
But when it comes to discussing these strategies with clients, advisors must tread carefully. Getting too close to the line between tax planning and advice can put the advisor at risk of legal liability — not just in the eyes of the IRS, but also in the eyes of their firm’s compliance department, which is often charged with overseeing these kinds of recommendations.
In fact, some E&O policies exclude coverage for a client’s taxes or penalties if they result from an advisor’s misguided recommendation – which makes many advisory firms fearful to even mention a potential strategy that could create this kind of liability. And, to make matters worse, most advisory firms haven’t developed policies and procedures specific to tax-related guidance — and don’t have the in-house expertise to effectively supervise these kinds of activities.
So what can advisors do to mitigate their exposure? One option is to think of tax planning as a spectrum. At the far end is pure tax information: simply explaining what the rules and regulations say without providing any further analysis that might be construed as a recommendation (and thus put the advisor at risk of liability). At the other end are strategies that would likely require a CPA or attorney’s sign-off if consulted on, such as certain types of tax avoidance schemes — although, as discussed above, there may be some ways to shape this type of advice so that it doesn’t constitute the kind of ’practice before the IRS’ that only attorneys, CPAs and EAs can practice.
Another option is to work with a trusted colleague, such as a CPA or tax attorney, on each and every tax-related recommendation. This helps the advisor build up their own expertise in this area while making it clear to clients that any specific interpretations of new rules or strategies might require a tax professional’s sign-off before being recommended to a client.
In addition, working with a tax professional can help reduce the potential liability an advisor might face from an improperly interpreted or recommended strategy if it’s not reported correctly on the client’s tax return. Ideally, this is done in a joint meeting with the advisor and tax professional or in a written document that clearly states that the recommendation (and the specific actions that should be taken to implement it) is coming from the tax professional and not the advisor alone. This can help to alleviate concerns from the firm’s compliance departments. Steuerberatung