Taxes are a complex subject. There are many rules, regulations, and exceptions that affect how you file your taxes each year. As a result, financial advisors are often nervous to engage with their clients on matters related to taxes because they fear that doing so may violate regulations and lead to an IRS penalty or even a lawsuit against the firm. Moreover, some E&O policies explicitly exclude any tax penalties from coverage – so the risk is real and can be costly to an advisory firm.
This is especially true for advisors who are not designated tax professionals like CPAs, attorneys, or EAs who have unique rules governing what constitutes formal ‘Tax Advice.’ The good news is that there is a middle ground that can allow advisors to confidently engage with their clients on tax-related topics without violating the rules set in place by their compliance departments. It involves a process that allows advisors to identify and fill in gray areas of the Internal Revenue Code while clearly communicating the benefits and risks of specific strategies to their clients.
The first step in this process is to consider the impact of a strategy on the client’s long-term financial picture. This can include running a tax projection in financial planning software, showing the results of different scenarios, and discussing the pros and cons of various strategies. This stage is unlikely to cross the line into giving tax advice because it is purely considered information and doesn’t suggest that the advisor is endorsing a particular strategy for the client.
Once the advisor has determined that a strategy is worthy of consideration, they can move into the Consultation stage and start to provide more detailed guidance on how a strategy will be implemented in practice. This includes providing the client with a detailed breakdown of the steps required to implement a strategy and how those steps would be structured. It also means advising the client that they should consult with their own CPA or other tax professional about whether they should proceed with the strategy.
It is important to note that oral advice can serve a taxpayer’s needs appropriately in routine matters and in well-defined areas, but written communications are generally preferred. Furthermore, advisors should always be aware that subsequent developments might affect their advice on significant matters. They should therefore take precautionary statements into account in writing when communicating and documenting such advice, stating that their advice reflects their professional judgment based on the facts and law existing as of the date of the communication. The same should apply to any subsequent changes or developments that occur after they communicate their advice to a client. This could be done by using cautionary language in the form of “as of” dates and using precautionary language throughout the communication to the taxpayer. For example: “This is a summary of the tax rules that currently exist, and it is based on the laws that are in effect as of this date.” — RIA compliance blog post. Steuerberatung