It's amazing how many different ways we Americans find to avoidpaying the taxes we owe.
Our complicated tax code gives rise to ever-shifting gray areas of what's illegal evasion and what's merely sensible and creative avoidance. In a morally relativistic age and a culture that prizes getting something for nothing, helping clients understand where to draw the line can be one of the most daunting tasks for an advisor.
In situations like the ones that follow, your expertise and talents may help save a tax-evasive client from a big fine, a lifetime of audits, or worse. Special thanks to Gene Balliett of Balliett Financial in Winter Park, Florida; Joan Coullahan of Kurtz, Connor, Browning & Phillips in Vienna, Virginia; and Melissa Hammel of Hammel Financial in Brentwood, Tennessee, for contributing to this discussion.
One of my clients, a dentist, is obsessed with avoiding taxes. One day he showed up at our offices with an enormous leather briefcase full of notebooks and a video for me to review. He'd attended a seminar on how to escape tax by setting up a family limited partnership--one of those deals where you pay a huge sum of money to listen to a pitch and then they give you this briefcase full of stuff to do it yourself. It took the combined efforts of his attorney and me to discourage him from undertaking this complicated and expensive process. Why do so many people let themselves be lured into unsuitable tax shelters, instead of focusing on a well-rounded financial plan? You did well to pry this client away from the fantasy of a tax-free life. The reason why so many folks are seduced by get-rid-of-tax-quick schemes is that that we are an instant-gratification-oriented society, where the idea of the quick fix seems so much more attractive than waiting years for a possibly better payoff.
We Americans tend to fall short in appreciating the value of steady, thoughtful planning to reach our goals. Many of us spend too much, save too little, and plan for vacations more carefully than we do for retirement. Because our goals tend to be short-term, we often choose quickie solutions that are more expensive in the long term and create more problems than they solve.
So whatever you did to persuade your client that an FLP was not in his best interest, hats off to you and to your legal colleague. Bringing excited clients down to earth is rarely fun for them or you; but once they overcome any temporary feelings of deflation, I believe you will further cement their respect and trust.
My client is concerned about the IRS going after her 75-year-old father, who has given up filing tax returns since her mother died. Since investments are his primary source of income, my client feels it's only a matter of time before her dad's brokerage 1099s alert the IRS to his delinquency. She has tried to persuade him to go to a CPA, but he says he's already paid enough tax in his lifetime. Can you suggest any way for her to get through to him? This question made me smile. When my dad was in his 80s, I was enlisted to help him write members of Congress suggesting what he called the Mellan Taxpayer Resolution: a policy that would exempt from income tax anyone over age 80 who had been a lifelong good citizen and faithful taxpayer. His proposal never went anywhere, but I understood the sentiment: he was feeling more and more overwhelmed by the complexity of filing taxes. Even getting the paperwork together for his accountant seemed too much to handle.
Your client's father may be more inclined to change his behavior if you take over from her in pointing out the risks to him. Ask him to visit your office so you can discuss a matter that is affecting his daughter's peace of mind. If he is willing to come, empathize as fully as you can with his sense of entitlement to a tax moratorium, without condoning his failure to file. He may also be feeling some paralysis (and possibly bitterness or anger) after his wife's passing. Let him know you understand how a loss of this magnitude can disrupt the completion of normal everyday tasks. Tax returns may be especially painful, reminding him over and over that he is no longer part of a couple.
After you've listened carefully to his feelings, educate him about the perils of his situation. Look up some of the actual penalties visited on recent tax evaders, and lay them out for him. Then propose a way to resolve the situation that will help him overcome his inertia. Will he allow you (or your client) to make an appointment for him with an accountant? Are you willing to go to his house and help him find the papers he needs to do his tax return himself?
If you first empathize with him, then motivate him, and finally suggest how he can put this task behind him, you may be able to help him get past his debilitating emotions and do the right thing.
During the several years that I've had a graphic designer as a client, I've enjoyed seeing his business grow. But one thing hasn't changed: he comes up short every quarter when it's time to pay estimated tax. Saving money in a separate account doesn't work, because he raids it to meet cash-flow shortfalls. Last time, I read him the riot act for paying taxes with his credit card. Do you think a psychological blind spot may be behind this money-management problem? If so, what can I do about it? Ask your client how he feels when it's time to pay taxes and he doesn't have the money. My guess is he will be at least a little embarrassed that he planned so poorly or spent so much on other things. But he may also feel somewhat hostile and rebellious about having to pay taxes in the first place. Whatever his response, listen without judging and try to validate any of his feelings and perceptions that you can get behind.
It may help to tell him about other business owners who overcame similar tax-avoidance tendencies, and scary stories about those who didn't. You might also examine how he spends his money and what he spends it on. If he's an impulsive or compulsive overspender, is he willing to acknowledge this problem and seek help for it?
Practically speaking, if he's unwilling to take responsibility for keeping his hands off a savings account, there must be a way to put aside money he can't withdraw by himself. An account that requires both your signatures on every check? Some sort of escrow account?
Whatever you do, help him face the fact that better tax planning can reduce his quarterly financial stress.
When a husband or wife does the family taxes, the spouse often doesn't even look at the completed 1040 before co-signing it. If deliberate tax evasion is involved, it will be hard for well-educated folks to claim they were "innocent spouses." Without casting aspersions on the wife or husband who prepared the taxes, how can I tactfully encourage a head-in-the-sand spouse to review the joint tax return carefully? Tell them about District of Columbia Congresswoman Eleanor Holmes Norton, who didn't notice that her otherwise competent husband failed to prepare D.C. income tax returns for seven years. She signed federal tax returns all that time without noticing the absence of D.C. returns. When a reporter discovered this oversight, the ensuing debacle cost her her marriage (not to mention more than $80,000 in taxes and penalties).
Unintentional mistakes are one thing. But as more and more clients have their own businesses, planners are seeing an increase in under-the-table cash payments and other tactics to reduce taxable income. I heard of one client's ex-husband who had gross income of more than $600,000 a year from an automotive franchise, but claimed expenses that reduced his net income to $14,000. Knowing what a drastic effect this would have on the man's child support payments, the client's advisor sent his tax return to a CPA, who found that many deductions were invalid.
To prevent spouses from being hurt by what they don't know, go over tax returns carefully with both wife and husband. You might also consider holding a seminar to help "avoider spouses" become knowledgeable enough to review their tax returns for errors or omissions. As money- phobic clients get better at this, their self-confidence and sense of empowerment will skyrocket, and they'll thank you for your prodding and your support.
A divorced client recently married a fellow who supplies bait to commercial fishermen. It's a high-volume business in which most transactions are in cash. When she asked him about a stash of $35,000 she found in a desk drawer, he told her it was to pay his suppliers. She's concerned that he may be hiding a lot of income from the IRS, and making it possible for his vendors to evade taxes too. What should she do? She doesn't want to harm her new marriage. I can sympathize with your newlywed client's reticence to confront the taboo issue of money with her husband. But after listening to her fears and empathizing about how difficult her situation is, you need to persuade her to take the bull by the horns. She should gently tell her husband that she is just not comfortable with this method of doing business and is concerned that it may endanger their financial stability.
If he tells her he knows how to handle his own business, you might suggest that she use your authority to back up her position. She could propose that the two of them meet with you to get better aligned on how they handle their money. If he ignores her concerns, it's better for her to find out now, before she commits too much time to this relationship.
When you're confronted with a problem of tax evasiveness, it forces you to walk a tightrope. You need to understand where these folks are coming from, confront their resistance, blindness, or venality when necessary, and let go of the ones whose lack of integrity might imperil your own good reputation. The more courageous you are in being truthful with your clients, the more likely you are to win the respect of those you want to keep.
Olivia Mellan, a speaker, coach, and business consultant, is the author with Sherry Christie of The Advisor's Guide to Money Psychology, available through the Investment Advisor Bookstore at www.investmentadvisor.com. E-mail Olivia email@example.com.