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The advisor opportunity in tax season

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With tax season now in full swing, you may well be looking for opportunities to convert clients’ and prospects’ heightened awareness of current or potential tax liabilities to solutions that will help them attain their financial goals.

You’re not alone. Many life insurance and financial service professionals, observers tell NUL, generate substantial business from planning opportunities stemming from tax issues. Tax avoidance is an especially rich topic this year because of the recently enacted American Taxpayer Relief Act of 2012, which ended the long-running sunset provisions on certain levies while boosting tax rates that will most impact  the high net worth, though individuals in lower tax brackets may also be affected.

But as the 2013 tax year is already underway, advisors can do little to affect clients’ 2012 year tax liabilities, apart  from serving in “reactive mode,”  observes  Richard Shakter, a CFP and principal of Financial Compass Group LLC, Wellesley, Mass. The scope of work includes, for example, reviewing documents to ensure the accuracy of items reported on this year’s IRS 1040 form and determining whether tax-deductible items have been overlooked. Among them: income-producing investments that clients may have forgotten about; appreciated stock gifted to charities; debt service (interest deductions) and employee benefits (medical deductions) items.

The main business opportunities, say experts, lie in leveraging tax season to help clients plan for next year’s tax filing.   

 “The income tax return is an inventory of all of a client’s assets—everything one own gets reported there,” say Herbert Daroff, a CFP and principal of Baystate Financial Services, Boston, Mass. “So it’s a good idea to review the document line by line with the client in advance of tax season. As clients are thinking about paying income taxes, now is a wonderful time to tell them, ‘As you prepare for your 2012 tax filings, let’s see how we can help you reduce your 2013 tax liability.”

See also: 8 annuity tax facts you need to know

And, he adds, it’s a good time to identify gaps in insurance coverage. A review of interest rates and the durations of client debts, may, for example, point up the need for additional life insurance, disability income insurance or long-term care insurance to cover outstanding liabilities in the event of a loss of income.

Leveraging such tax deductions to minimize one’s tax liability is good thing. The same cannot be said of tax refunds, which constitute interest-free loans to the government, money that would be better deployed elsewhere. The objective, says Daroff, should to be to maximize net income and assets after taxes, inflation and fees, then decide how to best to allocate the net after-tax income and assets.

2012 tax legislation

From an estate planning perspective, observers say, The American Taxpayers Relief Act of 2012 is a double-edged sword. Since the legislation provides significantly higher estate tax exemption levels than under the pre-2001 estate tax regime — $5 million per individual under the act versus $1 million per person under the old regime — fewer clients need life insurance to pay for estate tax. Conversely, clients looking to boost their legacy to heirs may be able to purchase additional life insurance without crossing over the estate planning threshold.

“Most Americans can now buy their life insurance with tax-deductible dollars inside qualified plans and not worry about estate tax inclusion of the death benefits,” says Daroff. “If I have a $2 million estate and want to buy life $2 million of life insurance, I’m still under $5 million. So why not buy life insurance through a qualified plan?”

Daroff adds the higher estate tax exemption levels under the Relief Act should also make certain trust planning vehicles more attractive to clients for income replacement purposes. Case in point: married couples reducing the value of their estates while retaining control of income for life by establishing a cross-spousal lifetime access trust.

To illustrate, a husband and wife can each creates a SLAT valued at $10 million ($5 million in assets plus $5 million in life insurance) for the benefit of the other. While alive, the couple generates income from the aggregate $10 million in non-insurance assets placed in the two trusts. At the death of the first spouse, $5 million in policy proceeds are paid to the surviving spouse, thereby replacing income no longer being generated from the trust established for the deceased.

The SLAT is available not only to married couples, notes Daroff. Individuals that don’t qualify for the federal marital deduction—co-habiting gays, lesbians and heterosexual couples, as well as resident aliens—can also leverage a SLAT to care for a domestic partner.

The higher tax rates on income, capital gains and dividends stipulated under the Taxpayer Relief Act, say experts, should also spur tax planning among singles and married couples earning more in annual income than $400,000 and $450,000, respectively. Those looking to defer income tax will have an even greater incentive than in past years to leverage the tax-favored treatment of life insurance and annuities.

These vehicles, market-watchers suggest, will also be more attractive to clients who in past years might have foregone tax-deferred vehicles. The reason: It was less costly to pay capital gains or dividends tax on the sale of securities than to pay income tax at the time of distribution on a life insurance policy or annuity.

“When capital gains and dividends taxes were lower, income tax deferral actually worked against the use of life insurance and annuities,” says Terry Altman, a CFP and financial planner at Global Financial Planning Group LLC, Troy, Mich. Financial professionals who invoked income tax deferral as a reason to recommend annuities or life insurance would lose an argument with a CPA opposed to these products — and justifiably so — because income tax deferral was not in the client’s best interest.

“It’s conceivable that going forward, income tax deferral may be as attractive as it was in the 1980s or 1990s because of the rise in income tax rates,” he adds.

The case for tax-deferral offered through non-qualified deferred compensation plans funded with life insurance is particularly strong in client engagements involving C-corporations, says Altman, because of the “brutally high” taxes these companies might be subject to absent the planning. He adds Internal Revenue Code Section 409A, finalized in 2009, has eased non-qualified deferred comp planning by clarifying rules regarding the timing of deferrals and distributions.

Market-watchers also anticipate greater leveraging of income tax-deferred vehicles for individual planning, and not only in respect to life insurance and annuities. Also likely to attract greater interest are tax-qualified individuals retirement accounts, including 401(k), 403(b) and other ERISA-compliant profit-sharing plans, plus traditional IRAs and Roth IRAs.

To be sure, life insurance can also play a role in mitigating the potential tax bite for clients electing these retirement vehicles. Baystate Financial’s Daroff says that an individual desiring to convert an IRA to a Roth IRA can use life insurance to pay income tax on the conversion at death, thereby boosting the income tax-free legacy for heirs.

Enlisting the help of a CPA

Certified public accountants frequently are needed to help advisors address the tax implications of such planning. This is particularly true, say experts, in cases involving high net worth clients and small business owners who have to consider how life insurance-funded arrangements might impact other aspects of their financial plans or (in respect to a company) their balance sheets. Life insurance-funded non-qualified deferred comp plans, Section 162 executive bonus plans and split-dollar arrangements are effective vehicles for recruiting, rewarding and retaining top talent. But such arrangements may have to be jettisoned or postponed until, for example, the business is better positioned from a cash flow perspective.

Enter the CPA, who can provide the expertise needed to address such questions. Just don’t expect their services during tax season, either because they’re too busy completing clients’ tax returns; or because the life insurance professional doesn’t have a pre-existing alliance with the CPA.

“If a life insurance agent wakes up February 1 and says ‘I want to find a bunch of CPAs to work with,’ then he’s about nine months too late,” says Nick Hodges, a CPA, CFP and president of NCH Wealth Advisors, Fullerton, Calif. “If you don’t have a relationship with the CPA well in advance of tax season, they won’t give you the time of day during tax season.”

The best time to build such partnerships, he adds, is during the second or third quarter of the calendar year, when CPAs have more time to review with the advisor entries on tax returns that might lend themselves to planning. The only topics that CPAs and insurance professions should discuss at tax time, observers say, are those questions affecting the current year’s tax return.

To be sure, says Hodges, accountants will frequently uncover planning opportunities when drafting tax returns, such as the need to adjust a client’s financial objectives or cash position because he or she is no longer employed; or because a business’s holdings of stocks and other assets are not advantageous from a tax perspective. To the extent that insurance professionals can acquaint partnering CPAs with planning opportunities in advance of next year’s tax season, the more profitable such alliances will be for both professionals.

The educational outreach need not be limited to private get-togethers with CPA partners alone. Hodges notes that he recently offered to meet jointly with 10 clients of a Texas-based CPA to allow him to see the financial planning  fact-finding process in action. The meetings yielded several new clients for Hodges.

Favoring a more academic approach to alliance-building is Baystate Financial Services. Daroff says that he regularly hosts seminars for other professionals who can assist in complex planning cases — attorneys, property and casualty agents, bank advisors, in addition to CPAs — the program content focusing on trends and joint opportunities in estate planning, retirement income distribution planning and business succession planning. Result: These advisors have become a key source of the firm’s referrals to client prospects.

He adds the new business arrives not only through introductions. Many of the CPAs are also licensed to sell life insurance and securities through, respectively, Baystate’s brokerage general-agent and broker-dealer. They thus can share in insurance commissions and planning fees resulting from a sale.

Does Baystate have established sales or referrals quotas for these professionals? Daroff says “no,” observing that production goals are “old hat.” He notes, however, that Baystate’s advisors are regularly in contact with other professionals; and that splits in commissions and fees are commensurate with a partner’s contribution to the client engagement.

When determining compensation, Baystate frequently elects a formula recommended by the Million Dollar Round Table, which pays the advisor 20 percent for securing the prospect; 20 percent for fact-finding and data collection; 20 percent for designing plan recommendations; 20 percent for executing the plan; and 20 percent for servicing the client. But the compensation formula will vary; in many instances, a simple 50-50 split is used.

Much of the time, agents and planners turn to CPAs solely for their tax expertise, a knowledge base that is particularly valued in complex wealth transfer and business planning cases. Establishing relationships with outside CPAs insures ready access to such expertise in cases where, for example, the client is without an accountant.

Still better is being able to tap that expertise in-house. Prior to joining Global Financial Planning Group, Altman says that he was employed by Rehmann, a firm that specialized in developing qualified and non-qualified compensation plans for company employees. There, Altman worked closely with accountants who, serving in the firm’s corporate auditing arm, were able to deliver high-level expertise—and often on cross-border tax questions. Example: Determining the U.S. and Canadian tax treatment of income earned by Americans working in Canada, a common issue among Rehman’s Michigan-based corporate clients.

In-house tax expertise was not always a good thing, however, for it sometimes led to perceived conflicts of interest. In cases where the firm’s accountants were auditing a company’s books, says Altman, financial planning services had to be outsourced to an outside firm. The alternative, doing the planning and outsourcing the auditing, was never permitted—even in instances when it was more profitable to do so—because the auditing practice was “very protective” of its business.

Altman no longer confronts such internal conflicts of interest in his current practice. The obstacle now, he says, is to overcome biases against life insurance and annuities among partnering CPAs, a particular challenge when the accountant has a pre-existing relationship with the client.

“CPAs have a tendency to immediately bristle at the mention of life insurance and annuities because they’ve often been trained to hate the products,” says Altman. “To have a productive relationship with the accountant, you have to be ready to confront this prejudice head-on.

“You have to know your material and be able to articulate the favorable usages of insurance-related products in a way that overcomes their predisposition against using them. There are a lot of really smart CPAs who don’t understand how life insurance can assist in tax planning.”

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