As the tax filing deadline approaches, we will be discussing tax-planning tips and other tax related issues. In this post, we will outline a process to determine which account(s) should bear advisory fees by calculating the method that yields the greatest income tax benefit for the client. Hence, if you are a fee-based or fee-only advisor, this information will provide you with a process to guide you in your fee deductions.
IRS Rules on Deducting Advisory Fees
1) IRA fees may be deducted from a taxable account (i.e., joint or single).
2) Fees on a taxable account may not be deducted from an IRA.
3) Fees deducted from an IRA are not tax deductible on IRS Form 1040; Schedule A (i.e., itemized deductions).
4) Advisory fees are a Tier II deduction and as such, are deducted on IRS Form 1040, Schedule A. The aggregate of Tier II deductions are deductible to the extent they exceed 2% of the taxpayers AGI.
5) This is not an IRS rule or law, but it’s best not to deduct Roth IRA fees from a Roth account. Making fewer fee deductions from a Roth will result in greater earnings that will eventually be withdrawn tax-free.
Here is an example to illustrate the process of determining the most tax beneficial method of deducting advisory fees.
- Client: Husband and Wife
- Annual Advisory Fee %: 0.65%
- Assets Under Management:
- Joint Account: $1,000,000
- Husband’s IRA: $400,000
- Wife’s IRA: $250,000
- Total Assets: $1,650,000
- Fees by Account (FMV x 0.65%)
- Joint Account: $6,500
- Husband’s IRA: $2,600
- Wife’s IRA: $1,625
- Total Fee: $10,725
- Taxpayer’s AGI: $350,000
- Schedule A, Tier II Deduction Threshold: $7,000 ($350,000 x 2%)
- Advisory fees are the clients only Tier II deductible item
- Marginal Tax Bracket: 35%
- Effective Tax Bracket: 29%
A) Deduct advisory fees from the applicable account
B) Deduct all fees from joint account