Advisors must help their clients navigate the nuances of the sweeping changes ushered in under the Tax Cuts and Jobs Act, as well as how the new law applies to their specific situations — both now and in the future — as opportunities and pitfalls abound, according to a just-released analysis by former tax attorney Andy Friedman.
In his new paper, Friedman of The Washington Update says that it’s imperative for clients to discuss with their advisors what actions they should consider to “take advantage, or blunt the adverse effects” of the new law.
Individuals’ and businesses’ tax situations can change, Friedman warns, as “many of the provisions” in the law are slated to expire.
For instance, investors may pay “significantly less tax” if they currently pay the alternative minimum tax, have large estates and are actuarially likely to die in the next few years, or own a pass-through business other than a service business, Friedman explains.
However, other investors, Friedman writes, “may not fare so well; they should examine their situation carefully to see if the benefit of the reduction in tax rates exceeds the cost of eliminated deductions.”
Friedman pointed out to ThinkAdvisor some areas that advisors should be focusing on related to the tax law changes.
Most advisors “are now aware that the new tax law repeals the deduction for investment fees and expenses, such as advisory fees paid in connection with separately managed accounts,” he said. “That change sets up a disconnect between the tax treatment of fees paid on separate accounts and fees paid on mutual funds and variable annuities.”
Unlike investors in SMAs, he continued, “mutual fund and variable annuity investors are able to reduce taxable income by fees paid, because fees are netted against the fund’s or annuity contract’s distributable taxable income. Thus, purely from a fee deductibility perspective, mutual funds and annuities provide a tax advantage.”
On the other hand, “the ability to harvest losses and manage taxes remains a significant advantage of separately managed accounts that could often outweigh the less favorable tax treatment of fees,” Friedman explained. Advisors “should consider with each client the form of investment that provides the greatest after-tax benefit in that client’s situation.”
Changes for Individuals and Businesses