Next Generation Planner: January 2023
Luis Rosa, CFP®, EA
Founder, Build a Better Financial Future, LLC
This article is an edited transcript of a Knowledge Circle presentation, “Incorporating Tax Preparation or Tax Planning into Your Practice: The Good, the Bad, the Ugly.” Visit www.financialplanningassociation.org/networking/online-communities/knowledge-circles to join a Knowledge Circle and view past events.
If you are doing financial planning truly holistically, you are inevitably going to have to give tax advice. I’m sure compliance wouldn’t want you to call it that, but you are going to give tax advice; you tell a client to do a Roth conversion, there’s a tax component to that. Selling appreciated or depreciated assets, or something as simple as contributing to an IRA or 401(k), is part of a tax strategy. A lot of planners can benefit from either incorporating tax prep—or just tax planning if you don’t want to deal with the headaches of doing taxes—but part of the overall financial planning process should have some version of tax planning that you can do during the year so that you can help your clients make the right decisions and avoid certain mistakes that cannot be fixed during tax season.
So what’s the difference between tax prep and tax planning? They don’t necessarily go hand in hand; you could actually do one without the other. Tax preparation is literally just gathering documents from your client, plugging all the information into a tax software, and then hitting the send button to file a return on behalf of your client. It’s very backward-looking in that sense because there’s not that much more you can do, with a few exceptions, at tax time; maybe contribute to an IRA before the deadline. For the most part, a lot of the things that you would want to plan for should be done ahead of time and not wait until actual tax season to do so. That’s where tax planning comes in. It gives you the ability to combine the client’s resources, your expertise, and then make decisions, assumptions, and strategies throughout the year.
I’ve seen a growth in advisers who are incorporating more and more tax services into their practices because it’s really helpful when you’re doing financial planning . . . and it gives you an opportunity to elevate yourself a little bit and even create good relationships or maybe some centers of influence like CPAs that you might be working with.
If you are considering incorporating tax preparation or planning into your practice, here are some questions you should ask yourself:
- Do I want to do tax prep, tax planning, or both? You can go either way, or you could do both. In my case, I do both. As of now, I’ve done 211 tax returns for the tax year 2022—that is a pretty high volume for one individual, and that’s one of the pitfalls you’ve got to keep an eye on if you decide to move forward with doing tax preparation. If that’s not your core business and you want to grow your financial planning or your AUM business, the tax preparation part of it could get in the way. If you don’t want to deal with the headaches of doing tax preparation itself, you can still do tax planning. A lot of great software is out there that you can use to simulate different things. You can import your client’s tax return that they’ve had prepared elsewhere and mock up what the next year is going to look like. You don’t need to be an enrolled agent for that. . .. I actually got my enrolled agent [credential] first, and then got my CFP® certification. In my experience, I learned more by working at a tax firm and doing returns and dealing with tax scenarios than actually studying for the enrolled agent exam. I don’t know if that’s the same for everyone, but I found that I had to learn things as part of the enrolled agent exam that I wasn’t really doing in real life.
- How will I charge for this service? Am I going to incorporate it in my financial planning fee? Am I going to bill for it separately? If I do AUM, will I include it in my AUM fee or maybe raise it a little bit? I have different models. If I charge 1 percent, I can say, “I charge one and a quarter and that includes your taxes.” Because I have so many different types of clients, I actually bill for it separately. I have about 100 tax-only clients that I only see once a year, and I do their tax returns. Then I have clients that are either financial planning clients, AUM clients, or a combination of the two. Depending on the revenue that I generate from the other two sources, sometimes I include tax prep for free. To give you an example, if I have a client that has $500,000 or more and I’m charging a 1 percent AUM fee, I’ll most likely include tax preparation as part of that and not bill them separately. But if I have a client that has $40,000 invested, it doesn’t make sense for me to not charge a separate fee.
- Will I do it myself? Will I hire someone else, or will I leverage a relationship with somebody like a CPA that has a center of influence? If you want to do it yourself, I would highly recommend, number one, the education piece. You want to make sure that you learn how to do tax returns. Even though you might be savvy enough about tax law, the preparation aspect is completely different. Most of the major tax software companies that are consumer facing usually offer some sort of tax preparation course, and they’re actually pretty good. I highly recommend you do one of those, even if you know taxes already, just so that you get focused on the actual tax preparation part of it.
- How much will this cost? The next thing to consider is going to be cost; what tax software will I use? You’ve also got to get a preparer tax identification number (PTIN), and you can get that through the IRS. If you don’t want to deal with all that and do it yourself, then maybe you can contract it out. In my case, as I grew, I ended up hiring two contractors last tax season. It was my first year doing that so I had to get the cloud-hosted version of my tax software so that I can have these people working with me who were remote so that they can get access to my tax software. I paid them an hourly rate, and they did a lot of the tax preparation data entry. . . . If you can leverage a relationship with somebody that you already know, like a CPA who has some bandwidth, that could be another great way for you to create and cultivate that relationship where you can talk to them and say, “I have 20 clients this tax season who need some tax preparation. Do you have some bandwidth?”
- Does this make business sense? This can get very labor intensive really quickly, and you might be able to make the same revenue or more from another activity already in your business that wouldn’t be as time consuming. To keep the math simple, let’s say that you were able to add 50 clients to do their tax returns. You’re going to charge them $500, so that’s $25,000 extra, which is a nice chunk of money for a short amount of time. But when you think about it, if you are charging [AUM fees] on an annual basis, now it would only take $2.5 million if you charge them 1 percent AUM to make that same $25,000, and it probably is not going to be as much work as doing 50 tax returns. It’s good to go for the sure thing that can make $25,000 this tax season, but then as you grow, that 50 clients becomes 75, then 100, 125, 150, and then you find yourself thinking, “What do I do now?” It also impacts your work–life balance. This particular tax season, because there are so many changes—the stimulus and advanced child tax credits and all kinds of stuff changing—it was super labor intensive.
- Do I need to create a new business entity? I choose to [offer tax services] as part of my RIA because it’s easier for me. It’s only me, and I don’t plan on selling my tax business, so it’s not like it will make it easier if I had a different LLC. One thing to keep in mind is [liability]. What I did was add on to my errors and omissions policy. It wasn’t really that expensive to cover me for the additional liability of tax prep. If you don’t own a firm and you work for a firm as a financial adviser, then you definitely want to make sure that you speak with them because from a compliance standpoint this is going to be considered an outside business activity, so you want to make sure the firm knows about it and is OK with it. Then you can create an LLC and have it completely separate from the work you do at the firm.
- Should I become a CPA or an enrolled agent? CPA certification is going to be overkill if you want to incorporate taxes into your practice because CPAs do a lot more work than just taxes: auditing and all kinds of other things that don’t make sense for you if all you’re trying to do is tax planning or tax prep for your existing financial planning clients. You do not need to be an enrolled agent to do taxes, just like you do not need to be a CFP® professional to be in the financial advice business. The enrolled agent [certification] is going to give you that additional credential. It’s the highest credential that the IRS offers, and it’s on a federal level, so not only does it give you the ability to prepare tax returns, but it also gives you the ability to represent people before the IRS. Right now, the IRS only lets you discuss a tax return that you have prepared yourself. As an enrolled agent, you can actually discuss tax returns that you did not prepare yourself, which is [important] because a lot of times when you get a tax client, they might bring issues from a prior year. Maybe after they became your client, they got a letter from two years ago, and they’re not going to go to their old tax person. They’re probably going to want to come to you.