Next Generation Planner: October 2022
With an extensive background that includes whitewater kayak instructor, data scientist, and board member for many nonprofits, Tina Wood-Wentz is a financial educator, paraplanner, and founder of Wood Financial Services LLC. This article was inspired by her work in tax preparation and supporting those with the enrolled agent or CERTIFIED FINANCIAL PLANNER™ and enrolled agent designations for three tax seasons, and teaching introductory tax preparation to new preparers, as Tina brings a passion for understanding numbers along with helping and educating others.
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Financial planners know taxes are important, but learning about them can be overwhelming. There is federal tax law, state tax law, and possibly locality tax law, all of which are always changing. Clients’ lives impact their tax obligations or are impacted by taxes in a number of ways, and those circumstances are always changing. Here are some tax-related insights useful for new financial planners as they try to grasp the complexities of the field of taxes.
Where Are We and How Did We Get Here?
The current tax environment is challenging on many fronts. The federal government has recently taken up a pattern of signing year-end legislation with tax impacts. These include:
- Protecting Americans from Tax Hikes (PATH) Act; signed into law on December 18, 2015
- Tax Cuts and Jobs Act (TCJA); signed into law December 22, 2017
- Consolidated Appropriations Act; signed into law December 27, 2020
In November and December 2021, we were still not sure if the Build Back Better Act would pass, with implications for 2021 tax planning and 2022 tax preparation. As one of the proposed components of that legislation impacted the ability to make backdoor Roth contributions, many were scrambling to make these contributions, flooding custodians with additional requests as the custodians were also processing the usual onslaught of December RMD requests. There have been non-year-end or not-current-year impacting legislation changes with income tax preparation implications as well, including the December 20, 2019, Setting Every Community Up for Retirement Enhancement (SECURE) Act, the American Rescue Plan of March 11, 2021, and the August 15, 2022, Inflation Reduction Act, but these don’t also add time-related stress to tax preparation.
There’s been the status of the IRS. The IRS’s lack of funding and staff shortages means that the agency is sitting on many unprocessed paper documents, including individual returns, amendments, and response letters. As of the end of June 2022, the IRS was finally catching up on the paper individual returns filed in 2021 for the 2020 tax year.1 In May 2022, the IRS destroyed around 30 million unprocessed information returns (think 1099-MISC) that it had received on paper, which means clients will not be able to request copies of those from the IRS, and the total impact of that destruction is not yet known. Many pieces of communication with the IRS are required to be on paper, such as if there is a disagreement about claiming of a child’s Social Security number, either as a dispute between parents or in the case of identity theft. Meanwhile, letters and penalties continue to be sent to clients by the system, which has no mechanism to process responses in a timely fashion. Taxpayers and tax professionals call the help lines to talk to an IRS agent and spend hours over a number of days on hold, often without achieving communication, let alone resolution. Fortunately, this is expected to improve between now and 2031 with the passage of the Inflation Reduction Act.2 Of the $80 billion going to the IRS from the act, $25.3 billion is slated for operations support (including IT), $3.2 billion for taxpayer services such as processing returns and answering phone calls, and $4.8 billion for business systems modernization including automated call-back systems. These dollars will take time to have an impact, however, so how difficult the tax return season in 2023 will be remains to be seen.
Then there’s the additional documentation required by pandemic-related emergency relief. Because of short-term, COVID-19-related benefits in the form of three economic impact payments and the monthly advance payout of the expanded child tax credit, several additional reconciliation components were added to 2020 and 2021 tax returns. The IRS was supposed to send documents to each taxpayer about their EIP payments (Notices 1444, 1444-A, 1444-B, 1444-C, and Letter 6475) and about how much advanced child tax credit dollars they had supposedly received (Letter 6419). Unfortunately, the implications of this barrage of new communications were not understood by taxpayers. Then, even though these additional documents were on the tax preparers’ document request checklists, often out of a lack of understanding, taxpayers failed to provide these new documents to their tax preparers, resulting in additional time commitments for the preparers and expenses for the taxpayers. Fewer of these are currently expected on the 2022 tax return, but it’s been a hard two years for tax preparers.
As tax clients can’t effectively vent their frustration with the tax legislation, the tax process, or their tax bill, with lawmakers or the IRS, they instead take it out on their tax preparer. Many preparers in the professional groups I subscribe to have said they are barely surviving the workload and the stress (two or more months of 10–14-hour days, without a single day off), while others have quit the field entirely. Another poignant description was of going to work every day feeling like you were a target. With all of this in mind, please give your tax preparer some grace, kindness, and courtesy in the 2023 tax season.
Frequently Asked Questions
Q: Should my clients be working with any tax preparer?
A: Some tax preparers specialize. Some only do individual returns, some focus on more complex business returns. Some only work with female business owners. Some include bookkeeping services for businesses in addition to the taxes. Some only prepare taxes, others are more comfortable with tax projections and estimating quarterly income tax payments. If your clients work with a tax preparer with additional expertise in their unique complexities, there are two benefits to you and your clients. First, the tax preparer will be more understanding of planning propositions you make, so you will spend less time explaining your proposals and what you need from them. Second, the tax preparer is more likely to be proactive about current-year tax issues, instead of merely a documenter of the prior year’s tax implications.
Q: My client received a letter from the IRS. Does this mean my tax preparer isn’t qualified?
A: Not necessarily. A lot of what clients perceive as tax preparer incompetence is the result of complexity, lack of client communication, forms that were not expected or that were received by the client late like a first-time K1, lack of time to be thorough, IRS code that is open to interpretation, or the fact that the IRS is very backlogged and not communicating based on current information. Dig deeper before you throw your professional colleague to the wolves. Communication with clients and colleagues is the key.
Q: How do state taxes differ from federal taxes?
A: There are seemingly infinite state-by-state differences. With each federal change, states have the ability to align their tax regulations immediately, align later, or to stay non-conformant forever. No two states’ income taxes are alike. Some jurisdictions have local taxes in addition to state taxes. Some exclude the first $20,000 of pension income from taxation upon reaching retirement age or same-state governmental pensions. Some have a healthcare mandate with a penalty.
States vary widely in their prioritization of education funding. Some give generous 529 contribution subtractions or credits, others give less generously, some only recognize same-state 529 plan contributions, some provide no tax break. Only some states follow the federal allowance of 529 funds for K–12 education expenses. Only some allow 529 contributions and withdrawals for same-year expenses.
Some states still allow deductions of employee expenses, a federal tax code component that went away with the Tax Cuts and Jobs Act. Some require you to paper file in order to claim exemption of multistate taxation. Some have chosen not to acknowledge the tax-advantaged status of the health savings account (HSA), so you don’t get the tax break on the contributions, your interest and dividends are taxable on the state return even though you won’t receive a 1099, and state capital gains taxes will be assessed on gains realized via reallocation or taking distributions.
Since each state has such case-by-case complexity, try learning about one state thoroughly, and then adding only one more state at a time. A state-by-state tax reference manual is also invaluable; there are a number on the market.
Q: Are taxes always due April 15?
A: No, there can be a number of exceptions. Major nationwide incidents such as COVID-19’s impact on the United States in spring 2020 can cause nationwide pushbacks of deadlines. If states are impacted by disasters such as storms, tornados, extreme winds, hurricanes, landslides, earthquakes, and wildfires, specifically near a tax deadline, they may be granted a disaster-related extended deadline. Some years, such as in 2022, the Emancipation Day holiday for Washington, D.C., causes the filing deadline to be pushed to April 18. Also, states do not have to conform to the federal deadlines.
Q: I did all of my clients’ tax planning work in October through mid-December. Does that mean I’m done with this year’s taxes?
A: Hopefully not. Not all tax preparers work this way, but if possible, have clients bring you their draft taxes in February or March for you to look for errors before submission. It’s always easier to correct errors before a return is submitted and accepted than after when it has to be amended. After clients’ tax returns are finalized, it’s time to think about tax planning for the new calendar year.
Q: I know it’s not always best to have lower taxes now. What are some scenarios where that’s the case?
A: It’s usually true that clients want to lower taxes this year. But as you already grasp, that’s not always the best scenario. Especially for younger clients, make sure to think about future income, future projected tax rates, and when your client wants to retire. For a physician in residency or fellowship, especially on an extended academia track, it may make sense to make Roth retirement contributions now. For older clients, it may not be about saving on their own taxes; it may be about leaving a legacy with a lower tax burden for their children who would at the time of inheritance be in their peak earning years. For older couple clients and in the year of the first spouse’s death, it may be about utilizing the higher tax brackets of the married filing jointly status instead of single status that the surviving spouse will be in later.
Q: You mentioned all those recent end-of-year legislative changes. Are there any big changes coming?
A: We can never know about tax changes until they are signed into law or expire as scheduled; there are many 11th hour extensions and many legislation pieces that don’t pass.
For example, for 2021 and 2022, the American Rescue Plan of March 2021 removed the income limit tax cliff for the premium tax credit on taxpayers’ healthcare insurance premiums, with the cliff originally scheduled to be reinstated for 2023. However, as of August 16, the Inflation Reduction Act extended the Affordable Care Act subsidies through 2025. One reality of tax law is that it’s never static.
Recommendations for Further Professional Development
There are a multitude of tax education routes you can undertake. The ones listed here are in order from beginner to expert, low effort to high effort. Note: that’s not the same as low to high impact! Each of these is a great step forward in your tax knowledge.
Read a lot of tax returns. Do you understand all of the complexities of your own return? What if you changed one or two facts with your situation; what would the implications be? Can you prepare your own tax return via paper and pencil?
- Read the IRS publications,3 a.k.a. instructions and forms.
- Join the FPA Connect community on Tax & Estate Planning. Attend the FPA monthly Tax & Estate Planning Knowledge Circle sessions.4 Look for other tax-centered courses in the FPA Course Catalog that occur regularly. Many of them are available at no additional charge beyond your FPA membership.
- Dig in deeper by reading the Internal Revenue Code.5
- Volunteer with the IRS’s Volunteer Income Tax Assistance (VITA) or Tax Counseling for the Elderly (TCE) programs to prepare taxes for those with low to middle incomes, and the elderly.6 Their tax needs are not exactly the same as what you might experience if you serve high-net-worth individuals as a financial planner, but the experience will still provide valuable hands-on learning about tax returns. The program is locally administered, so you may find your local branch working through a university, a nonprofit such as the United Way, or your county government. You may also be able to sign up directly with them. They train volunteers in the fall, so reach out soon.
- Join the National Association of Tax Preparers (NATP), which offers in-person and online tax preparation education, CE credits, a professional journal, and tax law news updates, along with 39 local chapters.7
- Become an enrolled agent (EA) with the option to join their professional organization, the National Association of Enrolled Agents (NAEA), which includes a network of fellow EAs with whom to discuss and learn from.8
Why should you consider going through all this effort to learn more about taxes? The reason is that you will see additional planning opportunities, while advisers who don’t understand taxes will miss them. You will be able to demonstrate to your clients that you can be trusted to be knowledgeable about complex topics. And you keep more conversations happening with you as their go-to resource, which increases client stickiness.
Endnotes
- Internal Revenue Service. 2022, June 21. “IRS Continues Work on Inventory of Tax Returns; Original Tax Returns Filed in 2021 to be Completed This Week.” www.irs.gov/newsroom/irs-continues-work-on-inventory-of-tax-returns-original-tax-returns-filed-in-2021-to-be-completed-this-week.
- Congressional Research Service. 2022, August 9. “IRS-Related Funding in the Inflation Reduction Act.” https://crsreports.congress.gov/product/pdf/IN/IN11977.
- See www.irs.gov/forms-instructions.
- See www.financialplanningassociation.org for FPA’s website, https://connect.onefpa.org/home for Connect, and https://fpalearning.onefpa.org for the Learning Center and Knowledge Circles.
- See www.law.cornell.edu/cfr/text/26.
- See www.irs.gov/individuals/irs-tax-volunteers.
- See www.natptax.com/Pages/default.aspx.
- See www.naea.org.
