Nobody likes a surprise letter from the IRS. But for financial advisers whose clients are audited, the inconvenience presents an opportunity.
By familiarizing themselves with how the dreaded process works, wealth planners can uncover a client’s honest mistakes, questionable moves, or unrealistic assumptions about investment returns. At a minimum, holding hands can soothe a panicked customer and build confidence that a nest egg is well fed. On a broader front, it can sharpen the picture of a client’s money hopes and expectations and help refine spending and retirement goals.
“Often financial advisors are silent on tax issues,” said Dan Herron, founder of Elemental Wealth Advisors, a fee-based firm in San Luis Obispo, Calif. Herron, who is both a certified financial planner and an accountant, added that advisers with clients under the IRS microscope “should be proactive — it’s good for the relationship.”
The jolt that taxpayers feel when they learn they are on the radar of the country’s tax collector has an analog: the anguish experienced by the most independent advisers when confronted with technical tax issues. With the exception of the few who have an accountant, most planners rely on the client to outsource everything.
The CFP Board, which oversees the financial planning profession, declined to say how many of its roughly 92,000 certified financial planners are also accountants, a designation considered more technically rigorous. Sheryl Rowling, an accountant and financial planner who is editorial director at Morningstar, said the number of holders of dual designations was “very few”. Less than 3% of accountants were also personal financial specialists, a competing planning degree, in 2018, according to the American Institute of Certified Public Accountants, the accounting industry’s trade group.
“The problem is that regular, non-CPA advisers don’t really know how to answer tax questions,” Rowling said. But at wealth management firms with salaried accountants, “clients place a higher value on your services because of the tax planning,” she says. wrote in a 2019 Morningstar rating.
The real unreal
Advisors may pay less attention to IRS entanglements because the risks of being audited have been declining for a decade. The rate for those earning between $1 million and $5 million fall to 0.6% in 2018. In 2010, it was 8.2%, nearly 14 times higher.
But the low likelihood hides a secret: supposedly “unreal audits.” These refer to computer-generated notices and letters from the IRS that report discrepancies on a federal return. The agency does not formally consider the missives a formal audit and does not include them in its statistics. But for taxpayers who fear the dreaded “A” word, an “unreal audit” looks and feels like the real thing.
When mailings are counted, the 12-month audit rate through September 2016 for those earning $1-5 million rose to 21.1% from an official 4.2%, according the National Taxpayer Advocate, the official watchdog of the IRS.
On the investment side, tax planning is a growing component of “holistic” financial management, which covers everything from paying for college and buying a home to planning for retirement and inheritance. For advisors, it typically focuses on strategies to generate additional profits, such as tax-loss harvesting, not the cogs in the milling processes like a Audit. For that unattractive event, here’s a cheat sheet on how to deal with a customer who’s under surveillance. It does not include obvious tasks: sort and organize documents and meet response deadlines.
“I’ve seen clients think it’s going to go away,” said Marianela Collado, CEO and senior wealth advisor at Tobias Financial Advisors, a fee-based advisory firm in Plantation, Florida. “Newsflash: it’s not!”
The most benign and frequent form of review is a correspondence audit – an “unreal audit” – which announces itself in the mail via a computer-generated letter. A typical missive, a 566 Letter, requests additional documentation, such as receipts that support deductions. Another common letter, the CP2000, says you owe more – or, rarely, less – tax than expected. Often, a correspondence audit will show minor, easily correctable items, such as taxable interest on a forgotten bank account or a discrepancy between what you reported earning from self-employment and what the employer reported to the IRS on the 1099 form. More than 70% of all audits are correspondence audits – and they are rarely a big deal.
“Unless you deliberately did something that you’re trying to hide,” said Kevin Williams, the founder of Full Life Financial Planning, a small wealth manager in Pembroke, Massachusetts, “the IRS is neither there to catch you nor as intimidating as many make it out to be.
The next level is the office audit, when a taxpayer goes to a local IRS office to explain things face-to-face to a tax compliance officer. Here, the agency generally looks for income that can be disguised, such as tips, pensions, annuities, rents, scholarships; deductions for business expenses and bad debts; ordinary income is mistakenly considered low-tax capital gains; and deductions for claims and theft. Ann Jevne, accountant and senior wealth advisor at GYL Financial Synergies, an independent firm in West Hartford, Connecticut, said advisors can step up “emphasizing the importance of reporting” all income and transactions, including bank deposits. .
the dreaded field audit, the most invasive and serious form of examination, involves an IRS tax agent visiting the taxpayer at their home, place of business, or personal accountant. Revenue officers are often the proverbial bean counters, and their presence signals that something bad is likely at stake. More of IRS criminal cases stem from field audits.
For serious situations, a client surely has an outside accountant and, probably, a tax lawyer involved. But while independent advisors who aren’t accountants or attorneys can’t represent a client before the IRS, they can do a lot for someone who receives a letter of correspondence.
If the advice relates to capital gains or losses, dividends or interest, the adviser should be able to provide the client’s accountant with detailed records. Similarly, if a client prepared their own statement and it covered the planning done by the advisor, the advisor can provide the client with documents that reconcile the numbers.
“Bank statements, anything with transaction data — that’s where they can deliver the value to the customer,” Herron said. Advisors, he added, should also contact the client’s accountant directly to say, “whatever you need, let me know.”
It’s not always your fault
Rowling said the IRS typically reviews a specific area. The agency may question a taxpayer’s basis, or original purchase price, for shares sold in a private company, or attempt to reconcile a Form 1099 it received with numbers the client has declared – or not declared – on his return.
A permanent trigger point: retirement accounts. IRS rules state that money withdrawn from an IRA or 401(k) must be renewed within 60 days to a new account if it is to avoid an immediate tax bill. Rowling said false flag issues often arise when clients take money out of an IRA in November or December to put money on a home, then sell their old property to fund a new account in January or December. February with the funds.
Over a 60-day period that begins one year and ends the next year, clients receive a document from their brokerage or plan custodian showing the cash flowing out of their original IRA. The same goes for the IRS, and it triggers the system. The agency does not know that the funds have been replenished, as it is a new year. In contrast, if it had all been done in the same calendar year, no Form 1099-R would have been issued – and no scary letters from the IRS would have been sent.
“Hopefully if the advisor isn’t a CPA, the client would have a CPA,” Rowling said. “It’s always best to have a CPA handle it.”