Where to begin when planning for clients' 2015 taxes

Start with investments, but don't forget the overall impact on portfolios and financial plans

Nov 29, 2015 @ 12:01 am

By Jeff Benjamin

There are tax-loss harvesting, charitable giving, exemptions and deductions, and required minimum deductions to think about. But when beginning to plan for clients' 2015 taxes, the place to start is the investment strategy.

“Do the portfolio review first to see what changes you want to make based on what's good for the portfolio,” said Christine Benz, director of personal finance at Morningstar Inc.

While it might seem obvious, Ms. Benz points out that it is easy to get caught up in trying to take advantage of tax-management strategies without fully considering the overall impact on a client's portfolio or financial plan.

But with the portfolio and the long-term objectives fully in context, Ms. Benz and other tax-focused analysts and advisers say there are some standard tax-management strategies that can help financial advisers add value this time of year.

Investment losses are a perennial favorite area for tax management, but because the stock market has been running so strong since the end of the financial crisis, Ms. Benz described imbedded investment losses this year as “few and far between.”

For tax purposes, investment losses in excess of gains are capped annually at $3,000, according to Craig Richards, director of tax services at Fiduciary Trust Company International, a subsidiary of Franklin Templeton.

He recommends work-ing with outside tax advisers to help capture any losses, especially those that might have carried over from previous years.

“There's no limit to how many years a loss can be carried forward; they can be carried forward until death,” Mr. Richards said. “Traditionally, you try and postpone the taxable income, but you want to accelerate the deductions.”


Unlike 2011 and 2012, which ushered in a raft of tax-law changes, 2015 isn't presenting any major new wrinkles that advisers need to consider other than the usual inflation adjustments to tax brackets, according to Tim Steffen, director of financial planning at Baird.

“Even though the laws and rates haven't changed, it's quite possible your situation has changed, such as working part time or entering retirement” he said.

Possibly the biggest tax law issue facing advisers and their clients is the anticipated last-minute approval by Congress and the president of the 2015 version of the Tax Increase Prevention Act. The 2014 version wasn't renewed until mid-December last year.

Advisers and tax-planning specialists are banking on another 11th-hour renewal this year, but there are never any guarantees as to how Washington politics will play out.

Assuming the law is passed, a number of so-called tax extenders that can help advisers and accountants reduce the tax hit on their clients will remain in effect.

Some specific extenders include mortgage insurance premium deductions, energy-efficient home improvement tax credits, the option to deduct state and local sales taxes over state and local income taxes for those living in states with no income taxes, and deductions of up to $4,000 for higher-education expenses.

But the tax break in the Tax Increase Prevention Act most closely watched by advisers who have lots of wealthy clients in retirement relates to the ability to make tax-free charitable donations directly from an IRA.

Once an individual is 701/2, there is an annual required minimum distribution from qualified retirement accounts, excluding Roth IRAs.

For clients who are philanthropic and who don't need the annul IRA distributions for living expenses, one strategy is to make a donation directly from the IRA to a charity. That meets the annual RMD without triggering an income tax bill related to the distribution.


“For clients with charitable in-tent, we're telling them hold off and see if we get that legislation by the end of year,” Mr. Richards said.

The tradeoff for avoiding the income tax hit by donating directly from an IRA is that clients who itemize their taxes will not get a charitable deduction for their donation, which includes the benefit of reducing adjusted gross income.

All things being equal, most advisers prefer direct donations from IRAs over paying the income taxes and taking the deduction. If nothing else, the direct-donation option provides a bigger donation for the charity because it isn't taxed on the way in.

However, as the clock ticks down toward year-end, some advisers are not interested in waiting for Congress to act.

“I have a client who has a pension and doesn't need her RMD to live on, so she gives most of it away,” said Rita Cheng, chief executive and co-owner of Blue Ocean Global Wealth.

Instead of waiting for a tax law change that might not come, Ms. Cheng has decided to initiate the RMD on behalf of her clients for a donation to charity, even though that triggers an income tax bill.

“We can't wait until the last minute to try and forecast what will happen,” she said.

Ms. Cheng calculates the annual RMD for each of her retired clients at the beginning of the year through a formula factoring in qualified account values at year-end and the client's life expectancy.

“Some clients will take RMD in monthly installments, and some prefer to take it in a lump sum to pay property taxes or for gifting purposes,” she said. “I feel it's best to get these things done by Nov. 15, because that leaves enough time to fix anything before the end of the year.”


Outside of qualified retirement accounts, the impact of investment gains and losses takes center stage when it comes to tax management.

“Charitable contributions are the first thing we think of, and you should do it sooner to get the deduction,” Mr. Richards said.

Along those lines, he recommends donor-advised funds that enable clients to contribute up to 50% of their adjusted gross income while taking as much time as they need to allocate the money to charitable causes.

Greg Sarian, managing director at HighTower Advisors, said donor-advised funds are a particularly useful tool for offsetting the tax consequences of a one-time income event. “It shocks me that more people aren't using donor-advised funds to accelerate charitable gifts,” he said. “If your income is up one year and, let's say, you normally give away $5,000 a year, you could put $20,000 away this year to capture the tax deduction this year.”

Another strategy for grabbing a deduction early is paying a property tax bill or quarterly tax bill that is due early next year prior to Dec. 31 this year, then deduct it on this year's federal tax return.

Mr. Sarian added that charitable donations are a great way to offload appreciated investments in taxable accounts, while resetting the cost basis of an appreciated asset. “Instead of giving $10,000 to the church, give $10,000 worth of Apple stock,” he said.

And because wash-sale rules do not apply when a security is donated to a charity, the client can repurchase shares of the same donated security without waiting 31 days, thus, establishing a new cost basis on the investment.

Appreciated investments also work better than cash for clients who are already providing financial support to certain qualified relatives.

If the relative is over age 24 and in the 15% income tax bracket or lower, he or she can sell the appreciated stock without paying taxes on the gains. It often makes tax-management sense to give those relatives appreciated stock that they can sell, instead of giving them cash.

Mike Lynch, vice president of strategic markets at Hartford Funds, said tax planning works best when it is practiced year-round, which can reduce the amount of scrambling that often takes place this time of year.

“From a charitable-donation standpoint, clients tend to donate whether the markets are up or down, but we don't always do a good job of tracking those donations,” he said. “And you should always be looking at current investments for anything underperforming and thinking of ways to diversify for the tax loss.”


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