Final tax bill gives pain, relief to financial advisers

A congressional agreement on sweeping tax-cut legislation reached late last week is causing consternation among some investment advisers because it will end tax deductions for advice. That is one ramification of a massive bill Republicans hope to pass and have on President Donald J. Trump's desk before year-end. Another change that will affect advisers is a deduction for businesses set up as so-called pass-throughs, in which business taxes are paid on personal returns — although whether it will cause them to shift to independent contractor models is a matter of debate. Advisers dodged a bullet when the final tax bill that melded the House and Senate versions of the measure left out a provision that would have forced clients to sell older stock shares before newer purchases, the so-called first-in-first-out provision. In addition to the modifications it has in store for advisers, the bill is stuffed with changes on individual rates, deductions and other tax rules that will keep financial professionals busy sorting through the details to figure out how the bill affects their clients. The House is expected to approve the tax legislation as early as Tuesday and the Senate could act by Wednesday. Republican majorities in each chamber are likely to prevail on party-line votes. One of the first changes that clients might experience has to do with their advisers. They no longer will be able to take an itemized deduction for advice that costs more than 2% of their adjusted gross income. "Our clients will not like the fact that they will no longer get to itemize and deduct our investment management fees," fee-only investment adviser George Papadopoulos wrote in an email. "This is certainly a negative for advisers."

Reminder: Deduction for advisory fees may be gone, but if you manage clients' IRAs/other #retirement accounts (not Roths) you can still get a virtual deduction by paying advisory fee from the account. Reduces amount growing tax-deferred, but pays after-tax bill w/ pre-tax dollars

— Jeff Levine CPA CFP® (@CPAPlanner) December 16, 2017

In a blog post on Monday, Michael Kitces, partner and director of wealth management at Pinnacle Advisory Group, said broker compensation paid via commission will remain a pre-tax payment. "In other words, the repeal of the investment advisory fee deduction effectively puts [registered investment advisers] at a tax disadvantage to commission-based advisers when work with clients," Mr. Kitces wrote. "As the 2017 tax year comes to a close, some financial advisers may also wish to accelerate invoicing and billing of advisory fees before the end of the year, specifically to allow clients to deduct their investment advisory fees in 2017 while still permitted." Tim Steffen, director of advanced planning at Robert W. Baird & Co., played down the change to the advisory fee deduction. "Most of our larger clients weren't getting a lot of benefit from this anyway," he said. Over the weekend, Mr. Steffen compiled a chart highlighting the major provisions of the final tax bill. Another area that will affect advisers is the pass-through provision. In the final bill, owners of pass-throughs, including financial advisers, will be able to deduct 20% of their income if they make less than $157,500 filing an individual tax return or less than $315,000, if they file a joint married return. That deduction is down from 23% in the Senate bill, which put the married threshold at $500,000. Above the threshold set out in the bill, the deduction would not be available for financial advisers and other service firms. The smaller tax break will catalyze less movement among advisory firm W-2 employees, Mr. Steffen said. "Large firms are less at risk of advisers leaving to go independent," he said. But Peter Schiff, chief executive of Euro Pacific Capital, said many brokers make less than the threshold in the tax bill and will be tempted to head out on their own. "I have a lot of brokers who are my employees who will restructure," Mr. Schiff said. Another factor that may push them out on their own is the fact that the tax bill won't allow deductions for business expenses for employees, such as entertainment and home-office costs. "They have created a huge incentive for people to be self-employed," Mr. Schiff aid. The tax treatment for big service businesses may spur big RIAs set up as pass-throughs to become traditional corporations, according to Mr. Kitces. The so-called "C" corporations will see their tax rate lowered from the current 35% to 21% under the final bill.

Overall, the pass-thru deduction under #GOPTaxPlan is substantially disruptive to financial advisory firms. Lower-income employees at RIAs and B/Ds will want to become independent contractors. Large RIAs will want to become C corps (or Check The Box to be taxed that way).

— MichaelKitces (@MichaelKitces) December 17, 2017

Advisers also will have a lot of parsing to do to figure out how the tax bill will affect their clients. For instance, the alternative minimum tax and estate taxes survived, although the exemptions for each were increased. The mortgage deduction stayed in place but was lowered to $750,000 from $1 million for a new home. Most state and local tax deductions were capped at $10,000. The standard deduction was doubled, but the personal exemption was eliminated.

With the standard deduction doubling next year in the #Republican #Tax Plan (and with tax rates going down for many), think about doubling up your #Charitable giving before year-end 2017!https://t.co/eaFjE6kiey https://t.co/Z0lB3C1WyN

— Scott Bishop, CFP® (@stawealthadv) December 18, 2017

Also eliminated: allowances for recharacterization of Roth conversions. Finally, most changes to individual taxation will expire in 2025, forcing Congress to debate renewing them, as they had to during the so-called 2012-13 "fiscal cliff." The bottom line is that taxes are going to become more complicated. "The dream of a postcard-size tax return died with this reform, if it was ever a real possibility to begin with," Mr. Steffen said.