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Incorporating tax preparation or tax planning into your practice: the good, the bad, the ugly

By Luis Rosa

Financial advisors often make recommendations to their clients that will have tax implications down the line, such as Roth IRA conversions and selling appreciated assets.

Unfortunately, financial advisors are not always in a position to advise their clients about taxes, whether because of compliance reasons or clients already having other professionals who handle that aspect of their financial lives.

To minimize the hurdles of properly planning for clients, some advisors take on tax planning and/or tax preparation in-house. As a result, financial planning strategies that have tax consequences can be analyzed in real time, leading to an overall better outcome and experience for both the advisor and the client.

If you’re thinking of incorporating tax planning and/or tax preparation at your firm, here are some things you should consider:

  • Do I want to offer tax planning, tax prep, or both?
  • Should I do it myself, hire someone in-house, or delegate it to an outside professional?
  • Does it make business sense? (For a solo or small firm, this question also leads to issues of work-life balance.)
  • Should I get another certification, like the enrolled agent (EA) credential?

My opinions on this topic have been informed by my experience as a financial planner, solo firm owner, and an EA who has been preparing tax returns for 20 years.

Do I want to offer tax planning, tax prep, or both?

Tax planning and tax preparation do not necessarily go hand-in-hand. Financial advisors can do either one without the other. For example, you can choose to simply prepare tax returns for your clients as an added service in order to increase business revenue. Alternatively, some financial advisors prepare tax returns even for nonclients, with the intent of later providing them with financial planning or investment management as well.

Financial advisors can also do tax planning without preparing tax returns. Using tax planning software like Bloomberg Tax Planner or Holistiplan, advisors can analyze scenarios with their clients before implementing them while seeing the impact it will have on clients’ taxes. Common scenarios include analyzing Roth conversions, calculating implications of selling appreciated assets, estimating tax payments, looking at the benefits of maxing out a 401(k) or SEP IRA, seeing the impact of exercising incentive stock options and how they may affect the client’s alternative minimum tax, etc.

Should I do tax prep myself, hire someone in-house, or delegate it to an outside professional?

If you decide to take on tax preparation yourself, here’s what you’ll need and some things to look out for. You’ll need to get your own preparer tax identification number (PTIN). You’ll also need to become an IRS-authorized e-file provider, which involves applying for an electronic filing identification number (EFIN), as well as passing a suitability check. Finally, you’ll need to obtain tax preparation software, which you’ll use to prepare and file your clients’ tax returns. Also, you should either purchase an errors and omissions (E&O) policy for your tax preparation practice, or ask your current E&O provider if they can add the tax preparation coverage to your existing policy.

If you’ve never done tax preparation, I highly recommend you get solid training. Some of the major tax preparation software companies offer courses, which they use as part of their recruiting efforts.

If you don’t want to go through all of that trouble, you can contract out tax preparation. You can hire someone to work for your firm in-house during tax season or use an independent contractor. Hiring someone in-house will give you more control over the process and client communications, while an independent contractor will likely work on the tax returns on their own time offsite. If you’d like to coordinate joint client meetings with the tax preparer or review tax returns prior to discussing them with a client, it is certainly easier to do so with someone who works in your office.

You can also leverage an existing relationship with a CPA, for example. This means you make a referral to the CPA and the client pays the CPA directly while keeping your firm in the loop. The benefit for you is not only helping your client, but cultivating a relationship with a center of influence who might refer prospects to you.

Another way to offer this service is to be the liaison between your client and the tax preparer. Using a service such as XY Tax Solutions, for example, you can insert yourself into the process without preparing the returns. This allows you to be involved by gathering documents and coordinating with the tax preparer. Because you are doing some work, you can choose to have the clients pay your firm directly, and then you pay the tax preparation service. You do give up control under this scenario because you won’t be able to control the overall volume and workflow of the third party, and any delays can reflect poorly on you and your firm.

Does it make business sense? How will it affect my work-life balance?

You’ll need to decide on pricing to see if tax preparation makes business sense. For example, if you add 50 tax clients at an average fee of $500, you add $25,000 of gross revenue to your firm in a short period of time during tax season while also gaining potential planning clients. You can also strengthen the existing relationships with your clients by offering this new service.

Compare this to the revenue that can be generated from investment management or financial planning fees. For example, if you charge 1% of AUM, you’ll need $2.5 million of additional assets to make the same amount you would preparing 50 tax returns, or if, for example, you charge $2,500 for a financial plan, you’ll need 10 financial planning clients instead.

However, tax prep can become a time drag that, if left unchecked, can take a big bite out of your planning work as well as client acquisition. It can also be a time suck that can negatively affect your work-life balance during tax season.

Although tax prep has been a great revenue source and lead generator for my planning/investment management business, especially during the early stages of launching my own firm, the volume has hurt my work-life balance during tax season. As a result, going forward I will offer my tax-only clients the opportunity to become investment or financial planning clients as part of a bundled service, or I will not do their taxes. I don’t expect everyone to sign up, but I believe that enough clients will upgrade to my new offering, resulting in fewer tax returns overall, with more time and revenue to the firm and a better work-life balance as well.

Should I get another certification, like the EA credential?

Getting a credential like the EA is not necessary to do basic tax preparation or tax planning. However, if you decide to lean more heavily toward incorporating tax preparation or planning into your practice, consider getting the credential. It is the highest credential that the IRS awards. As a federally licensed practitioner, you’ll be able to not only prepare tax returns, but also have the ability to represent clients before the IRS.

If you decide to go the EA route, you’ll need to obtain your PTIN, pass the Special Enrollment Examination (which is a three-part exam), apply for enrollment, and pass a suitability test. In addition, to maintain your credential, you’ll need to renew every three years and obtain 72 hours of continuing education during those three years.

Tax preparation isn’t the best route for every advisor or advisory firm, and the EA is best for advisors who want to make tax work integral to their financial planning practice. However, all advisors need to have a working knowledge of tax issues and a strategy for helping clients evaluate major decisions in light of tax issues. At the very minimum, I recommend that advisors take tax-focused continuing education during the year in order to stay abreast of the latest tax updates as they relate to their clients’ financial plans.

Luis Rosa, CFP®, EA, is the founder of Build a Better Financial Future LLC, a financial planning firm in Los Angeles. He’s also the host of the “On My Way to Wealth” podcast and co-founder of the BLX Internship.

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