As the financial industry evolves, advisors are increasingly tasked with creating value for their clients by providing advice on tax strategies. Unfortunately, the complexities of the tax code make it difficult for advisors to clearly understand how to create and communicate these strategies without crossing the line into “tax advice” — which can put them at risk of violating IRS regulations and incurring liability with their firms’ compliance departments.

The good news is that while a tax strategy can be considered tax avoidance, it’s also possible to optimize taxes by simply timing income recognition or by using specialized accounts, like the Roth account or tax-deferred retirement plans. But in either case, any strategy that involves interpreting existing rules in a new way is considered tax advice and should be left to attorneys and CPAs who can ensure they’re not practicing law or offering a type of advice prohibited by Treasury Department Circular 230.

To protect themselves from legal liability, many advisors have opted to avoid giving tax-related recommendations altogether — even when doing so would add significant value to their client relationships. This can be frustrating for advisors who want to remain on the cutting edge of tax strategy, and it also puts them at a disadvantage as many clients are seeking out innovative solutions that may not yet be available elsewhere (e.g., backdoor Roth conversions).

It’s no wonder that so many advisory firms don’t offer tax-related recommendations – it can be challenging to develop policies and procedures relating to what does and doesn’t constitute tax advice, as well as develop the in-house expertise to ensure advisors are fully trained on their firm’s regulations. In addition, some E&O policies exclude coverage for any tax or penalty incurred by a client as the result of an advisor’s recommendation.

Fortunately, there are strategies that advisors can use to help their clients minimize their tax bills. The key is to be clear in how you’re describing the benefits of each strategy and to take steps to ensure that any interpretation or implementation of those strategies does not cross into “tax advice.”

One way to do this is to provide the “consideration” phase of a tax-related strategy, where an advisor sketches out a plan for how they would follow a particular course of action but doesn’t explicitly recommend that the client implement it. Another is to give ranges rather than an absolute number, which makes it less likely that you’re giving formal tax advice. Finally, it’s important to collaborate with a client’s tax professional when discussing these strategies so they can provide their own opinions on whether the strategy is appropriate. With these safeguards in place, advisors can feel more confident about educating their clients on innovative strategies that optimize taxes. After all, if forward-thinking advisors waited for the IRS to sanction tax-optimization strategies before recommending them, those strategies could never be introduced in the first place! For more insight into navigating the gray areas of tax planning, join us for our webinar, “Tax Planning for Your Investing Clients” on Wednesday, September 12 at 11:30 AM EST.Steuerberatung