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Become a Year-Round Tax Hero

Prove your value to clients by saving them time and money on taxes.

Helen Modly and Tommie Monez, 12/08/2011

The rush to implement last-minute tax strategies is again upon us. But how about the rest of the year? Adopt these year-round strategies to prove your value to clients by saving them money on taxes while reducing the time they spend on tax matters.

Eliminate the Chore of Estimated Tax Payments
Remembering to make quarterly estimated tax payments is not only a nuisance, but it costs money when clients forget. Here are some steps to ease the burden:

1. Pay the entire next year's estimate in April. Seriously. We have several retired clients that gladly make that one payment to just be done with it. They love the idea that the specter of the IRS doesn't hang over them all year long. With today's low interest rates there is very little downside if they have the cash available.

2. Sign up for electronic estimated tax payments using the Electronic Federal Tax Payment System (EFTPS) at www.eftps.gov. Payments can be set to be pulled automatically and can be scheduled up to 365 days in advance for individuals. Many, but not all, states also provide electronic payment capability for state taxes.

3. Adjust pension withholding to cover the estimated tax or safe harbor amount (100% or 110% of the prior year's tax obligation).

4. Use IRA required minimum distributions (RMD) to make tax payments. This is treated like withholding from wages in that it is considered as paid throughout the year no matter when the taxes are withheld. High net worth clients with large RMDs will especially appreciate this strategy. We usually schedule our RMDs for mid-November so if there is a projected estimated tax liability, we have it withheld it from the RMD.

Take Advantage of Unemployment or Low-Income Situations
This is the ultimate in making lemonade from lemons. Don't miss the opportunity presented by a low or negative income situation. A temporary situation such as a job loss or large farm loss (think vineyards) can be a great tax saving opportunity. For those clients who have reached age 59½, plan to take IRA distributions or make Roth conversions up to the amount that will trigger tax.

Harvest Tax Losses Throughout the Year
This is front of mind as the year winds to a close, but there is no need to wait for crunch time. By keeping track of gains and losses throughout the year, advisors can make a meaningful contribution to the client's bottom line and take advantage of market dips. This is especially important when taking on a new client that just happens to come on board at a high point in the stock market or a new client that has embedded gains in a portfolio that is in need of restructuring.

Tax-loss harvesting isn't always an easy concept for clients to grasp, but it's worth the extra time and effort to explain. By explaining how loss harvesting has a measurable effect on the client's bottom line, either now or in the future with losses carried forward, the advisor can demonstrate how professional management adds value even in a down market.

Save Taxes by Investment Selection

Use Low-Turnover Strategies. High-turnover in a mutual fund or a stock portfolio will generate commissions and transaction costs, and may result in short-term gains. When making buy and sell decisions, be sure to consider whether or not it makes sense from a tax perspective as well as from an investment perspective.

Use Tax-Managed Funds. These funds often invest in the same or similar stocks as other funds, but the managers seek to minimize the year-end distributions of gains by using strategies such as harvesting tax losses and reducing turnover. They may also tilt away from a benchmark by limiting the number of stocks paying high dividends.

Use Exchange-Traded Funds (ETFs). ETFs have an advantage over mutual funds in the way that distributions are made from the fund. A mutual fund must pass through capital gains realized on the fund level. An ETF is able to dispose of most capital gains through the creation/redemption process among its institutional partners, thus passing through little to no capital gains to owners of its shares. Thus investors usually only realize capital gains upon the sale of their shares of the fund.

Avoid Embedded Capital Gains. Mutual fund shareholders can be hit with gains on the fund level even if the shares are owned only for a short time. Regardless of when during the year the fund realized the gain, any shareowner as of the distribution record date gets hit with a share of the gain and the tax liability. This is particularly painful for an investor who has recently purchased a fund that has declined in value. The solution is to keep track of the distribution dates published by the fund companies to avoid buying a fund just prior to the record date (the date that tags the fund owner for tax purposes).

Avoid Buying Into a Dividend. This is similar to the situation with embedded gains. All share owners on the record date will receive a share of the dividend and the tax liability. This situation can apply to stocks and ETFs as well as mutual funds, presenting an additional challenge in tracking dates. The dividend distribution isn't as sinister as the embedded capital gains, but it is a tax event that should be monitored

Inherited IRA Tax Savings
When clients or prospective clients tell you about having an inherited retirement plan or inherited IRA account, be sure to inquire whether or not the decedent's estate paid estate taxes. If estate taxes were paid on the value of the deceased's retirement plan accounts, then the beneficiaries of those inherited accounts can receive an income tax deduction for distributions up to the amount of the estate tax paid on the account.

It is calculated by determining the amount of estate tax with the retirement account included in the estate and without it. The difference in estate tax is attributable to the retirement account and is available to the beneficiary as they withdraw funds from the inherited account until exhausted.

This tax break is often missed by beneficiaries and their accountants who may not know whether or not an estate tax return was ever filed.

Give Yourself Credit
Most clients really hate paying taxes. Let them know that you are taking a proactive role in reducing their taxes and increasing their net worth. The extra effort is a great way to increase credibility with high net worth clients and establish yourself as a year-round tax hero.

The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.
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