Sheryl Rowling's Practice Wise: Should RIAs Offer Tax Services?

Sheryl Rowling’s new Practice Wise column is available first in Morningstar Office Cloud.

My practice, which started out as 100% tax services, has gradually morphed to about 90% investment management and 10% financial planning and tax services. These days, one question I'm often asked is "Does it make sense to provide tax services as an RIA?" First, some personal history.

I started out my career as a CPA working at one of the big firms. When I decided to go out on my own, I focused primarily on preparing tax returns for individuals and family businesses. That turned out to be a good move, but I was always interested in saving my clients’ money. Thus, I added in tax planning. By the time I was ready to prepare tax returns, I already knew what to expect for each client and had ensured they had taken necessary steps to minimize the tax due.

Saving money on taxes was only a piece of each client’s overall financial picture. Tax planning really required some financial planning as tax strategies typically revolved around transactions of one kind or another. Realizing there was a lot to know about financial planning, I got my MBA in finance, with an emphasis on personal financial planning. With a new degree and initials after my name, I was now able and “certified” to prepare comprehensive financial plans for clients.

Financial planning, combined with tax planning, truly made a difference in my clients’ lives and was very rewarding for me. However, when it came time to implement investment recommendations, I could only refer the management out to others.

So, I jumped through more professional hoops and began to manage my clients’ portfolios in addition to providing financial planning, tax planning, and tax preparation.

As much as preparing tax returns is not joyful (especially with the new tax laws!), the ability to integrate all of a client’s financial picture truly provides the greatest likelihood of providing the best advice while keeping everything coordinated and efficient.

Clients appreciate the “one-stop shop” and rest assured that everything we do is aimed at making the most of what they have, both on a pretax and post-tax basis. In fact, our offering of CPA services along with financial planning and investment services has become a differentiator. We have noticed numerous prospects contacting our firm just because we can incorporate tax strategies into what we do.

Our firm’s motto is:

For RIAs that are not CPAs, offering tax services is more challenging. At a very uncomplicated level, the RIA firm could simply engage in a formal relationship with a CPA firm. It’s not quite as good as having everything under one roof, but the fact that you have the resources available will put you ahead of much of the competition.

A better solution is to hire one or more CPAs. The benefits of having this targeted talent within your firm are many:

• Clients are “stickier” as they must contact you each year for tax preparation.

• Clients place a higher value on your services because of tax planning.

• Year-round CPA expertise provides the firm with resources for RMD strategies, Roth conversion analysis, CRT calculations, and more.

In my firm, the CPAs are responsible for:

• Tax return preparation;

• Year-end tax planning;

• Estimated tax payment calculations and client reminders;

• CRT distribution calculations;

• RMD calculations as well as first-year distribution options and Qualified Charitable Distribution planning;

• Roth conversion analyses;

• Input on tax impacts of client transactions, such as sale of a home or like-kind exchange;

• Input and tax savings strategies incorporated within portfolio management;

• Retirement withdrawal strategies.

Other than direct tax preparation and complex special projects, all tax services are provided free of charge as part of our overall client offering. We have found that the cost of CPA salaries is minimal in relation to benefits reaped by clients, as well as the additional business it brings in.

For example, in December 2017 when we became aware of major tax law changes taking effect January 1, 2018, we jumped into action, even though the work was extremely concentrated into the final two weeks of the year.

We analyzed the new tax proposals and developed individual year-end strategies for each of our clients. It felt like going through an entire tax season in two weeks! But we were able to reap huge benefits for our clients, that, without our efforts, would not have been possible.

For some clients, we recommended bunching deductions in 2017 before the new limitations would apply. This meant prepaying state and property taxes, establishing donor advised funds, and prepaying tax preparation and investment management fees. For other clients, it was better to postpone deductions and accelerate income. The majority of our clients saved hundreds to thousands of dollars in taxes.

When we don’t prepare tax returns for clients, there are often missed opportunities. The most common example is neglecting to consider Roth conversion. When clients don’t provide you with prior-year tax returns and don’t keep you posted on their income situation, it is virtually impossible to come up with planning strategies. This can be a huge disadvantage when clients have a very low-income year and fail to move money–at no to little tax cost–from an ever-increasing high tax rate account to an account that will never be subject to taxes.

Of course, there are downsides to bringing tax services in-house to consider as part of the cost/benefit analysis. Negatives can include:

• A significant increase in workload in the weeks and months prior to April 15 and Oct. 15 (the original and extended due dates for personal tax returns).

• An increase in risk to the firm–preparing tax returns can be tricky; errors can cause liability and unhappy clients. Insurance can help, but it won’t cover bad feelings.

• Increased wage costs–at a minimum, you need to hire one CPA; two is better because one can review the other’s work.

• Perceived competition threat from referring CPAs.

How does having CPAs in-house affect referrals from outside CPAs? This seems to be a major concern among RIAs. I have a rule in my firm. If a new client already has a CPA that they like, and the CPA appears to be doing a good job–or the client is referred by a CPA–I will honor that relationship and not seek the tax preparation work. This reinforces client loyalty and shows the CPA that we are not competition. It might actually offer us a marketing window, by meeting with the CPA (after tax season), we can talk about how we save the client money and work with them. In the end, it is not unusual for us to receive client referrals from CPAs.

If you are interested in adding tax services to your RIA offerings, I recommend you start small. Consider hiring a CPA part-time (new mothers are a great pool) to begin adding the services I’ve described above. Don’t try to do too much too quickly. By being deliberate and methodical, you can ensure a good foundation while you build out these services.