Five Reasons a Financial Advisor Should Review Your Tax Return

Personal Finance

Mar 20

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You know to seek the guidance of a financial advisor when navigating investment options, retirement planning, and wealth accumulation. While advice in these areas is undeniably crucial, if you’re not also tasking your financial advisor with reviewing your tax return, you’re potentially missing out on the opportunity to make the most of your hard-earned money. Let’s explore why.

Year-round tax-planning benefits

While filing taxes may seem like a routine annual task, the decisions you make throughout the year can ultimately have profound implications on your tax liability. Even if you work with a CPA to file your taxes, he or she may not know the nuances of your financial situation and investments the way your financial advisor does—with this holistic perspective unearthing valuable insights to optimize your financial strategy all year round. Here are five specific reasons to go this route…

1. You can better understand your marginal tax rate

Enlisting the help of a financial advisor to review your tax return is invaluable for comprehending your marginal tax bracket and associated implications. By analyzing your income sources, deductions, and credits, he or she can determine which tax bracket applies to different portions of your income.

The federal marginal tax rate is a progressive system, meaning different portions of your income are taxed at different rates; as your income increases, you may move into a higher tax bracket and thus owe more taxes. Your marginal tax rate—the rate at which the last dollar of your income is taxed by the government—is likely higher than your effective tax rate (the average rate you pay on all income).

Once your advisor knows the former, he or she can identify opportunities to minimize your tax liability by tailoring strategies to keep you within lower tax brackets: employing income-deferring tactics such as delaying an IRA or 401(k) distribution, implementing tax-efficient investment allocations such as investing in municipal bonds, or timing strategies for deductible expenses (property taxes, charitable gifts, etc.) by accelerating them when your income is higher, perhaps. By staying within or strategically navigating your marginal tax bracket, you can potentially scale back the taxes you owe.

2. You can plan for retirement more effectively

Though tax advantages associated with retirement accounts shine through as one of their biggest benefits, it also complicates them just the same. A financial advisor can assess your current retirement savings strategy and recommend adjustments to optimize tax benefits, which may involve strategically allocating contributions between pre-tax and after-tax retirement accounts while accounting for your current tax bracket and anticipated future income. Furthermore, a financial advisor can guide you regarding the timing of withdrawals during retirement to minimize tax implications.

Traditional IRAs, Roth IRAs, 401(k)s, and other tax-advantaged retirement accounts each have unique tax implications. A financial advisor can review these consequences within the context of your long-term financial plan, but two specific areas where guidance from a financial advisor may prove especially valuable are Roth conversions and withholding on IRA distributions.

Roth conversions
Just as the name implies, a Roth conversion involves moving funds from a traditional IRA to a Roth IRA. While this incurs immediate tax liability, it can also offer significant long-term benefits as qualified Roth IRA withdrawals are tax-free. Timing is critical here, and a financial advisor can assess your current tax situation, projected future income, and tax rates to determine the most advantageous time for a conversion—perhaps converting when your income is lower to minimize tax impacts.

Withholding on IRA distributions
When you withdraw funds from a traditional IRA, you have the option to withhold federal income tax—with this amount sent directly to the IRS on your behalf. A financial advisor can help customize this to align with your current tax situation, ensuring you neither overpay nor underpay taxes to optimize your cash flow and preserve your retirement nest egg. An incorrect approach here can lead to penalties or unexpected tax bills, so you want to make sure you do this right.

3. You can take advantage of tax-loss harvesting

No one likes investment losses, but they eventually happen to everyone. The good news, however, is that you can transform these into a tax benefit via tax-loss harvesting: selling securities that lose value to potentially offset capital gains (profit made from selling an investment).

For example, let’s say you sell Stock A and make a $20,000 profit. In the absence of tax-loss harvesting, you would owe capital gains tax on the full $20,000. If you also decide to sell Stock B (which is down), however, you’d incur a loss of $10,000: which you can then use to help offset your Stock A gains by lowering your taxable capital gains from $20,000 to $10,000.

While this may sound fairly straightforward, things can become complicated quickly. For example, excess losses can offset up to $3,000 of ordinary income ($1,500 if married but filing separately). Remaining losses can also be carried forward, with those from the previous year potentially impacting the current one.

Strategically managing capital gains and offsetting losses dictate you consider related factors such as the holding period of investments, tax rates, and the overall impact on your taxable income. By proactively addressing capital gains and losses (rather than waiting until the end of the year, which is common), you can potentially not only minimize your current tax burden but also lay the groundwork for sustained investment portfolio growth moving forward.

4. You can better manage rental income (if applicable)

Anyone who owns rental property can specifically benefit from the help of a financial advisor tasked with reviewing tax returns—because while rental income is often a significant source of revenue, it also comes preloaded with its very own set of tax complexities.

One specific area where a financial advisor can provide guidance is with respect to property depreciation: a key tax benefit for rental property owners. In this case, an advisor can help navigate the nuances of depreciation schedules to ensure the full maximization of these deductions to offset taxable rental income and enhance overall cash flow. A financial advisor can also review expenses ranging from maintenance to property management fees to identify legitimate deductions, reducing taxable income and enhancing profitability. Finally, as property values tend to appreciate over time, an advisor can help develop a tax-efficient strategy for realizing gains on appreciating assets (e.g., 1031 exchanges or other tax-deferred methods) to enhance one’s overall financial position.

5. You can better manage multiple income streams

If you have multiple income streams—whether from income-generating investments, a side business, freelance work, etc.—your taxes become that much more complicated. A financial advisor, in turn, can help create a plan for managing capital gains and exploring tax-loss harvesting opportunities (as mentioned above). He or she can also consider other opportunities to limit your tax burden, such as utilizing tax-advantaged accounts or charitable donations to do the same.

For those engaged in a side business or freelance work, a financial advisor can assist in structuring your business to optimize tax benefits: choosing the right business entity, maximizing deductions, and implementing effective tax-planning strategies, for example.

The key takeaway

In the realm of personal finance, collaboration between individuals and financial advisors extends beyond traditional investment management; a thorough tax return review by a knowledgeable advisor can uncover opportunities for optimization, paving the way for a more holistic financial plan.

Need help with your taxes? Advisor Tax Prep, a sister company of Vision Retirement, employs an integrated approach to personal income tax returns to support your long-term wealth aspirations.