Why the tax law is very bad for RIAs
The stated goals of the Republican tax overhaul were clear: simplification, making business more competitive both globally and at home, creating more high-paying jobs and tax cuts for the middle class.
Unfortunately for advisors, there are at least three serious problems with the new law.
It discriminates against our industry by excluding any married advisors who are pass-through owners with income over $315,000 (half of this for single taxpayers) from benefiting from the new preferential pass-through tax rates (20% deduction).
This means that the most successful RIAs, who employ the bulk of the advisors in our industry, are “have-nots” yet small (i.e. sole practitioners) still benefit from the 20% lower partnership, LLC or S-Corp pass-through rates.
- Despite the significant broadening of the proposed tax base (i.e. no more SALT deductions), top tax rates are dropping to only 37%. Thus, advisors in high tax states will actually pay more taxes even after benefiting from a slightly lower top marginal rate.
- Clients are no longer able to deduct investment advisory fees nor tax preparation expense. This means the cost of advice just went up! In the past, advisory fees and tax preparations fees were itemized deductions subject to the extent they exceeded 2% of a taxpayer’s AGI. So, clients now get taxed on their gross investment returns instead of their net (after paying us) returns.
Why are they picking on advisors?
Concerns regarding SALT have been raised by others, and were addressed (although just partially) in the final version, so let's focus on the discriminatory aspects of the law.
Congress has admirably tried to prevent higher paid accountants, lawyers, consultants and other personal services professionals who bill by the hour from gaming the system by simply reclassifying their wage compensation (taxed up to 37%) into business profits (taxed at 20% lower pass-through rates).
In one regard, this makes sense. Without guardrails, we would quickly become an economy of 1099 workers, each abusing the system by setting up pass-through entities to arbitrage tax rate differentials.
But advisors have gotten caught in the crossfire. Unfortunately, in their zeal for simplicity, the politicians have errantly assumed that 100% of advisory firm earnings are wage compensation and 0% consists of bona fide business profits.
It doesn't matter if an advisory firm owner makes $100,000 or $100 million. The politicians are totally ignoring the fact that many of our advisory businesses earn real profits based on our goodwill, retained earnings, invested capital, intellectual capital and recurring revenues and profits. The law simply assumes successful advisors are profitless working stiffs and our businesses are worthless outside of providing us a paycheck for the 40 or so hours we work per week.
As result, the law whacks successful advisors’ earnings at (up to) the top ordinary income rates while our business owner friends and clients (in other industries) benefit from the new pass-through partnership, S-Corp or LLC rates which are up to 20% lower. And even worse, those of us who reside in high income and property tax states will now actually end up paying even more federal taxes than before due to losing SALT deductions.
I don't think that the intent of the law was to pick on advisors and our industry. But in the rush to get a bill passed by Christmas, it seems clear Congress is unintentionally harming our industry.
My hope is that these tax provisions can be addressed later on in a corrections bill. But this will require our industry to present a loud and unified voice regarding the unfair and harmful tax policy that has become law.
Editor's note: This story was updated Dec. 28.