Slideshow 8 Tax Mistakes Advisors Think Accountants Make

  • March 22 2013, 12:56pm EDT
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8 Tax Mistakes Advisors Think Accountants Make

By: Paula Vasan

It’s tax season, and that means a lot of scrambling to prepare and find ways to cut taxes. But advisors are skeptical that accountants are making all the right moves. Here are 8 mistakes advisors think accountants might make when preparing taxes for clients.

1. Misunderstanding the Pease Rule

Accountants working with wealthy clients commonly misunderstand the way the Pease rule (the itemized deduction phase-out) works, said John Przybylski, director of Financial Planning for Federal Street Advisors. The Pease rule, which has been back in effect starting in 2013 as a result of ATRA (the American Taxpayer Relief Act of 2012), reduces itemized deductions by the lesser of either 3% of the amount by which a tax payers’ adjusted gross income (AGI) exceeds a certain limit or 80% of itemized deductions.

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2. Not Recording Itemized Deductions Properly

Accountants sometimes put their tax preparation fee as a miscellaneous itemized deduction on Schedule A, but often the taxpayer is not able to deduct it because it has to be above 2% of adjusted gross income, says Mike Piershale, president of Piershale Financial Group. If the taxpayer has rental income, a sole proprietorship, or is incorporated, the tax fee could be put on the Schedule E, C, or 1120s if applicable, and the full deduction can be taken.

3. Not Capitalizing on Passive Income-Related Expenses

Expenses related to rental property, such as a cleaning expense, are sometimes not deductible on Schedule E because of the limitation on passive losses being limited to only offsetting passive income. If the tax payer has a small business, these expenses can be put on Schedule C or the 1120s tax form, if applicable, and written off, says Mike Piershale, president of Piershale Financial Group.

4. Miscalculating Cost Basis for Long-Term Gains

If we see that the gain on the sale of an investment is three times what the investor paid for that investment, often it is a mistake, says Mike Piershale, president of Piershale Financial Group. When accountants calculate cost basis to figure gains, they may not take into account the re-invested dividends, Piershale says. Reinvested dividends increase the cost basis, and remember; basis is not taxable. People can end up paying a lot more in capital gains taxes if the wrong cost basis is used, he adds. Accountants often have to rely on the investor to get the accurate basis. It’s important for the investor to not just use the original price paid but add in all re-invested dividends, says Piershale.

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5. Leaving Negative Taxable Income Alone

Clients sometimes have itemized deductions and exemptions that are greater than their income. The problem is that you don’t usually get to carry that forward, says Mike Piershale, president of Piershale Financial Group. In such instances Piershale often recommends pulling money out of a pre-tax IRA to offset the unused deductions and exemptions. That money comes out without tax since the deductions and exemptions shelter it, then the client can convert it to a Roth IRA where it will grow tax free and later come out tax free, says Piershale.

6. Being Reactive Instead of Proactive

Accountants tend to be rearward focused, says Alan Moore, founder of Serenity Financial Consulting. “They will work with clients on their tax return, but they are never looking ahead to help reduce taxes in the future,” he says. “I would like to see more accountants doing tax planning, and providing advice for the future as opposed to always looking in the rear view mirror.”
One area where accountants could arguably get more actively involved is to help their retired clients manage their tax burden on a year-to-year basis by helping them figure out which asset pools (taxable, tax-deferred, Roth, etc.) to draw their cash flows/living expenses from, says Christine Benz, director of Personal Finance at Morningstar.

7. Not Realizing Impact of Tax Planning

Advisors should remember that tax planning has huge impact on client returns. Morningstar recently introduced a research paper on “Gamma” – a concept designed to quantify the additional expected retirement income achieved by an individual investor from making more intelligent financial planning decisions. The research paper can be found here

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8. Failing to Partner With Financial Planners

The best accountants should be partners with their clients’ financial planners, and that means thinking with a financial planning hat on. The tighter coordination needed between the two professions are giving rise to more CPAs adding planning to their practices and more firms looking to recruit CPAs to the planning side.