This tax season, as investors gather records and prepare to meet with advisors, they will see the impact of tax reform for the first time. Advisors anticipate that most of the leading questions from taxpayers will focus on changes to popular tax deductions.
While many tax code changes were covered widely in the media, such as the limitation on state and local taxes (the SALT deduction), other changes may not have garnered much attention.
The repeal of miscellaneous deductions, for example, may have a significant impact on some taxpayers’ filings.
With the industry shift to from commission-based investments to advisory accounts, one change in particular may impact many investors – the repeal of the deduction for investment advisory fees. Previously, advisory fees were considered a miscellaneous 2% deduction meaning that a taxpayer could deduct these expenses once the total amount exceeded 2% of adjusted gross income (AGI). Additionally, like other miscellaneous 2% deductions, the deduction for investment advisory fees was not available as a deduction for alternative minimum tax (AMT).
Consider deducting advisory fees directly from retirement accounts
While these fees are no longer deductible from income, existing tax law does allow fees to be deducted directly from retirement accounts without penalty or taxes.* In this case, the taxpayer benefits from using pre-tax retirement funds to pay the fee. Note that this approach generally does not benefit Roth accounts, where “outside” funds should be used to pay the advisory fee, rather than withdrawing funds from a tax-free Roth. Also, investors cannot deduct funds from a retirement account to pay an advisory fee on the non-retirement portion of the advisory portfolio.
Utilize a trust as owner of the advisory account
Individuals can no longer deduct advisory fees, but a trust as owner may still be able to take this deduction. The repeal on deducting advisory fees under the new law does not apply to irrevocable (i.e. non-grantor) trusts or estates. Therefore, the deduction for advisory fees is still available (and not subject to a 2% of AGI floor limitation).
Prior to the new tax law, there was an exception that applies to trusts and estates under IRC § 67(e) that allowed these entities to deduct investment fees without being subject to a 2% of AGI limitation. In Notice 2018-61, the IRS clarified that, under the Tax Cuts and Jobs Act, an irrevocable, non-grantor trust can deduct investment advisory fees on the trust tax return. This would also apply to other fees such as tax preparation fees, appraisal fees, and fiduciary expenses. Of course, this type of approach must be carefully analyzed considering the costs and other complexities associated with establishing and maintaining these types of trusts.
Consult a tax professional
With the complexities of the tax code changes, investors considering these types of strategies should consult with a tax professional.
* See Treasury regulation 1.404(a)-3(d)
For informational purposes only. Not an investment recommendation.
This information is not meant as tax or legal advice. Please consult with the appropriate tax or legal professional regarding your particular circumstances before making any investment decisions. Putnam does not provide tax or legal advice.