Taking charge of your finances can be tricky. Even if you are confident and comfortable making your own financial decisions, you cannot be 100% sure that the decisions you make are suited for the financial goals you wish to achieve. However, getting insights from expert financial advisors can help in making sound financial decisions, which can significantly impact your investment returns and long-term financial goals. Working with a financial advisor can help you create a failproof financial plan and accommodate all critical aspects such as budgeting, saving, debt management, investing, retirement planning, estate management, etc. As per a study, expert financial advice can potentially increase your investment portfolio returns by 3% annually. This has often been referred to as the edge a financial advisor can likely bring to your portfolio. Further, a competent financial advisor not only offers sound financial advice but saves time and reduces money-related stress.
Despite such significant benefits, many people wonder if hiring a financial advisor is worth it. This is a valid question. Typically, a financial planner costs about 1% of your assets under management each year. However, the cost compared with the improvement in returns falls significantly short. Additionally, the peace of mind and improvement in financial well-being adds to the value a financial advisor brings to the table. According to a study, 66% of the survey respondents, who had a financial advisor, specified they were financially secure. Further, 85% of the participants with professional financial support stated their lives were on the right track.
Apart from offering monetary and non-monetary benefits, the money you pay for financial advisory services can help you get tax benefits. So, if you are wondering – ‘Are my financial advisor fees tax deductible? - the answer is a partial yes. Even though rules regarding these advisory fees tax-deductible status have been revised, the tax exemption is still available in a constrained manner. Earlier, until 2017, investment and financial planning services were categorized as miscellaneous itemized deductions. You could get partial or total exemption in your federal income tax return. However, later in 2018, after the Tax Cuts and Jobs Act, some significant changes were made to this taxation aspect, specifying what could and could not be considered as investment advisor fees tax-deductible.
If you want to know if financial planning advice tax-deductible, read this guide to understand the intricacies involved and how you can best benefit from the advisory fees tax deductible option:
Before the tax overhaul by the Tax Cuts and Jobs Act 2017, you could deduct the fees you paid to a professional for “investment advice” by classifying them as miscellaneous expenses on Schedule A of your income tax return for the year. These deductions are for expenses, such as:
To qualify for this advisory fee tax-deductible, you had to show that your miscellaneous itemized deductions were higher than 2% of your annual adjusted gross income (AGI). AGI is your total annual income (including wages, dividends, salaries, bonuses, and capital gains) minus specific deductions, such as personal exemptions and itemized deductions. The IRS (Internal Revenue Service) uses the AGI to determine your yearly tax liability.
For instance, in 2016, if your AGI was $300,000, then miscellaneous expenses (including financial advisor fees and investment-related expenses) over 2% of your AGI or $6,000 were eligible for deduction from AGI. So, if in 2016, you paid $8,000 as fees for financial advisory services, then you could deduct $2,000 from your AGI. That said, you would not get any deduction if your financial advisor fee or related investment expenses were under 2% of your AGI or less than $6,000.
However, with the passage of the Tax Cuts and Jobs Act in 2017, the category of miscellaneous itemized deductions was eliminated effectively from the tax year 2018. This change in the tax code, along with other rules laid down in the act, will remain effective till 2025 unless the government renews it.
Technically, after the removal of the miscellaneous deductions, there are no other specific rules set for the deductibility of financial advisory fees. This means that the remuneration you pay to your financial advisor now falls under the standard deductibility rules. Presently, the IRS gives tax deductions only if you are incurring an expense for earning assessable income. Assessable income is the income that is subject to federal income tax laws.
In general terms, you can claim a tax deduction for the financial advisor fee, provided that the advice is directly concerned with or leads to a specific investment option that generates taxable income. Alternatively, if the money you pay to your financial advisor is for counsel that has no bearing on producing assessable income, then the investment advisory fee is not deductible.
For instance, if you want to hire a professional financial advisor to help you with loan processing for your private residence, then the fees you pay to the expert for their help will not be tax deductible because you are not earning any money from the property you are buying. However, in the same scenario, if you were engaging professional advisory services to get a loan for a commercial property purchase, you could claim a tax deduction for the fees paid to the expert for their help.
Even though the passage of the Tax Cuts and Jobs Act can cost you miscellaneous tax deductions, you have not lost the complete benefit. In many instances, the elimination of the tax deductions has had no impact on the income or the tax benefits. Removal of the miscellaneous tax deductions primarily affected investors who paid fees for investment advisory services according to the percentage of their assets invested in non-qualified investment accounts. A non-qualifying investment account does not have any tax benefits like a custodial account, Transfer-on-Death (TOD) account, individual or joint account, etc. Non-qualifying investments are taxed annually.
So, if you are paying your investment advisory fees from qualified plans like an IRA, you have not lost any of the tax-deductible benefits. This is because the advisor fees from an IRA, a 401(k), or similar qualified accounts are paid on a non-taxable basis. Hence, there is no loss of tax benefit when the fees are given from these types of assets. But it is not advisable to pay for investment advisory fees from a Roth IRA because withdrawals from a Roth IRA are not taxed. After all, the original contributions to these accounts are made on an after-tax basis. It is wiser to allow the money in this account to grow tax-free for as long as possible.
Furthermore, there were significant hurdles when it came to claiming the advisory fees tax-deductible; for example, the deduction was available only if your total miscellaneous expenses exceeded 2% of your AIG.
For instance, in 2017, you earned $150,000, had savings worth $1million ($500,000 in qualified accounts and $500,000 in non-qualified accounts), and paid an investment advisory fee of 1%. The investment advisory fee paid from the qualified accounts, such as an IRA, would not be taxable. Hence, there is no requirement to deduct those expenses from your AIG because typically, you are already getting an exemption by not paying taxes on the sum paid from an IRA.
Alternatively, investment advisory fees paid from non-qualified accounts would be deductible in 2017. But you would only have been able to deduct $2,000 ($5,000 - $3,000) from your AIG because of the 2% threshold (2% * $150,000 = $3,000). This is significantly lower than the actual amount $5,000 paid to the professional (1% *$500,000 = $5,000).
That said, irrespective of whether the new tax codes affect you or not, it is critical to be aware of them.
Presently, here are some of the deductions that you can claim as a part of the investment advisory fees tax deductible:
The ultimate objective of using the investment advisory fees tax deductible is to lower the taxable income and reduce your tax liability. However, it is also possible to reduce your taxable income by opting for other methods, such as:
Even though the current advisory fees tax deductible IRS status is non-deductible, with the expiry of the Taxes Tax Cuts and Jobs Act in 2026, the rules may change, and favorable tax benefits for financial advisory services can likely come into force. Meanwhile, you can take advantage of several other significantly wise tax-saving opportunities. Moreover, with due guidance from a professional financial advisor, you can boost your yearly returns and work effectively to minimize taxes.
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