After 11th-hour tax reforms, advisors worked to calm clients

  • The passage of the Tax Cuts and Jobs Act sent many taxpayers into a panic to optimize their 2018 tax liabilities as quickly as possible.
  • One fee-only advisor had two important and nervous clients ask if he could deduct commission on a pretax basis.
  • Another advisor had to stop clients from canceling insurance policies and changing their incorporation status from an S-corp to a C-corp.

The $1.5 trillion tax bill, signed into law with only eight days left in 2017, sent many taxpayers into a panic to optimize their 2018 tax liabilities as quickly as possible. Financial advisors had to move just as quickly to prevent their clients from making costly mistakes.

Residents of high-property-tax states were especially up in arms because the new law capped the write-off of property and income taxes at $10,000.

"The biggest panicky moves we know about here in ultrahigh-tax states like New Jersey were those prepaying one to three years' worth of real estate taxes," said Thomas H. Yorke, certified financial planner and managing director of Oceanic Capital Management.

A man fills out a U.S. 1040 tax form.
Julie Thurston | Getty Images

He warned that many of these prepayers may become subject to the alternative minimum tax, explaining that once taxpayers determine their AMT liability, they can't go back in time to pay their real estate tax bill to their advantage.

"Prepaying half a year was very likely worth it for most, but any more probably not," he said.

There is another downside to prepaying real estate taxes, according to K. Lane Mullinax, a CFP with NPV Advisory Services. "What it amounts to, for many, is simply paying more tax than is owed, only to have it come back as a taxable refund next year," he said.

"It's only taxes that have already been assessed and paid in 2017 for 2018 tax that the IRS is allowing to be counted as a deduction on 2017 taxes," Mullinax added. "This is not the case in many tax jurisdictions."

Say what?

In the wake of the new law, Rick Kahler, CFP, owner of Kahler Financial Group, received some questions that stunned him.

"I had two clients ask me if I would start charging commissions so they can deduct them pretax," he said. "I am fee-only, and my fees are no longer deductible. Both of their accountants suggested it, and they are my biggest clients — a little frightening," Kahler added.

He declined the requests.

For his part, Scott Bishop, CFP and partner with STA Wealth Management, had to run interference on two significant client moves.

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The first instance involved an irrevocable life insurance trust set up a few years ago for a client with a net worth of $15 million, to help in the ultimate payment of estate taxes.

"He called me, adamant, to cancel the policy now that he would no longer owe the tax due to the higher death tax or unified credit, now at $22 million," said Bishop, who advised the client that it was only a temporary hike and that the old law would revert back in 2026.

"Although I had put that in my newsletter, he selectively read it and saw 'no need for estate-planning life insurance,'" Bishop added. "I told him that we could look at other strategies in terms of gifting, or charitable strategies that we could take advantage of in the interim, but that he should not cancel the life insurance until we coordinate it with his overall financial and estate plan."

Slow down

In the second instance, a client of Bishop's who had a pass-through S-corporation business called a meeting with both his corporate attorney and Bishop upon hearing that C-corporations would now have a 21 percent tax bracket.

"In our meeting right after Christmas, the attorney already had the documents drawn up," Bishop said. "I told them to slow down and to let the ink dry so that we could run the numbers and see if there were any tax impacts of the conversion and what it would mean to him."

That was wise counsel as, after consulting with his CPA and a tax attorney, the client realized there would be tax complications on conversion and, as he could qualify for the pass-through deduction, he was actually better off remaining an S-corp. He also had forgotten that to receive distributions from a C-corp., he would have to pay double tax on the dividends.

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The bottom line, said Bishop, is to "give smart tax specialists the time to review the law to come up with best practices and then run the numbers to see if it makes sense for you now and into the future."

"Don't do it for a short-term tax break with long-term consequences," he added.

Mullinax at NPV Advisory Services noted that in many areas of the new tax law, the IRS "will need to issue guidance before we know exactly where certain lines are drawn."

"There will be many areas of this that will have to play out in U.S. tax court, federal district and appellate courts and the Supreme Court," he said.

— By Deborah Nason, special to CNBC.com

Financial Advisors

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