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Top seven reasons your financial advisor needs to see your tax return

June 30, 2023

Emma sat across from her advisor listening intently as they discussed the markets and how her investments were doing. As the meeting was coming to a close, and after much discussion around contemplating downsizing her home and thinking about increasing her charitable giving, the advisor asked, “Could I please see a copy of your most recent tax return?” Emma furrowed her brow and asked the very common question –

“Why do you need my tax return?”

Here are the top seven reasons we do.

1. We need to know your current overall tax picture
While an advisor is not a replacement for working with an accountant, financial advisors are able to glean quite a bit of helpful information from your annual tax filing. Every tax year is going to look different. Whether it was retiring from work, investing new cash into a high-yield savings account, starting distributions from an IRA, or selling investments and realizing gains, each tax year will have a story to tell and could prompt subsequent financial decisions.

2. Checking for possible reporting inaccuracies or other errors
That overall tax picture includes, at the most basic level, checking that there are no errors in your tax return. The devil, as ever, is in the details. Some of the best strategies can fail if the activity is not reported correctly. Whether this is due to a miscommunication or simply human error, it’s essential to have a professional ensure that your intentions were carried out properly.

Most of the time, it’s a matter of checking that a contribution or deduction was picked up. Some of the more commonly missed items include contributions to a Health Savings Account (HSA), 529 college-savings plan contributions, Qualified Charitable Distributions (QCDs) from IRAs, and Donor Advised Fund (DAF) contributions. We at Bridgewater take pride in training our team on where to identify these items on a tax return, and to recognize when activity might be missing or mis-stated.

If nothing else, it never hurts to have a second set of skilled eyes on your tax return.

3. Fine-tuning retirement and investment strategies
Two very helpful pieces of information are a client’s marginal tax rates for both ordinary income – items such as wages or social security – and the marginal bracket for preferential tax items, such as long-term capital gains and qualified dividends. This information can help determine whether or not a taxpayer should be making contributions to a pre-tax retirement plan versus an after-tax or Roth retirement plan. It can help determine if a taxpayer might want to consider converting some of their traditional IRA money into a Roth IRA. It can also indicate if a taxpayer is better off in higher yielding corporate bonds versus accepting a lower yield in municipal tax-free bonds.

4. Assessing opportunities for portfolio rebalancing
A client’s capital loss carry-forward information is also important. Knowing there are losses on file can allow an advisor to more freely rebalance a portfolio or sell certain concentrated positions without necessarily incurring a high tax bill. On the other hand, if we see substantial realized gains each year, there are tax-loss harvesting strategies that can be put in place to offset these gains.

5. Making tax-efficient charitable giving decisions
Is the client benefiting from itemized deductions? As in Emma’s case above, using her tax return to see what marginal bracket applies, and her other itemized deductions, the advisor could make better recommendations on how to increase her charitable giving in the most tax-efficient way. These might include opening a Donor Advised Fund (DAF), and implementing a “bunching” technique, especially in the year she might be selling her home and potentially realizing gains.

6. Help with planning ahead
Using the most recent tax return as a “base case,” we use tax-planning software that allows us to create future scenarios. Perhaps we need to adjust income or change certain deductions. Once we have modeled our best estimates on the current year’s tax activity, we can determine the impact of potential decisions in either the current year or future years. For example, Emma might have room within the 24% bracket in the current tax year, but is expected to fall into the 35% bracket in later years, and could therefore benefit from intentionally realizing income at the lower rate.

7. Being mindful of Medicare premiums
By using software that looks at all angles of the tax picture, we can determine if realizing additional income would have other impacts. For example, if Emma were over age 65 and receiving Medicare benefits, realizing more income in the 24% bracket would push her into a higher Medicare bracket. As you may know, Medicare premiums are tied to past income, and your premiums can increase as your income increases.

Whether it’s allowing us to better manage your portfolio or identify additional planning opportunities, there are many ways a tax return can help us do a better job in our work together. While we are not a replacement for your tax preparer, these seven points can deepen our understanding of your big picture and can lead to productive conversations.

– This is not a solicitation, or an offer to buy or sell any security or investment product, nor does it consider individual investment objectives or financial situations.
– Information in this material is not intended to constitute legal, tax or investment advice. You should consult your legal, tax and financial advisors before making any financial decisions.
– IRS Circular 230 Disclosure: Pursuant to IRS Regulations, neither the information, nor any advice contained in this communication (including any attachments) is intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax related penalties or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.