CORRIE DRIEBUSCH for the Wall St Journal writes: The year's strong stock market performance means gains for many financial advisers' clients. Now those advisers find themselves with a challenge: how to prepare clients for what could be significantly bigger tax bills.
New, higher income and capital gains tax rates give the issue even more importance. And advisers face a shrinking pool of possible tax losses to harvest and offset those gains. The losses many investors suffered in the 2008 and 2009 financial crisis have been largely used already.
Some financial advisers say that this year they are spending as much as twice the time they typically do sifting through clients' portfolios to look for ways to minimize taxes. They are being forced to be more creative devising strategies to recommend, from donating high-flying stocks to shifting types of investments.
"There are still opportunities [for tax-loss harvesting], but you have to look for them," says Jay Allen, a senior wealth strategist at UBS UBSN.VX +1.27% Wealth Management Americas, who works with financial advisers and their clients on tax-related issues. "Equity markets have performed really well, but not all asset classes have participated in that."
The tax rate hikes and a new 3.8% surcharge on investment income have "caused planning to become much more necessary on a case-by-case basis," says Ben Newhouse, a financial adviser and certified public accountant in Springfield, Mo.
He gives the example of two clients, each making $450,000 a year in taxable income and holding $1 million in an investment portfolio. In one case, the investments are in a taxable brokerage account and the other in tax-deferred IRA accounts. In the past, Mr. Newhouse says he would likely have treated these clients similarly in terms of time and effort when it came to tax preparation. Now, however, the client with the brokerage account would face a significantly higher tax bill and require additional attention.
Jack Oujo, a New Jersey-based financial adviser and CPA, says he anticipates a bigger tax liability for clients with rental properties that have no mortgage and produce steady income. He has helped some of those clients reduce the tax hit by placing property in a limited partnership and then start gifting stakes in the partnership to adult children.
"It becomes imperative for advisers to structure client portfolios strategically," he says. He is emphasizing the need to make full use of tax-deferred accounts and sometimes recommending giving more to charity. When those donations are made in the form of long-term appreciated securities, the client not only gets a tax deduction but also avoids capital gains taxes on the assets.
Investors shouldn't take efforts to reduce taxes to extremes, notes Andrew Ahrens, chief executive of Louisiana-based wealth management firm Ahrens Investment Partners. "What happens is, when clients do massive tax-loss selling, their asset allocation could get out of whack," he says.
Still, Mr. Ahrens says his firm is being especially diligent this year in identifying investments that can and should be sold at a loss now, to offset taxes on gains. They are looking at municipal bonds and other fixed-income products, along with commodities-related investments, which in general have fared relatively poorly this year.
"Last year we would look at holdings and take out big and obvious ones," Mr. Ahrens says. "This year clients are saying, 'Even if we're down only 1% to 2%, just take it [to sell] and we'll buy it back in 30 days.'"
"You can find losses in muni bonds and precious metals, and it's easy to exchange those positions for something similar," says Mr. Oujo.
Tax strategy is something advisers should work on at the start of the year, not just the end, so many are already looking ahead to get their clients in shape for 2014's tax bill.
Mr. Oujo is encouraging muni bonds for high-income earners as a way to shrink tax liability. Though their interest rates are low, most clients who understand how they work appreciate their tax-free status, he says. He is also a proponent of variable annuities, which are often derided, for certain investors.
"It can be a very good strategy for people to invest in the market and avoid taxes on dividends," he says, with the caveat that they have a lot of liquidity with their other investments.
Bryan Stephens, a New York-based financial adviser with UBS, says he puts much of his clients' assets into passive exchange-traded funds, shielding them from big tax hits such as mutual fund distributions. "It's enormously tax efficient," he said.
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