Also, tax planning that is linked directly to the calculation or collection of a tax whether in an income tax planning or estate planning context. How about financial planning fees or fees that financial professionals charge for per-project or hourly consulting?
Unfortunately, none of these fees are directly connected to income production or investment transactions, so nothing like a deduction can be derived from these expenses. This is the reality through At that date, things may change, as the suspension of miscellaneous deductions under the Tax Cuts and Jobs Act may end. In the present, taxpayers have far less ability to deduct expenses linked to investing, asset management, and tax and financial planning.
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All is not lost however, as commissions paid increase the adjusted cost base ACB of an investment at purchase or sale, thus reducing capital gains or increasing capital losses when the investment is eventually sold. Although not specified in paragraph 20 1 bb , fees charged by the trustee of a registered retirement savings plan, directly to the annuitant, are also not deductible, as the shares or securities held in the plan belong to the trust and not the annuitant.
This means that no fees are deductible if paid in relation to a registered account i. Paragraph 20 1 bb mentions that the advice given has to be related to a share or a security owned by the taxpayer. What is considered a security? Stocks, bonds, mutual funds, corporate class mutual funds and ETFs, would generally all qualify as securities and would normally allow the deductibility of advisory fees if paid for advice regarding the purchase or sale of the securities or administration of the securities.
Do segregated funds constitute a security? It seems not. CRA has taken the position that, for the purpose of paragraph 20 1 bb , a segregated fund contract is an insurance contract and not a share or security 2. Consequently, according to CRA, paragraph 20 1 bb does not apply to fees paid by a taxpayer in respect of the advisability of the acquisition or disposition of segregated fund or for the administration or management thereof.
Please note that to be deductible, the advisory fee must be paid by the taxpayer and needs to be paid for advice or service pertaining to shares or securities held directly by the taxpayer. These requirements, described in 20 1 bb , create many ramifications.
As the investor is not charged this fee directly, it is not deductible at the investor level. Similarly, any trailing commission paid to the dealer in respect of the sale of the mutual fund is also paid by the mutual fund and not the investor directly. So, such commissions are also not deductible.
If an advisory fee is charged directly to the investor, the advisory fee is charged directly to the investor i. However, mutual fund portfolio management fees themselves are not normally deductible at the investor level. Again, par. The CRA has supported this position in several technical interpretations. We are using advisory fees, as it is a more familiar term. And ironically, while both the business and regulatory trend has been to move away from commissions and towards fees, for taxable accounts, the Tax Cuts and Jobs Act distinctly favors commissions with respect to tax efficiency of how the client compensates their advisor.
Example 3 : Sarah is a hybrid advisor who is starting a relationship with a new client, Sam. However, on December 31 st of the same year, concerned about a recession, Sarah liquidates the portfolio and moves Sam to cash. However, any commissions paid by Sam on a purchase will add to the cost basis of his investment. Similarly, any commissions paid by Sam on a sale will reduce the proceeds of that sale. Note that this is in direct contrast to advisory fees, which have no similar impact on basis.
For advisors primarily using mutual funds within their models, the transition to a commission-centric, pseudo-deductible model might be even easier. Put differently, individuals are actually better off from a tax perspective having C shares with a 1.
The total fee paid by the account owner, in either case, is the same, but the tax treatment is not! Example 4 : Eric is a hybrid advisor who is starting a relationship with a new client, Agnes. In this situation, Agnes is clearly better off, from a tax perspective by utilizing the C share mutual funds in her planning. As such, advisors considering this option should be sure to check with their compliance department to understand their protocols and guidelines regarding the use of C shares.
Furthermore, even if such shares are allowed to be used for prolonged periods of time, advisors should carefully — make that very carefully — document the reason for their use over other potential investments.
For instance, another way that RIAs can help their clients offset the loss of the deductibility of investment advisory fees is to transition their own use of internal model portfolios, or separately managed account SMA models, to being restructured as mutual funds or ETFs.
The primary benefit of this approach is to allow for the same pre-tax payment of fees as brokers using the commission model. Of course, this strategy only has the potential to work if the RIA is model-based, or at least is willing to become model-based.
Though for a variety of reasons, not the least of which is the ability to scale, a growing number of advisors already run their businesses by placing clients into one or more standardized models.
And remember, those fees are separate from the actual advisory fees that the RIA would want to bill the mutual fund or ETF to generate its revenue! To make matters worse, many RIAs would have to establish and maintain more than one mutual fund or ETF to continue their current investment management strategies uninterrupted, given that most firms have a range of models for clients, not just one solution.
For instance, suppose an RIA typically places its clients and one of five models ranging from conservative to aggressive. For which there are some cost efficiencies — as creating a series of five funds in a single offering is less expensive than just making 5 standalone funds — but would still increase the total cost significantly for the typical advisory firm. This may, however, require the RIA to change its investment philosophy somewhat, as many advisors not only reduce the amount of equities they own for a client as the client becomes more conservative, but they change the makeup of those equities as well.
By opting for this approach though, RIAs would, once again, increase their initial and ongoing costs due to the number of funds that would be required. In the month after the transition, however, the same client would open up your statement and see one position… the ABC Moderate Growth Fund.
That ABC Moderate Growth Fund could own exactly the same positions in exactly the same percentages as the client had owned previously via their SMA, in which case the client would technically be no more or less diversified as a result of the change in implementation. Simply put, client psychology matters… a lot. A challenge that should not be underestimated. For instance, how would the RIA transition clients from their current model account holdings into a mutual fund?
Will they simply liquidate the account and purchase their newly established mutual fund? Thus, selling those positions to reinvest the funds into a mutual fund model of the same positions could trigger substantial taxable income in the form of capital gains. And while an advisor could choose not to sell certain individual positions in the account, the uniformity and non-customizable-ness of a mutual fund means that any position held for tax purposes might be overweight from an asset allocation standpoint when it is purchased again indirectly via the mutual fund.
This is not the only potentially harmful negative tax impact though. On January 1, , Marjorie purchased shares of Mutual Fund.
Now, suppose that Mutual Fund's manager sells all the shares of Blue Company on December 31, Thus, despite losing money, Marjorie will have taxable income which could be reduced if she sold her Mutual Fund at a loss in — but while doing so might provide a tax loss harvesting benefit, it would in turn require Marjorie to wait more than 30 days to repurchase the Mutual Fund to avoid the wash sale rule.
The ability to efficiently harvest losses, and to manage gains, is a significant benefit for many taxpayers. And hopefully, at a lower upfront and ongoing cost than the relatively prohibited expense of creating a mutual fund or ETF or a series thereof in the first place. However, the limited partnership approach is not without its own challenges.
From a regulatory perspective, such investments would almost certainly not be registered securities, which means the partnerships would be treated as private securities, and thus, generally available only to high-net-worth and other accredited investors.
More substantively, though, is simply the challenge of legitimately being able to claim management fees of the partnership as an expense beyond just an already-non-deductible advisory fee. Alternatively, if the limited partnership is deemed a standalone business of its own, then the ordinary and necessary expenses associated with that business would be deductible as business expenses.
The case involved an LLC taxed as a partnership Lender LLC that was serving as a family office of sorts for three separate investment entities owned by various members of the Lender family.
The IRS challenged those expenses, claiming that they were investment expenses and not business expenses, and thus, not deductible by Lender, LLC. The Tax Court, however, held that based on the evidence presented at trial, Lender, LLC was, in fact, engaged in a trade or business, and thus, was able to deduct such investment management fees as expenses at the entity level.
Thus, some firms may wish to try and emulate the Lender, LLC setup. Historically, this is how private equity or hedge funds have collected their performance-based fees.
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