Combine Income Tax Preparation and Estate Planning

When tackling a jigsaw puzzle, you’ve likely taken the “divide and conquer” approach, separating the larger puzzle into more manageable sections. Eventually, you bring the different areas of focus together to put the finishing touches on the full image.

Wealth management is the same. Estate planning emphasizes an array of complex matters spanning death taxes, asset protection, incapacity, guardianship and family missions. Compartmentalizing can be helpful, but advisors must remember to bring the pieces of the puzzle back together in the end. It’s critical that strategies to maximize the value of your clients’ estates are coordinated with their retirement, financial and income tax planning.

Income taxes are important at all estate levels due to new marginal income tax rates and the rising federal estate tax exemption. This year, the federal estate tax exemption rose to $5.43 million per person and $10.86 million for a married couple. If your client’s estate is below this threshold, you can prioritize and tackle income tax issues … with an estate-planning attorney.

Estate-planning attorneys customarily complete and file gift returns, trust returns, estate returns and foundation returns, but many professionals likely don’t realize that they may also be able to tap these trusted colleagues for personal income tax return preparation, as well, in order to best coordinate the client’s income tax plan with his estate tax plan. For example, income tax on the capital gains from the sale of an asset could be as high as 33 percent, including federal, state, local impositions and the Medicare surtax. For stock positions, business interests, real estate and alternative investments that have appreciated significantly, high-quality income tax planning becomes paramount. There’s a strong, integral relationship between personal returns and the various estate and trust returns, particularly under the current tax regime, where income tax planning opportunities are closely tied to the estate planning structure. For the purpose of consistency in accomplishing these important objectives, it’s often better for one firm to address the whole.

Most estate planners make every effort to keep their clients’ other wealth advisors updated regarding the strategies that they’re implementing, but, unfortunately, their work sometimes fails to be captured by a relevant third party, such as an accounting or brokerage firm, despite everyone’s best efforts. Keeping income tax planning in-house with an estate-planning attorney can ensure that all of the planning pieces are reflected in your clients’ income tax returns, even in the event of a communication failure. For example, if your client has established and funded a Grantor Retained Annuity Trust (GRAT), each year an annuity must be paid back to him. The total income tax liability on the GRAT is taxable to the grantor—not only the annuity amount, but also all gain, dividend and interest income must be reported on the personal return. Thus, in this way, and in myriad others, income tax planning is a natural outgrowth of estate planning.

Using an estate attorney for your clients’ income tax planning not only ensures that all steps are coordinated, but also provides a perfect opportunity for the annual review of your clients’ estates overall—an important discussion, even if you opt to add an accounting firm to the mix. While income tax planning focuses on earnings, rather than the size of your client’s estate, meeting with an estate planner before April 15^th helps you monitor the estate tax (an estate planner will bring up well in advance the implication of potential tax laws and address them in your clients’ plans accordingly) and helps you keep an eye on your clients’ estate assets, so you’re ahead of the game and prepared to respond.

One of the most compelling reasons for tasking an estate-planning attorney with preparing your clients’ income tax returns is that they will be protected by attorney-client privilege. This shield is particularly valuable when considering that the IRS could audit all of your client’s records if they determine that a more comprehensive review of a return is necessary. A signature followed by the letters E-S-Q communicates that your client is serious. In an era where there’s great uncertainty as to the red flags and triggers that will cause an IRS agent to place a return on the pile for in-depth examination, it’s critical to put your client’s best foot forward.

Estate planning  or income tax preparation alone isn’t enough. Continuing engagement is needed to ensure proper wealth management, which is achieved through harmonization of diverse, intricate strategies. Just as a jigsaw puzzle remains unfinished if the sections are kept separate, estate planning and income tax preparation must come together for a complete wealth management picture.

John O. McManus is a top AV-rated estate planning attorney and the founding principal of Tri-State Area-based McManus & Associates.