Are Tax-Deductible Investment Advisory Fees Still Available?

Are Tax-Deductible Investment Advisory Fees Still Available?

Tax deductions were available for investment management and financial planning costs up until the 2017 tax year. They belonged to the class of supplemental itemized deductions that the Tax Cuts and Jobs Act (TCJA) abolished from the tax code beginning with the 2018 tax year. 

Even if you had the opportunity to recover these fees but chose not to, everything isn’t necessarily lost. For a period of three years following the date you filed your tax return, or two years following the date you paid any associated tax, whichever comes first, you may go back and make changes to it. Furthermore, the TCJA is scheduled to expire at the end of 2025 unless Congress extends it, so it’s possible that this deduction might return at that point. 

Old Deduction Claiming Regulations

Prior to 2018, tax preparation expenses and investment management fees could both be deducted as miscellaneous itemized deductions on a taxpayer’s return, but only to the extent that they exceeded 2 percent of the taxpayer’s adjusted gross income (AGI).

If your AGI was $100,000 and you paid $3,000 in financial planning, accounting, and/or investment management fees, for instance, you wouldn’t get a deduction for the first $2,000 of fees you paid, but you would be able to deduct the last $1,000 — the amount that exceeds 2 percent ($2,000) of your AGI — from your taxes.

Because it’s convenient, you might be tempted to pay these fees by check using after-tax money, but if you have money in an IRA, there may be a better option.

Using an IRA to pay fees

You could pay financial planning or investment management fees that are calculated as a percentage of assets taken directly from the managed account. Fees paid in this manner are not regarded as withdrawals from an IRA account. Because the fees are an investment expense, you are paying them before taxes.

Because the money stored in a typical IRA will eventually be subject to taxation, it makes sense to pay fees directly out of these accounts whenever possible. If you pay fees out of this kind of account, income tax is not due on that amount of the payment.

Unfortunately, you can only use an IRA to cover the portion of the cost that is related to that specific IRA. For instance, if you have $500,000 in an IRA and $100,000 in a non-retirement account, and you pay 1% annually in fees, you can deduct $5,000 from your IRA, but you cannot deduct $1,000 from your non-IRA account.

Using a Roth IRA to pay

Due to the fact that withdrawals from a Roth IRA are tax-free, it is not a good idea to pay fees on this account. Roth account deposits are made with after-tax money. As long as possible, you should let the money grow in a Roth IRA tax-free. 

Fees for internal mutual funds and trading expenses

Fees for mutual funds are calculated using an expense ratio.

 Before you receive your portion of the fund, this expense is subtracted from the return. 

Because that sum was used to cover expenses directly, this return or gain was never disclosed to you. For this reason, you are not required to add up your mutual fund fees and deduct them.

In the event that you purchase a stock and pay $10 for the transaction, the money is added to the stock’s cost basis. When you sell the stock, the amount of the trading cost is deducted from the capital gain reported.

Purchasing Advice

Some investment advisors provide both tax preparation and financial planning services. They are frequently offered as a package of services, and their cost is calculated as a percentage of the assets they manage. When you look at the prices for these services for the tax years in which they are deductible, you might find that they are surprisingly affordable.

The price of actively managed mutual funds, which employ a management staff of research analysts that analyze stock market data in an effort to generate higher returns, is another factor to take into account. Because it costs more to employ this group of research analysts, actively managed funds frequently charge fund fees as high as 0.71 percent annually. 

You could work with a fee-only financial advisor who builds the portfolio using inexpensive index funds rather than actively managed ones. These funds have minimal overhead, and some may even have no overhead costs. By arranging services in this way, you might be able to receive far more individualized guidance for around the same price.

Accounts That Are Managed Separately

For high-net-worth households with numerous investments, many financial counselors advise individually managed accounts rather than mutual funds. Since you directly own the equity, there is no expense ratio. Instead, an investment management charge is deducted from the account and used to cover all fees.

Pre-tax funds are used to cover the costs deducted from an IRA. Prior to tax year 2018, fees qualified for the miscellaneous itemized deduction, subject to a 2% cap, and they may do so again if the rules change after 2025.

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