Tax returns are an interesting read for even the non-accountant advisor. If you know where to look they can reveal much information about the activities and interests of the taxpayer that even he or she has forgotten, and disclose assets that aren’t on the financial statement. Discovering them alerts a client that you know more and see more than other advisors.
Here’s a story that will make you believe. Several years ago, we were reviewing the data for a client in California. She was in her eighties and her net worth was in excess of $80 million. Her husband had died several years prior and the attorneys who brought us into the case realized that there was work that needed to be done and that her situation was a little out of control. As we went through her tax returns and bank statements we knew something didn’t reconcile. There was too much interest income for the amount of assets reported. Nothing made sense. Ultimately we discovered an additional $18 million on deposit that she had simply forgotten. A building that she owned had been sold the prior year and she never moved the money from the account where the closing took place.
This is an extreme example, but it happens regularly and discovering this type of disparity is critical and valuable to the planning process. One good place to look on the return is the Schedule E. This is where “pass-through” entities such as real estate holdings, partnerships, LLCs, and S Corps report income to the taxpayer. It is also the source of many questions that can lead to charitable gifts.
Frequently there is “phantom” income reported to the owners of pass-through interests. That is, tax on income never received. Often the entity distributes enough to meet the tax obligation, but there is still the need to discuss what is happening with these assets. If there is more income than the client needs to live on, it might be possible to use a Charitable Lead Trust to take the asset off their tax return for a number of years and to make charitable gifts in that manner.
Assets such as real estate or LLC interests can always open the discussion for pre-sale repositioning into a Charitable Remainder Trust, a Pooled Income Fund or some other charitable structure to avoid capital gains tax and reduce current income taxes. What many advisors fail to consider or discuss is that the client doesn’t have to go “all in” when dedicating an asset for charity. Many of these entities and structures allow partial interest gifts that help balance tax against gain. A zero-tax exit strategy can make an ordinary advisor into a hero. Business owners, real estate investors and sometimes even professional practices utilize these types of entities.
By keeping a sharp eye on the tax return, and not just the charitable gifts on Schedule A, the wise advisor can help their clients more effectively, build credibility, and bring more gifts to charity. That practice model is hard to beat.
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