Building on Compliance: The Evolution of Tax Services

Editor: Theodore J. Sarenski, CPA/PFS, CFP, AEP

Job security is a beautiful thing. Since the establishment of the earliest known governments, taxes have been imposed on the populace to enable government spending—they are not going anywhere. Today’s tax complexity ensures a place at the table for CPAs. A recent study showed that 95% of tax filers understand a CPA’s tax qualifications, but those filers also understand that CPAs are not the only game in town.

Despite this, the news is good for CPAs: Members of the public also recognize a CPA’s role as a trusted adviser for all their financial needs and are increasingly looking to consolidate those needs with a single service provider. This is a golden opportunity for individual CPAs and their firms, not only to expand their services to their clients, but also to keep the compliance services they might have seen diminishing over the past decade or more.

Growth of Integrated Services

This past October, the author addressed the AICPA Council about consumers’ need for high-quality integrated services. The need is real. Baby Boomers are retiring at a rate of 10,000 per day, and the nation will soon witness the largest transfer of generational wealth in history—an estimated $15 trillion in bequests over the next 20 years. Millions of Americans need retirement guidance. Millions more are inheriting wealth. Where do they go for help? CPAs have been doing this for over 100 years; it is not new to them. What is new, however, is a change in the core strategy of how CPAs have approached integrated services.

Integrated services include various services CPAs can provide to individuals: tax compliance and planning, risk management, investments, charitable planning, retirement planning, and estate planning. “Integrated” refers to the interrelatedness of these services. Investing is often part of retirement and education planning, for example. Estate and charitable planning frequently coincide. Tax is an undercurrent in all of it. For now, CPAs’ clients might be going to two or more places to get these services, but trends suggest that it will not be that way for long.

In the author’s experience, what individuals want today is a comprehensive group of services and a comprehensive relationship with their CPA. It is deeper than just getting the return prepared; clients want a one-stop shop where all their financial needs can be met. What does this mean? Consider the following.

The health care industry is making this same transition. Several health provider organizations have adopted a business model where general practitioners are supplemented by specialists—often in the same building—who can provide same-day or nearly same-day care for any issues discovered during the initial consultation. In this system, patients do not have to wait days or weeks to see results. It all occurs in one place, under one banner. That is a powerful value proposition. Consumers are all looking for one-stop shopping to give them more time for the rest of life.

CPAs might not be accustomed to thinking about their services in this way, but times are changing. Clients have increasing demands on their time, and service providers that can meet client needs with one consolidated, value-conscious offering will keep business and win market share. Compliance work will always be there, especially for CPAs with wealthy clients or those who handle corporate or business returns. But will compliance always be enough?

Consumers have a growing awareness of their options for getting their returns prepared. Those options are numerous now and could become even more so. And there is a very good reason: Tax compliance is the perfect entry point for offering personal financial planning (PFP) services. For professionals working in financial planning, owning the client’s tax filing means having a wealth of information they need to determine what PFP services the client is ready for.

Make no mistake: This constitutes a threat to CPAs. Other market players are aiming for this compliance work to get a shot at these other services. In the near future, clients will bring their tax compliance business to the entity that can also provide a full menu of integrated services. Many CPAs do not like the term “financial planning.” For them, it conjures images of selling products, and concerns over ethical standards. But the fact remains that if a CPA is conducting any of the activities outlined above, he or she is engaged in financial planning.

Speaking the Consumers’ Language

Nothing is more important than talking to clients in language they can readily understand. Just as a doctor knows to tell a patient whether test results are “normal” or “not normal,” rather than tossing out arcane-sounding terms, CPAs should be prepared to use the words clients understand.

If a CPA offers any or all integrated services, clients will recognize these as financial planning. CPAs who want prospective clients to find them should get comfortable with the term. An Applied Research Consulting report in 2015 found that 78% of high-net-worth consumers (those with $500,000 to $5 million in assets) found the term “financial planning” most appealing as an umbrella term for integrated services. Changing the way CPAs refer to these services is far easier than convincing 78% of their clients to change the way they refer to them.

The Value Proposition

A CPA knows the landscape and can survey his or her client base in a very intuitive way—through the database of completed tax returns. It is time to conquer PFP services and build on a compliance business.

CPAs in tax are uniquely positioned to offer PFP services, and that position owes to more than just owning the tax relationship. The CPA has a client-centric approach to service, and that approach is part of the value offering. By contrast, in the PFP space, many providers’ relationships with their clients are based on sales quotas, specific product tie-ins, and the like. That is not meant to undersell the importance of the tax return, however. Here are just a few things a tax return can tell CPAs about the kinds of services their clients might need in the realm of PFP.

Family Status

Gaining an understanding of a client’s family structure (married, single, or divorced) and the age of any dependents (children and even parents) is critical to assess the entire personal financial picture. Is the client taking advantage of dependent care credits or funding a flexible spending account to pay for day care? It is also important to make sure a client with children who aspires to fund education is setting aside enough money to cover a portion or all of college. The CPA can ask if the client has assets in a Sec. 529 plan and, if so, whether the client is maximizing the state tax benefits of plan deductions. The CPA can also inquire about the allocation of the plan’s portfolio to make sure it fits the children’s time horizon.

Employment Status

A client’s employment status reveals a great deal. A CPA can use this information to start a conversation to learn about the client’s current and future career path. If the client is a W-2 employee, a review of the Form W-2, Wage and Tax Statement, will show how much money the client is saving for retirement, what kind of benefits are available to the client, and whether his or her withholdings should be adjusted. If the client is self-employed, the CPA can advise on the best way for the client to save for retirement and how much he or she can put into tax-deferred accounts.

Charitable Giving

A client inclined to give to charities may represent a window of opportunity for a CPA, as the trusted adviser, to help add immediate and long-term value. Strong charitable desires should be recognized, as they affect a client’s short-term cash flow and future estate planning opportunities. For instance, does the client want to make a regular annual donation? Has the client explored using a donor-advised fund? For a client with significant wealth, should a private foundation be considered?

Home Ownership

Getting a clear picture of a client’s housing situation will help a CPA make key recommendations with regard to current cash flow and long-term planning. For instance, ensuring a client has taken advantage of the dramatically low-interest-rate environment by restructuring a home mortgage is an opening for adding value. If the client has a second home, asking how the client intends to use this home in the future will help the CPA guide the client in planning now, especially if the client intends to move or sell in the future. The CPA can also explain the rules covering gain exclusion on the sale of a primary residence and create a plan to maximize that benefit.

Investment Portfolio

A CPA should take a look at the client’s interest, dividends, and capital gain distributions to determine where they are coming from. The CPA can help clients understand the importance of asset allocation (stocks vs. bonds) and asset location (which assets should be held in tax-deferred accounts vs. taxable accounts). The information on the annual tax return is a window to what the client owns.

Titling of Assets, Trusts

Knowing how assets are titled is essential for estate planning. Forms 1099 issued from investment accounts can give a sense of who owns what and whether it is in a trust. If trusts are on the return, the CPA needs to dive deeper to know more. Who is the beneficiary? Will the trust assets ultimately be distributed to children, and how are assets currently invested? Does the client have any incidents of ownership?

Retirement Status, Required Minimum Distributions

If a client is over age 70½ and taking required minimum distributions (RMDs), this income can be planned for each year. The CPA should ask the client if this income covers cash flow needs or if some of it is being reinvested in taxable accounts. Clients who are charitably inclined might want to take advantage of the ability to make the distribution directly to charity to avoid being taxed on the income.

If a client has not yet reached age 70½, there might be planning opportunities that take advantage of the time before distributions start. For instance, if a client is temporarily in a lower tax bracket between retirement and RMD age, the CPA can use this time to draw funds from a retirement account or convert some of the funds to a Roth IRA, resulting in lower taxation per dollar.

Available Cash Flow

Clients often do not have a clear grasp of what they are spending. Rather than have the client try to write out every expense on a monthly basis, it is better to run the calculation backward. All of the client’s income, less taxes, needs to be accounted for. A key component of planning requires determining whether there is a gap in clients’ understanding of net cash flow and what they think they spend.

Passive Investments

The CPA should understand how a client’s investments in partnerships, S corporations, and other passive vehicles fit into an overall investment strategy. If the client regularly has passive losses, the CPA can advise on generating passive income to offset those losses, or vice versa. It is important to differentiate between passive entity types such as private equity or real estate and to find out how involved the client is in these investments. The CPA should review the client’s Schedules K-1 to learn more about these investments.

Domicile and Multistate Activities 

A client might be able to change residency to avoid taxes either in the near term or long term (upon selling an asset). Thinking through this planning opportunity could prove extremely beneficial for clients in the top tax brackets, especially those who live in high-tax states. If a client has property in more than one state, this can also have a significant impact on estate planning. It is critical to have a conversation about how homes and investment properties are titled so that there are not multiple probate processes in multiple states at death.

Developing Expertise

An AICPA Personal Financial Planning Division checklist can help CPAs highlight key financial planning information on clients’ tax returns. The checklist (available at www.aicpa.org) was developed by Chris Benson, CPA/PFS, Lyle Benson, CPA/PFS, and Sarah Hughes, CPA/PFS. While the checklist is comprehensive and likely more detailed than a CPA needs for every client, it is a great guide to start thinking about planning opportunities for clients just from reviewing their tax returns.

CPAs should also consider the specific laws governing the services they want to offer. The AICPA’s PFP Section (aicpa.org/PFP) offers a broad range of informational resources that will help CPAs get started, as well as a full range of resources related to the requirements of offering financial planning services on an ongoing basis. Demonstrating competence is the best way to connect with a client, and for CPAs in financial planning, the Personal Financial Specialist (PFS) credential does just that. More information about the PFS credential is available at aicpa.org/PFS.

Working in tax has always meant being adaptable. CPAs constantly encounter new clients, new businesses, and new rules and regulations. CPAs innovate ways to act in a fiduciary capacity for their valued clients. Expanding their services to include financial planning is the ultimate expression of this; building on the compliance work they already do and extending their role as a trusted adviser to the totality of their clients’ financial health will provide clients with better service as well as prepare CPAs and CPA firms for the future.