As clients expect more from advisors when it comes to taxes, some advisors are seeking additional tax credentials to better serve them. One path is becoming an enrolled agent (EA), a designation granted by the IRS that requires passing a three-part test.
For advisors like Kevin Thompson, founder and CEO of Fort Worth, Texas-based 9I Capital Group, becoming an EA was not only about providing more comprehensive service but also about deepening client relationships.
"I'd rather have a sticky client relationship than a referral that's … here today, gone tomorrow," Thompson said. "That sticky client relationship is valuable, and that's why I got EA."
Andy Panko, founder of Metuchen, New Jersey-based Tenon Financial, also became an enrolled agent.
Panko said he found the studying required to become an EA to be helpful for his work. It "forces you to get exposure to a lot of these principles and tax return concepts that will come into play," he said.
The service is highly sought by clients, he said. Panko went from completing four or five tax returns in his first year as an EA to 85 last year.
"I struggle to not say 'yes' when a new advisory client asks me to do their return," he said. "They find it a tremendous value-add."
And the knowledge he has as the client's planner makes it easier to complete the return, he added.
Thompson said being an EA allows him to more fully discuss taxes and tax planning with clients.
"I can't successfully call myself a financial advisor without having a tax conversation," Thompson said. "The reality is advisors are trying to have tax planning conversations but without giving advice. And when I say, 'Hey, roll over a 401(k),' well, that's tax advice. You can just say, 'Oh, well, it's not because … I'm servicing a client.' No, you're giving tax advice."
Before he was an EA, he felt he had to be careful what he talked about when it came to tax topics.
"I was tired of talking around everything," he said. "I wanted to be more involved in it."
READ MORE: Tax advice is a no-no for many financial advisors. Tax guidance is not
Consider a wall between tax, advisory businesses
Both Thompson and Panko maintain separate entities for their tax and financial advisory practices. This can help protect both businesses from potential liability issues. However, the complexities of maintaining separate operations can put a strain on small RIAs.
A combined business can have advantages. Panko said most of his tax clients are also advisory clients, so operating a single entity would bring greater efficiencies.
On the other hand, a combined business could expose extraneous records during regulatory exams or audits, as the Securities and Exchange Commission or IRS would have access to the entire company instead of just the advisory or tax information they require.
READ MORE: Expanding into tax prep? Be aware of these risks
Pros and cons of in-house tax prep
One downside to offering in-house tax prep services is that it can be less lucrative than advisory work on an hourly basis.
Panko estimated that returns can take up to five hours if complications pop up. In comparison, advisors who charge traditional assets under management fees spend roughly 20 hours per year on an entire advisory relationship.
That said, the tax-prep experience can enhance the advisory work.
"Doing returns keeps me fresh and really in the thick of understanding taxes and, by extension, tax planning for clients because tax planning is really just being able to visualize how a financial planning activity or inactivity is going to show up on a client's tax return," Panko said. "So the more you're comfortable with and can think in and visualize, 'What is this going to be like on a tax return?', the more you can effectively do tax planning."
Firms recognize a need for tax expertise
It's not just advisors who see the benefit of adding tax expertise. Royce Kurtz, a Madison, Wisconsin-based wealth manager at Merit Financial Advisors, said he became a tax professional at his firm's request. He said he's glad to now be an enrolled agent.
"Although tax season is a little grueling at times, it is a nice way to be able to help clients long term to be able to see every piece of it," he said, "whether it's saving money on taxes, or whether it's giving them an outlook for what their investments may cost them from a tax perspective," he said. As an EA, Kurtz said he is better able to help clients understand capital gains distributions from mutual funds and to move their money into more tax-efficient funds.
Understanding the tax code and being an EA has given him a "great opportunity" to help clients and to grow his business, he said.
"I've just seen the impact that you can have and the way you're able to help people plan to not give them the April surprise when they have a large balance due," Kurtz said.
The risks involved in only having a PTIN
For advisors considering adding tax prep to their offerings, obtaining a preparer tax identification number (PTIN) is generally the minimum requirement. Becoming an EA, by comparison, requires passing a three-part IRS exam and demonstrating broad knowledge of tax law, though EAs and other preparers are required to have PTINs.
Panko said the difference matters.
"The barrier to entry to do tax returns for money is concerningly low," Panko said. "You just need a PTIN, which basically means you have a pulse, and you're not a convicted criminal in most crimes."
According to the IRS website, "Most first-time PTIN applicants can obtain a PTIN online in about 15 minutes." The difference in expertise levels can be stark.
Thompson said he has had to make corrections for clients based on what non-EA preparers with PTINs did.
"The stuff that I have seen from these individuals in particular is absolutely insane," he said. "Having to fight with them because they don't have, necessarily, understanding around the tax code — it's very interesting."
