Kitces.com - Advancing Knowledge in Financial Planning

How Business Owners Get Preferential Tax Rates With 199A QBI Deduction-Production Income

April 3, 2019 07:06 am 1 Comment CATEGORY: Taxes

One of the most significant changes made by the Tax Cuts and Jobs Act of 2017 was the creation of new IRC Section 199A, which provides small business owners with an up-to-20% deduction on the profits of their business. High income business owners have a number of complicated restrictions and/or “tests” that can reduce or eliminate that deduction, but for taxpayers with income below the start of their applicable phaseout range ($160,700 for single filers / $321,400 for joint filers) the deduction calculation is far more straightforward. Taxpayers “simply” receive a deduction equal to 20% of their (combined) qualified business income. Or, if lower, simply 20% of their taxable income (less capital gains and qualified dividends).

Notably, this potentially-lower 20%-of-taxable-income limit on the Qualified Business Income (QBI) deduction means that small business owners need to have some level of non-QBI income, to absorb the various tax deductions (e.g., the standard deduction or itemized deductions) they claim on their personal return, or they may not get the “full” QBI deduction on their business income. And while some business owners do have substantial amounts of non-qualified-business-ordinary-income, enabling them to receive the 20% deduction on the full amount of their Qualified Business Income, other business owners’ incomes are completely (or, at least, substantially) comprised of only Qualified Business Income. In such situations, the business owner’s deductions effectively get applied against their Qualified Business Income, reducing their QBI deduction (to “just” 20% of taxable income after those deductions).

However, not all deductions claimed on the personal tax return create this QBI deduction “problem” for small business owners. Some above-the-line deductions, such as the deduction for SE tax, SEP IRA contribution, and self-employed health insurance reduce both qualified business income and taxable income. Other above-the-line deductions, such as the deductions for IRA contributions, HSA contributions, and student loan interest, along will below-the-line deductions (either itemized deductions or the standard deduction) reduce only taxable income, potential limiting what could be a higher QBI deduction to 20% of taxable income.

Thankfully, though, this complication also presents taxpayers with a significant tax planning opportunity. By accelerating income, a portion of the tax liability that would normally be attributable to the increased income can be covered by a corresponding increase in the taxpayer’s 199A QBI deduction. And ultimately, this can lead to the “Deduction-Production” income being taxed at “just” 80% of the otherwise-applicable tax rate. And this Deduction-Production income strategy can continue to produce favorable results until a taxpayer’s total ordinary income, which is not qualified business income, equals the total of their deductions that reduce taxable income, but not qualified business income.

Of all of the ways in which a taxpayer can accelerate their income and engage in 199A QBI Deduction-Production, the “best” way will most likely be via Roth conversions. Not only do such conversions allow the business owner to reap the benefits of the “discounted” (via Deduction-Production) effective tax rate today, but they also help manage future taxes via continued tax-deferral and future tax-free distributions from the Roth account. Roth conversions are also easy to initiate and allow the business owner to precisely control the amount of income generated.

For those business owners who would benefit from Deduction-Production income, but who cannot make Roth IRA conversions, other options include earning additional W-2 wages, transitioning qualified dividend-producing investments to investments that generate ordinary income, taking distributions from non-qualified annuities, and simply timing deductions so that they occur in other years.

Of course, generating Deduction-Production income only works when the addition of more taxable income would increase the business owner’s 199A deduction. For high-income (taxable income of more than $160,700 for single filers, and more than $321,400 for joint filers for 2019) owners of specified service trade or businesses (SSTBs), additional income may reduce the current QBI deduction further, even if it’s currently constrained by the taxable income limitation, making Deduction-Production income a moot point. The same issue may also present itself to high-income owners of non-SSTBs if their QBI deduction is impacted by the wage or wage-and-depreciable-property tests.

In the end, though, the important thing to remember is that tax planning is first and foremost about trying to pay taxes at the lowest possible rate… something that is a lot easier to do when 20% of your income is effectively tax-free thanks to a deduction that increases in tandem with your income. Thus, for business owners who have their QBI deductions restricted by the taxable income limitation, accelerating “Deduction Production” income must be given adequate and careful consideration.

#FASuccess Ep 118: Passion Prospecting To Small Business Owners Through A Niche With Bass Fishermen, with Jared Reynolds

April 2, 2019 07:04 am 2 Comments CATEGORY: Financial Advisor Success Podcast

Welcome back to the 118th episode of Financial Advisor Success Podcast!

My guest on today's podcast is Jared Reynolds. Jared is a partner in Wilkerson & Reynolds, an advisory firm in Columbia, Missouri that oversees nearly $160 million in assets and/or management, with a heavy focus in working with small business owners and their 401(k) plans.

What's unique about Jared, though, is the way that he's grown his business with small business owners by forming a niche in working with bass fishermen, for whom he organizes fishing and hunting trip expeditions, and gets an opportunity to spend hours or even days at a time in close proximity with small business owners to form relationship and then, eventually, share a little bit more about what he does for his clients.

In this episode, we talk in-depth about how Jared formed his niche with bass fishermen, in what started out as a family connection through his father into the bass fishing community. And then, morphed into attending bass fishing trade shows and tournaments. And then, developing an expertise in working with bass fishing tournament winners on tax strategies for their prize winnings and how to negotiate their endorsement deals and TV contracts.

And, ultimately, evolved beyond just working with competitive bass fishing professionals and into those who engage in bass fishing as a luxury sport, many of whom are also very successful small business owners. We also talk about how, exactly, Jared was able to turn his hobby and passion into an actual prospecting activity. The way he organizes fishing and hunting trips with prospects is an opportunity to form new relationships.

While he has a firm policy of not branding his advisory firm as part of the expeditions, to downplay his own background as a financial advisor, and allow the conversation of how he can help prospective small business owners to occur more organically. How he's found that more extreme marketing activities actually tend to develop the best prospects. And his advice on how any advisor can turn their own hobby into a passion prospecting strategy to attract their own clients.

And be certain to listen to the end, where Jared talks about the hockey stick of growth that emerges as you focus into a niche. How it often takes three years to really get established with a specialty, but the way it compounds exponentially further after 10 or more years, to the point that Jared's biggest regret is that he didn't focus even earlier on just trying to do business with, as he puts it, his people, the fishermen and hunters that he enjoys working with the most anyways.

The Latest In Financial Advisor #FinTech (April 2019)

April 1, 2019 07:03 am 1 Comment CATEGORY: Technology & Advisor FinTech

Welcome to the April 2019 issue of the Latest News in Financial Advisor #FinTech – where we look at the big news, announcements, and underlying trends and developments that are emerging in the world of technology solutions for financial advisors and wealth management!

This month's edition kicks off with the blockbuster deal of the decade in advisor technology: Envestnet acquiring MoneyGuidePro for a whopping half a billion dollars, or nearly 10X its forward revenues… though ultimately, the purchase may not merely be a testament to Envestnet’s expectations for growing MoneyGuidePro’s software revenue, but the potential to link its new Insurance Exchange to MGP as a means to facilitate the distribution of fee-based insurance and annuity products to independent advisors through the software as well.

From there, the latest highlights also include a number of interesting advisor technology announcements, including:

Schwab adds a new “Premium” option to its Intelligent Portfolios robo-advisor, that will offer human CFP professionals providing personal financial planning… not for a traditional AUM fee, but a financial planning monthly subscription fee instead.
AdvicePay announces half a dozen new partnerships with broker-dealers and signs 17,000 advisors under Enterprise contracts as fee-for-service financial planning models expand deeper into the RIA and hybrid broker-dealer communities as well.
Hidden Levers signs a 7-figure deal with Focus Financial in a pivot from portfolio stress testing software into a business intelligence platform that can stress test the revenue and profits of an entire advisory firm (or an aggregated collection of them).
Economic Laurence Kotlikoff rebuilds his popular-with-consumers financial planning software platform ESPlanner into a new web-based solution dubbed MaxiFi Planner and rolls out a financial advisor version for “just” $499/year.

Read the analysis about these announcements in this month's column and a discussion of more trends in advisor technology, including the winners of the recent TD Ameritrade Innovation Quest FinTech Competition, the opening of submission for the latest (4^th Annual) XY Planning Network FinTech Competition, a recap of the recent ScratchWorks FinTech competition at the Barron's Independent Advisor Summit, and the arrival of Harbor Plan, a new player in the world of digital marketing automation for financial advisors with a unique tool specifically to help advisors send timely follow-up messages to prospects without allowing any to accidentally slip through the cracks while servicing their existing clients as well.

And be certain to read to the end, where we have provided an update to our popular new “Financial Advisor FinTech Solutions Map” as well!

I hope you're continuing to find this new column on financial advisor technology to be helpful! Please share your comments at the end and let me know what you think!

*And for #AdvisorTech companies who want to submit their tech announcements for consideration in future issues, please submit to [email protected]!

Weekend Reading for Financial Planners (Mar 30-31)

March 29, 2019 02:53 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" – this week's edition kicks off with the big news that Charles Schwab is launching a new financial-planning-for-a-monthly-subscription-fee solution as a new "Premium" version of its Schwab Intelligent Portfolios solution, providing full access to a CFP professional for ongoing financial planning advice, and accelerating consumer awareness of the new and increasingly popular financial advisor business model (particularly for 'next generation' clients who are willing to pay for financial advice but don't have investment accounts large enough to merit a financially viable AUM relationship).

Also in the news this week was an announcement that FINRA is considering whether to modify or even just consolidate its suitability rule once Regulation Best Interest comes out, noting the similarity and overlap between the two... and ironically showing, by FINRA's willingness to consolidate the suitability rule into Regulation Best Interest, that Reg BI apparently really isn't a material improvement or change to broker-dealer standards in the first place (or it would be deemed 'too disruptive' to the industry to even try to consolidate the standards!).

From there, we have a number of articles around practice management, and specifically how to attract and retain top talent, including one article looking at the rise of "student loan repayment" as a popular new employee benefits to attract young talent, a second highlighting that more flexible paid time off (or flex time in general) is also an increasingly popular perk, best practices in how to structure interviews for prospective hires, and a fascinating look at how digital-media-savvy Ritholtz Wealth Management has been able to leverage its blog and social media presence to attract good advisors to the firm.

There are also several investment-related articles, from a look at the potential recessionary implications of the recent inversion of the yield curve (from the researcher who first pioneered the study showing how inverted yield curves can foreshadow recessions), to a new BlackRock study suggesting that there might not actually be an "illiquidity premium" after all (but that there is a premium for complexity and more challenging due diligence and governance in private markets that also often happen to be illiquid), and a discussion of how structured products are once again making a resurgence, not to the levels they peaked at in 2007, but driven this time not only by investors who may be nervous about markets and want more downside protection, but also a number of new technology platforms that are trying to make it easier for advisors to shop more efficiently for structure note solutions in the first place.

We wrap up with three interesting articles, all around the theme of how to be more efficient and effective when running meetings: the first looks at some of the scientific research studies on how to run better meetings (along with a study that shows the leader of the meeting is not actually very good at judging the quality of their own meeting!); the second provides some tips about how to carve out or break up meetings that may have gotten "too big" (as invitee lists tend to expand over time!); and the third provides a series of detailed tips on how to not just make meetings more efficient, but to literally make them more effective, from how the meeting itself is run to be inclusive of all participants, to more carefully considering the invitee-list to the meeting, and simply being especially cognizant of why the meeting is being called, its ultimate purpose, and whether it really needs to happen in the first place (or if another medium, from email to company intranet, would be better to accomplish the same meeting goal).

Enjoy the "light" reading!

Kitces & Carl Ep 04: Does Social Media Really Matter For Financial Advisors

March 28, 2019 07:07 am 0 Comments CATEGORY: Kitces & Carl Podcast Marketing

Despite the recent public scrutiny of various social media platforms, the number of active users on mediums like Twitter, Facebook, LinkedIn, and Instagram continues to grow exponentially, making social media an increasingly attractive channel for financial advisors to not only reach prospective clients and centers of influence, but to nurture relationships with existing clients as well. Yet, it’s also incredibly easy to spend a lot of time (and potentially money) on social media, only to find that your efforts have been for naught, leading many to wonder if social media really matters for financial advisors at all.

In our fourth episode of “Kitces & Carl”, Michael Kitces and financial advisor communication guru Carl Richards sit down to discuss the question of the extent to which financial advisors should or “have to” participate in social media (or not), why it might be a worthwhile endeavor if done correctly, some ideas that advisors can use immediately to get more out of their social media efforts, and why, ultimately, using social media successfully is ultimately about a series of “micro interactions” to better connect with other individuals.

The first question to consider is whether or not it’s absolutely essential for financial advisors to build a social media presence to begin with. As while there are numerous stories of advisors landing multi-million-dollar clients solely through social media, the reality is that the only non-negotiable virtual presence that every advisor must have is a modern, professional-looking website (not a social media account). Because, in a world where consumers are far savvier and more informed than they’ve ever been, the one thing you can count on is that a prospective client will have done their due diligence on you before they decide to book that first meeting, and there’s no better way to throw ice water on a warm prospect than an outdated website… or one that prominently features a sailboat, lighthouse, or long, winding road tapering off towards the horizon, that doesn’t really connect with prospects today.

Beyond that, though, for financial advisors, the task of getting in front of prospective clients has always been primarily a social endeavor, and at its core, social media is an avenue for humans to communicate and interact with each other. Which means that social media can not only augment and amplify how you present yourself to the public, but it can be a particularly effective means of connecting with others… especially if you have yet to crack the code of networking events or other organized social activities. In other words, whether face-to-face or through “the interwebs”, authentic communication is the best pathway for developing relationships, and social media is simply one of many channels to do so.

And when it comes to social media, a side benefit is that even those you’re not interacting with can see how you communicate with others, and can form their own opinions about you and decide whether or not they want to learn more about you and your services. Because one of the most powerful aspects of developing a social media presence is that it allows you to reach a much larger audience than would be possible by concentrating solely on in-person events. Moreover, social media can also open avenues of access to centers of influence and other people in your target market that you might not have access to otherwise.

Ultimately, though, the key point is to recognize that developing a quality social media presence takes time. There are no overnight successes, and you won’t miraculously have a line of people who want to hire you banging on your door because you sent out a tweet or few, but (as is the case when helping clients build their own solid financial foundations) small actions taken repeatedly can still lead to massive changes. Or stated more simply: repeated authentic interactions compound over time, whether in-person or via social media. In other words, regardless of the way in which you make it happen, in the end, communicating authentically with others is the most reliable and effective way for any financial advisor to build a successful practice. Social media just happens to be a particularly efficient channel to do so. At least for some advisors.

Financial Planning Research Highlights From The 2019 CFP Board Academic Research Colloquium

March 27, 2019 07:02 am 0 Comments CATEGORY: Planning Profession

From February 19th through February 21st, the CFP Board’s Center for Financial Planning hosted their third annual Academic Research Colloquium (ARC) for Financial Planning and Related Disciplines in Arlington, VA. This year's event saw a 20% increase in attendance, bringing together roughly 230 attendees, of which about 35 were practitioners, to share and discuss research relevant to the financial planning profession, as a part of the CFP Board Center’s longer-term goal of establishing itself as the “academic home” for the financial planning profession.

In this post, Derek Tharp – lead researcher at Kitces.com, and an assistant professor of finance at the University of Southern Maine – provides a recap of the 2019 CFP Academic Research Colloquium, and highlights a few particular research studies with relevant takeaways for financial planning practitioners.

The 2019 CFP Academic Research Colloquium again had a strong showing from CFP Board-Registered Ph.D. programs, with scholars from Missouri, Texas Tech, Georgia, and Kansas State producing nearly 32% of all research (when weighted by type of presentation and authorship rank). Additionally, Ohio State, Alabama, and the College for Financial Planning contributed another 13% of total research. Despite the concentration among top programs, the ARC remains an academically diverse event, drawing in scholars from a total of 69 institutions, including Harvard, Wharton, and Stanford.

The colloquium featured a wide breadth of topics. Some particularly relevant themes for financial planning practitioners included a number of studies on financial psychology of both clients and practitioners, including measuring brain activity during financial conversations to determine whether planning or emotional areas of the brain were activated during financial conversations, examining the tools that do (and do not) work for measuring risk-taking behavior, assessing perceptions of success and satisfaction among female advisors, and identifying gaps between perceptions of both financial planning graduates and employers regarding student preparedness for a career in financial planning. In addition, there was research on the impact advisors may have on clients- both good and bad - including differences in financial decision-making among households that use a financial planner versus a transactional advisor, the use of municipal bonds among advisor-assisted investors, and the characteristics of those who report being victims of investment fraud.

Overall, the third Academic Research Colloquium again brought together a strong mix of academics and practitioners to present and discuss financial planning research. However, some considerable challenges and opportunities going forward include continuing to develop Financial Planning Review into a high-impact journal, dealing with (potentially) declining institutional and sponsorship support, and the Center’s general push to continue to establish the ARC as the “academic home” of financial planning. Only time will tell if the Center for Financial Planning will be successful in their pursuit, but the ARC continues to be a conference worthy of attending for both academics and practitioners who wish to engage in academic research.