Betterment Resources | Original Content by Financial Experts

Five common Roth conversion mistakes

Five common Roth conversion mistakes Nov 21, 2024 9:00:00 AM Learn more about Roth conversion benefits—for high earners and retirees especially—and common conversion mistakes to avoid. Converting pre-tax funds from your traditional retirement accounts into a post-tax Roth IRA (i.e., a Roth conversion) can make sense in certain scenarios. But before you move any money, we recommend connecting with a trusted financial advisor and, in some cases, a tax advisor. They can help you sidestep five common Roth conversion mistakes: Converting outside of your intended tax year You must complete a Roth conversion by a year’s end (December 31) in order for it to count toward that specific tax year’s income. Keep in mind this is different from the IRA contribution deadline for a specific tax year, which (somewhat confusingly) bleeds into the following calendar year. As we’ve mentioned before, Roth conversions require careful planning on your part (and, ideally, your tax advisor) to determine how much you should convert, if at all, and when. Converting too much Speaking of, the question of how much to convert is a crucial one. Blindly converting too much could push you into a higher tax bracket. A common strategy used to avoid this is called “bracket filling.” You determine your income and how much room you have until you hit the next tax bracket, then convert just enough to “fill up” your current bracket. Of course, it can be difficult to determine your exact income. You might not know whether you’ll get a raise, for example, or how many dividends you’ll earn in investment accounts. Because of this, we highly recommend you work with a tax advisor to figure out exactly how much room you have and how much to convert. You no longer have the luxury of undoing a Roth conversion thanks to the 2017 Tax Cuts and Jobs Act. As a side note, you can squeeze more converted shares into your current bracket if the market is down since each share is worth less in that moment. To be clear, we don’t recommend making a Roth conversion solely because the market is down, but if you were already considering one, this sort of market volatility could make the conversion more efficient. Withdrawing converted funds too early When making a Roth conversion, you need to be mindful of the five-year holding period before withdrawing those converted funds, which is different from the 5 year holding period for qualified distributions. And as we mentioned earlier, you’ll typically pay taxes on the amount you convert at the time of conversion, and future withdrawals in retirement can be tax and 10% penalty free. After making a Roth conversion, however, you must wait five tax years for your withdrawal of your taxable conversion amount to avoid the 10% penalty. Withdrawals of amounts previously converted are always tax-free. Notably, this countdown clock is based on tax years, so any conversion made during a calendar year is deemed to have taken place January 1 of that year. So even if you make a conversion in December, the clock for the five year rule starts from earlier that year in January. One more thing to keep in mind is that each Roth conversion you make is subject to its own five year period related to the 10% early withdrawal penalty. Paying taxes from your IRA Paying any taxes due from a conversion out of the IRA itself will make that conversion less effective. As an example, if you convert $10,000 and are in the 22% tax bracket, you’ll owe $2,200 in taxes. One option is to pay the taxes out of the IRA itself. However, this means you’ll have only $7,800 left to potentially grow and compound over time. If you’re under the age of 59 ½, the amount withheld for taxes will also be subject to a 10% early withdrawal penalty. Instead, consider paying taxes owed using excess cash or a non-retirement account you have. This will help keep the most money possible inside the Roth IRA to grow tax-free over time. Keeping the same investments Conversions can be a great tool, but don’t stop there. Once you convert, you should also consider adjusting your portfolio to take advantage of the different tax treatment of traditional and Roth accounts. Each account type is taxed differently, which means their investments grow differently, too. You can take advantage of this by strategically coordinating which investments you hold in which accounts. This strategy is called asset location and can be quite complex. Luckily, we automated it with our Tax Coordination feature.

Four ways we can help limit the tax impact of your investments

Four ways we can help limit the tax impact of your investments Nov 21, 2024 8:00:00 AM Betterment has a variety of processes in place to help limit the impact of your investments on your tax bill, depending on your situation. Let’s demystify these powerful strategies. We know that the medley of account types can make it challenging for you to decide which account to contribute to or withdraw from at any given time. Let’s dive right in to get a further understanding of: What accounts are available and why you might choose them The benefits of receiving dividends Betterment’s powerful tax-sensitive features How are different investment accounts taxed? Taxable accounts Taxable investment accounts are typically the easiest to set up and have the least amount of restrictions. Although you can easily contribute and withdraw at any time from the account, there are trade-offs. A taxable account is funded with after-tax dollars, and any capital gains you incur by selling assets, as well as any dividends you receive, are taxable on an annual basis. While there is no deferral of income like in a retirement plan, there are special tax benefits only available in taxable accounts such as reduced rates on long-term gains, qualified dividends, and municipal bond income. Key Considerations You would like the option to withdraw at any time with no IRS penalties. You already contributed the maximum amount to all tax-advantaged retirement accounts. Traditional accounts Traditional accounts include Traditional IRAs, Traditional 401(k)s, Traditional 403(b)s, Traditional 457 Governmental Plans, and Traditional Thrift Savings Plans (TSPs). Traditional investment accounts for retirement are generally funded with pre-tax dollars. The investment income received is deferred until the time of distribution from the plan. Assuming all the contributions are funded with pre-tax dollars, the distributions are fully taxable as ordinary income. For investors under age 59.5, there may be an additional 10% early withdrawal penalty unless an exemption applies. Key Considerations You expect your tax rate to be lower in retirement than it is now. You recognize and accept the possibility of an early withdrawal penalty. Roth accounts This includes Roth IRAs, Roth 401(k)s, Roth 403(b)s, Roth 457 Governmental Plans, and Roth Thrift Saving Plans (TSPs). Roth type investment accounts for retirement are always funded with after-tax dollars. Qualified distributions are tax-free. For investors under age 59.5, there may be ordinary income taxes on earnings and an additional 10% early withdrawal penalty on the earnings unless an exemption applies. Key considerations You expect your tax rate to be higher in retirement than it is right now. You expect your modified adjusted gross income (AGI) to be below $140k (or $208k filing jointly). You desire the option to withdraw contributions without being taxed. You recognize the possibility of a penalty on earnings withdrawn early. Beyond account type decisions, we also use your dividends to keep your tax impact as small as possible. Four ways Betterment helps you limit your tax impact We use any additional cash to rebalance your portfolio When your account receives any cash—whether through a dividend or deposit—we automatically identify how to use the money to help you get back to your target weighting for each asset class. Dividends are your portion of a company’s earnings. Not all companies pay dividends, but as a Betterment investor, you almost always receive some because your money is invested across thousands of companies in the world. Your dividends are an essential ingredient in our tax-efficient rebalancing process. When you receive a dividend into your Betterment account, you are not only making money as an investor—your portfolio is also getting a quick micro-rebalance that aims to help keep your tax bill down at the end of the year. And, when market movements cause your portfolio’s actual allocation to drift away from your target allocation, we automatically use any incoming dividends or deposits to buy more shares of the lagging part of your portfolio. This helps to get the portfolio back to its target asset allocation without having to sell off shares. This is a sophisticated financial planning technique that traditionally has only been available to larger accounts, but our automation makes it possible to do it with any size account. Performance of S&P 500 with dividends reinvested Source: Bloomberg. Performance is provided for illustrative purposes to represent broad market returns for [asset classes] that may not be used in all Betterment portfolios. The [asset class] performance is not attributable to any actual Betterment portfolio nor does it reflect any specific Betterment performance. As such, it is not net of any management fees. The performance of specific funds used for each asset class in the Betterment portfolio will differ from the performance of the broad market index returns reflected here. Past performance is not indicative of future results. You cannot invest directly in the index. Content is meant for educational purposes and not intended to be taken as advice or a recommendation for any specific investment product or strategy. We “harvest” investment losses Tax loss harvesting can lower your tax bill by “harvesting” investment losses for tax reporting purposes while keeping you fully invested. When selling an investment that has increased in value, you will owe taxes on the gains, known as capital gains tax. Fortunately, the tax code considers your gains and losses across all your investments together when assessing capital gains tax, which means that any losses (even in other investments) will reduce your gains and your tax bill. In fact, if losses outpace gains in a tax year, you can eliminate your capital gains bill entirely. Any losses leftover can be used to reduce your taxable income by up to $3,000. Finally, any losses not used in the current tax year can be carried over indefinitely to reduce capital gains and taxable income in subsequent years. So how do you do it? When an investment drops below its initial value—something that is very likely to happen to even the best investment at some point during your investment horizon—you sell that investment to realize a loss for tax purposes and buy a related investment to maintain your market exposure. Ideally, you would buy back the same investment you just sold. After all, you still think it’s a good investment. However, IRS rules prevent you from recognizing the tax loss if you buy back the same investment within 30 days of the sale. So, in order to keep your overall investment exposure, you buy a related but different investment. Think of selling Coke stock and then buying Pepsi stock. Overall, tax loss harvesting can help lower your tax bill by recognizing losses while keeping your overall market exposure. At Betterment, all you have to do is turn on Tax Loss Harvesting+ in your account. We use asset location to your advantage Asset location is a strategy where you put your most tax-inefficient investments (usually bonds) into a tax-efficient account (IRA or 401k) while maintaining your overall portfolio mix. For example, an investor may be saving for retirement in both an IRA and taxable account and has an overall portfolio mix of 60% stocks and 40% bonds. Instead of holding a 60/40 mix in both accounts, an investor using an asset location strategy would put tax-inefficient bonds in the IRA and put more tax-efficient stocks in the taxable account. In doing so, interest income from bonds—which is normally treated as ordinary income and subject to a higher tax rate—is shielded from taxes in the IRA. Meanwhile, qualified dividends from stocks in the taxable account are taxed at a lower rate, capital gains tax rates instead of ordinary income tax rates. The entire portfolio still maintains the 60/40 mix, but the underlying accounts have moved assets between each other to lower the portfolio’s tax burden. We use ETFs instead of mutual funds Have you ever paid capital gain taxes on a mutual fund that was down over the year? This frustrating situation happens when the fund sells investments inside the fund for a gain, even if the overall fund lost value. IRS rules mandate that the tax on these gains is passed through to the end investor, you. While the same rule applies to exchange traded funds (ETFs), the ETF fund structure makes such tax bills much less likely. In most cases, you can find ETFs with investment strategies that are similar or identical to a mutual fund, often with lower fees.

The benefits of estimating your tax bracket when investing

The benefits of estimating your tax bracket when investing Nov 21, 2024 6:00:00 AM Knowing your tax bracket opens up a huge number of planning opportunities that have the potential to save you taxes and increase your investment returns. If you’re an investor, knowing your tax bracket opens up a number of planning opportunities that can potentially decrease your tax liability and increase your investment returns. Investing based on your tax bracket is something that good CPAs and financial advisors, including Betterment, do for customers. Because the IRS taxes different components of investment income (e.g., dividends, capital gains, retirement withdrawals) in different ways depending on your tax bracket, knowing your tax bracket is an important part of optimizing your investment strategy. In this article, we’ll show you how to estimate your tax bracket and begin making more strategic decisions about your investments with regards to your income taxes. First, what is a tax bracket? In the United States, federal income tax follows what policy experts call a "progressive" tax system. This means that people with higher incomes are generally subject to a higher tax rate than people with lower incomes. 2024 Tax Brackets Tax rate Taxable income for single filers Taxable income for married, filing jointly 10% $0 to $11,600 $0 to $23,200 12% $11,601 to $47,150 $23,201 to $94,300 22% $47,151 to $100,525 $94,301 to $201,050 24% $100,526 to $191,150 $201,051 to $383,900 32% $191,951 to $243,725 $383,901 to $487,450 35% $243,726 to $609,350 $487,451 to $731,200 37% $609,351 or more $731,201 or more Source: Internal Revenue Service Instead of thinking solely in terms of which single tax bracket you fall into, however, it's helpful to think of the multiple tax brackets each of your dollars of taxable income may fall into. That's because tax brackets apply to those specific portions of your income. For example, let's simplify things and say there's hypothetically only two tax brackets for single filers: A tax rate of 10% for taxable income up to $10,000 A tax rate of 20% for taxable income of $10,001 and up If you're a single filer and have taxable income of $15,000 this year, you fall into the second tax bracket. This is what's typically referred to as your "marginal" tax rate. Portions of your income, however, fall into both tax brackets, and those portions are taxed accordingly. The first $10,000 of your income is taxed at 10%, and the remaining $5,000 is taxed at 20%. How difficult is it to estimate my tax bracket? Luckily, estimating your tax bracket is much easier than actually calculating your exact taxes, because U.S. tax brackets are fairly wide, often spanning tens of thousands of dollars. That’s a big margin of error for making an estimate. The wide tax brackets allow you to estimate your tax bracket fairly accurately even at the start of the year, before you know how big your bonus will be, or how much you will donate to charity. Of course, the more detailed you are in calculating your tax bracket, the more accurate your estimate will be. And if you are near the cutoff between one bracket and the next, you will want to be as precise as possible. How Do I Estimate My Tax Bracket? Estimating your tax bracket requires two main pieces of information: Your estimated annual income Tax deductions you expect to file These are the same pieces of information you or your accountant deals with every year when you file your taxes. Normally, if your personal situation has not changed very much from last year, the easiest way to estimate your tax bracket is to look at your last year’s tax return. The 2017 Tax Cuts and Jobs Act changed a lot of the rules and brackets. The brackets may also be adjusted each year to account for inflation. Thus, it might make sense for most people to estimate their bracket by crunching new numbers. Estimating Your Tax Bracket with Last Year’s Tax Return If you expect your situation to be roughly similar to last year, then open up last year’s tax return. If you review Form 1040, you can see your taxable income on Page 1, Line 15, titled “Taxable Income.” As long as you don’t have any major changes in your income or personal situation this year, you can use that number as an estimate to find the appropriate tax bracket. Estimating Your Tax Bracket by Predicting Income, Deductions, and Exemptions Estimating your bracket requires a bit more work if your personal situation has changed from last year. For example, if you got married, changed jobs, had a child or bought a house, those, and many more factors, can all affect your tax bracket. It’s important to point out that your taxable income, the number you need to estimate your tax bracket, is not the same as your gross income. The IRS generally allows you to reduce your gross income through various deductions, before arriving at your taxable income. When Betterment calculates your estimated tax bracket, we use the two factors above to arrive at your estimated taxable income. You can use the same process. Add up your income from all expected sources for the year. This includes salaries, bonuses, interest, business income, pensions, dividends and more. If you’re married and filing jointly, don’t forget to include your spouse’s income sources. Subtract your deductions. Tax deductions reduce your taxable income. Common examples include mortgage interest, property taxes and charity, but you can find a full list on Schedule A – Itemized Deductions. If you don’t know your deductions, or don’t expect to have very many, simply subtract the Standard Deduction instead. By default, Betterment assumes you take the standard deduction. If you know your actual deductions will be significantly higher than the standard deduction, you should not use this assumption when estimating your bracket, and our default estimation will likely be inaccurate. The number you arrive at after reducing your gross income by deductions and exemptions is called your taxable income. This is an estimate of the number that would go on line 15 of your 1040, and the number that determines your tax bracket. Look up this number on the appropriate tax bracket table and see where you land. Again, this is only an estimate. There are countless other factors that can affect your marginal tax bracket such as exclusions, phaseouts and the alternative minimum tax. But for planning purposes, this estimation is more than sufficient for most investors. If you have reason to think you need a more detailed calculation to help formulate your financial plan for the year, you can consult with a tax professional. How Can I Use My Tax Bracket to Optimize My Investment Options? Now that you have an estimate of your tax bracket, you can use that information in many aspects of your financial plan. Here are a few ways that Betterment uses a tax bracket estimate to give you better, more personalized advice. Tax-Loss Harvesting: This is a powerful strategy that seeks to use the ups/downs of your investments to save you taxes. However, it typically doesn't make sense if you fall into a lower tax bracket due to the way capital gains are taxed differently. Tax Coordination: This strategy reshuffles which investments you hold in which accounts to try to boost your after-tax returns. For the same reasons listed above, if you fall on the lower end of the tax bracket spectrum, the benefits of this strategy are reduced significantly. Traditional vs. Roth Contributions: Choosing the proper retirement account to contribute to can also save you taxes both now and throughout your lifetime. Generally, if you expect to be in a higher tax bracket in the future, Roth accounts are best. If you expect to be in a lower tax bracket in the future, Traditional accounts are best. That’s why our automated retirement planning advice estimates your current tax bracket and where we expect you to be in the future, and uses that information to recommend which retirement accounts make the most sense for you. In addition to these strategies, Betterment’s team of financial experts can help you with even more complex strategies such as Roth conversions, estimating taxes from moving outside investments to Betterment and structuring tax-efficient withdrawals during retirement. Tax optimization is a critical part to your overall financial success, and knowing your tax bracket is a fundamental step toward optimizing your investment decisions. That’s why Betterment uses estimates of your bracket to recommend strategies tailored specifically to you. It’s just one way we partner with you to help maximize your money.

Asset Location Methodology

How to plan for retirement

How to plan for retirement Nov 18, 2024 9:00:00 AM It depends on the lifestyle you want, the investment accounts available, and the income you expect to receive. Most people want to retire some day. But retirement planning looks a little different for everyone. There’s more than one way to get there. And some people want to live more extravagantly—or frugally—than others. Your retirement plan should be based on the life you want to live and the financial options you have available. And the sooner you sort out the details, the better. Even if retirement seems far away, working out the details now will set you up to retire when and how you want to. In this guide, we’ll cover: How much you should save for retirement Choosing retirement accounts Supplemental income to consider Self-employed retirement options How much should you save for retirement? How much you need to save ultimately depends on what you want retirement to look like. Some people see themselves traveling the world when they retire. Or living closer to their families. Maybe there’s a hobby you’ve wished you could spend more time and money on. Perhaps for you, retirement looks like the life you have now—just without the job. For many people, that’s a good place to start. Take the amount you spend right now and ask yourself: do you want to spend more or less than that each year of retirement? How long do you want your money to last? Answering these questions will give you a target amount you’ll need to reach and help you think about managing your income in retirement. Don’t forget to think about where you’ll want to live, too. Cost of living varies widely, and it has a big effect on how long your money will last. Move somewhere with a lower cost of living, and you need less to retire. Want to live it up in New York City, Seattle, or San Francisco? Plan to save significantly more. And finally: when do you want to retire? This will give you a target date to save it by (in investing, that’s called a time horizon). It’ll also inform how much you need to retire. Retiring early reduces your time horizon, and increases the number of expected years you need to save for. Choosing retirement accounts Once you know how much you need to save, it’s time to think about where that money will go. Earning interest and taking advantage of tax benefits can help you reach your goal faster, and that’s why choosing the right investment accounts is a key part of retirement planning. While there are many kinds of investment accounts in general, people usually use five main types to save for retirement: Traditional 401(k) Roth 401(k) Traditional IRA (Individual Retirement Account) Roth IRA (Individual Retirement Account) Health Savings Account (HSA) Traditional 401(k) A Traditional 401(k) is an employer-sponsored retirement plan. These have two valuable advantages: Your employer may match a percentage of your contributions Your contributions are tax deductible You can only invest in a 401(k) if your employer offers one. If they do, and they match a percentage of your contributions, this is almost always an account you’ll want to take advantage of. The contribution match is free money. You don’t want to leave that on the table. And since your contributions are tax deductible, you’ll pay less income tax while you’re saving for retirement. Roth 401(k) A Roth 401(k) works just like a Traditional one, but with one key difference: the tax advantages come later. You make contributions, your employer (sometimes) matches a percentage of them, and you pay taxes like normal. But when you withdraw your funds during retirement, you don’t pay taxes. This means any interest you earned on your account is tax-free. With both Roth and Traditional 401(k)s, you can contribute a maximum of $23,000 in 2024, or $30,500 if you’re age 50 or over. Traditional IRA (Individual Retirement Account) As with a 401(k), an IRA gives you tax advantages. Depending on your income, contributions may lower your pre-tax income, so you pay less income tax leading up to retirement. The biggest difference? Your employer doesn’t match your contributions. The annual contribution limits are also significantly lower: just $7,000 for 2024, or $8,000 if you’re age 50 or over. Roth IRA (Individual Retirement Account) A Roth IRA works similarly, but as with a Roth 401(k), the tax benefits come when you retire. Your contributions still count toward your taxable income right now, but when you withdraw in retirement, all your interest is tax-free. So, should you use a Roth or Traditional account? One option is to use both Traditional and Roth accounts for tax diversification during retirement. Another strategy is to compare your current tax bracket to your expected tax bracket during retirement, and try to optimize around that. Also keep in mind that your income may fluctuate throughout your career. So you may choose to do Roth now, but after a significant promotion you might switch to Traditional. Health Savings Account (HSA) An HSA is another solid choice. Contributions to an HSA are tax deductible, and if you use the funds on medical expenses, your distributions are tax-free. After age 65, you can withdraw your funds just like a traditional 401(k) or IRA, even for non-medical expenses. You can only contribute to a Health Savings Accounts if you’re enrolled in a high-deductible health plan (HDHP). In 2024, you can contribute up to $4,150 to an HSA if your HDHP covers only you, and up to $8,300 if your HDHP covers your family. What other income can you expect? Put enough into a retirement account, and your distributions will likely cover your expenses during retirement. But if you can count on other sources of income, you may not need to save as much. For many people, a common source of income during retirement is social security. As long as you or your spouse have made enough social security contributions throughout your career, you should receive social security benefits. Retire a little early, and you’ll still get some benefits (but it may be less). This can amount to thousands of dollars per month. You can estimate the benefits you’ll receive using the Social Security Administration’s Retirement Estimator. Retirement accounts for the self-employed Self-employed people have a few additional options to consider. One Participant 401(k) Plan or Solo 401(k) A Solo 401(k) is similar to a regular 401(k). However, with a Solo 401(k), you’re both the employer and the employee. You can combine the employee contribution limit and the employer contribution limit. As long as you don’t have any employees and you’re your own company, this is a pretty solid option. However, a Solo 401(k) typically requires more advance planning and ongoing paperwork than other account types. If your circumstances change, you may be able to roll over your Solo 401(k) plan or consolidate your IRAs into a more appropriate retirement savings account. Simplified Employee Pension (SEP IRA) With a SEP IRA, the business sets up an IRA for each employee. Only the employer can contribute, and the contribution rate must be the same for each qualifying employee. Savings Incentive Match Plan for Employees (SIMPLE IRA) A SIMPLE IRA is ideal for small business owners who have 100 employees or less. Both the employer and the employee can contribute. You can also contribute to a Traditional IRA or Roth IRA—although how much you can contribute depends on how much you’ve put into other retirement accounts.

What is a tax advisor? Attributes to look for

What is a tax advisor? Attributes to look for Nov 18, 2024 8:00:00 AM Since Betterment isn't a tax advisor, we often suggest that customers see a tax advisor regarding certain issues or decisions. Who exactly is a tax advisor and how should you think about picking one? Tax season is now upon us. Now that you’ve probably received all of your tax forms, you may be facing a choice for how to proceed with filing: do it yourself with tax software or hire a professional tax advisor? Although it certainly will be more expensive than using tax software, hiring a tax advisor makes sense for certain individuals, depending on their financial circumstances. Here are two important factors to consider when deciding if a tax advisor is right for you: Time: Even with tax software guiding you, filing your taxes yourself can be time consuming. You’ll need to make sure that you’ve entered or imported the data from your tax forms correctly, which often takes at least several hours, and your time is worth something. Complexity: The more complicated your financial situation, the more a tax advisor may be able to help you. Have partnership income, or income from an S corporation? Been subject to alternative minimum tax in past years? Received or exercised stock options this year? Tax software can handle these issues, but it will take time, and the risk of mistakes (and even an audit) increases. If you decide that your situation warrants professional assistance, some further questions are worth exploring: what exactly is a tax advisor and how should you think about picking one? Who counts as a tax advisor? Anyone with an IRS Prepare Tax Identification number (a “PTIN” for short) can be paid to file tax returns on behalf of others. But merely having a PTIN doesn’t tell you much about the tax preparer; tax preparers have different experience, skills, and expertise. What you really want is a tax advisor, a professional with a certification and experience level that qualifies her not only to prepare your return, but to use her knowledge of the tax code to provide advice on your financial situation. There are three different professional certifications to consider, each of which qualifies a tax advisor to practice with unlimited representation rights before the IRS. This means that in addition to preparing returns, they also are licensed to represent their clients on audits, payments and collection issues, and appeals. Certified Public Accountants (CPAs) CPAs have completed coursework in accounting, passed the Uniform CPA Examination, and are licensed by state boards of accountancy (which require that they meet experience and good character standards). Some, but not all, CPAs specialize in tax preparation and planning. You can find complaints about CPAs either by searching records with state boards of accountancy and at Better Business Bureaus. Enrolled Agents Enrolled agents are licensed by the Internal Revenue Service after they have passed a three-part examination and a background check. The IRS maintains complaints about enrolled agents on the website of its office for enrollment, and you can also find complaints on the National Association of Enrolled Agents website. Licensed Tax Attorneys Licensed attorneys have graduated from law school, passed a state bar exam, and are admitted to the bar in at least one state. Some, but not all, attorneys specialize in tax preparation and planning. Many tax attorneys have completed an additional year of law school study in a master’s program in tax (called a Tax LL.M. degree). Disciplinary actions against attorneys can be found by searching the state bar associations with which the attorney is registered. How to Select a Tax Advisor or Tax Consultant No tax advisor with one of the certifications described above is necessarily better than any of the others in all situations. Rather, what matters most is: How the advisor approaches the tax preparation process, including the specific experience the tax advisor has with issues relevant to your particular financial situation. Whether you feel comfortable with the tax advisor. How the advisor structures their fees. You may be able to screen potential advisors along several of these dimensions based on information you can find about them online; for others, an initial meeting will be critical to determine if the advisor is right for you. 1. Assess your confidence in the quality of a tax advisor's recommendations, as well as their experience. Here are a few specific factors to consider carefully when assessing the potential quality of a tax advisor's work. First, you should try to identify a tax advisor who will act ethically and with integrity. Before scheduling a meeting with a potential tax advisor, check to see if the advisor has been subject to any complaints, disciplinary actions, or other ethical infractions. When meeting with the advisor, be on the lookout for outlandish promises: if an advisor guarantees you a certain refund without having first looked at your returns, you should be wary (any promise that sounds too good to be true probably is). If the advisor suggests taking a position on a tax return that strikes you as overly aggressive (because it is not grounded in your actual financial situation) or if you simply do not understand something the advisor is saying, make sure to ask, and keep asking until you are satisfied with the answer. Having a tax advisor prepare your returns does not take away your responsibility for the accuracy of your tax return. Of course, an advisor who knowingly takes an improper position on a tax return will face consequences, but it is your return, and you can too. A good tax advisor also should provide more value than simply filling out your returns. She should help you to structure your finances in an optimal way from a tax perspective. Not every tax advisor has expertise with every nuance of the tax code, and so you’ll want to make sure that the advisor you select has significant experience with the particular issues for which you’re seeking expert advice. Of course, there are certain common issues that every good advisor should know: for example, how to maximize the value and efficacy of your charitable contributions, how to weigh the tax tradeoffs between renting and owning a home, or how to save money for or gift money to family members. For other less common situations, however, you’ll want an advisor with specific experience. If you own a business or are self-employed, if you work for a startup and own a significant number of stock options, or if some portion of your income is reported on a K-1 (because you are a partner in a business or own shares in an S corporation), you likely will be best served by finding an advisor who has worked with a significant number of clients with these tax issues. Finally, maintaining the security of your personal information is more important than ever these days, and the inputs for your taxes is some of the most sensitive information you have. There will always be some risk of data breaches, but a good tax advisor will take steps to safeguard your information. Make sure that you ask about how the tax advisor stores your personal information and what methods she uses to communicate with you regarding sensitive topics. You also should ask about whether the advisor has ever been subject to a data breach and what steps the advisor is taking to protect against future ones. 2. Assess your comfort level with the working relationship. You want to make sure you have a good rapport with your tax advisor, and that you feel like you understand each other. At your first meeting, make sure to bring three years’ worth of old tax returns for your advisor to review. Ask if you missed any deductions, and if your old returns raise any audit flags. Consider the advisor’s responses. Does the advisor seem willing to spend time with you to ask thorough questions to fully understand your situation? Or does she rush through in a way that makes you feel like she might be missing certain issues or nuances? Does the advisor explain herself in a way that is understandable to you, even though you don’t have a tax background? Or does the advisor leave you confused? A tax advisor may work by herself or be a member of a larger organization or practice. Each approach has its benefits and drawbacks. You can be sure that a solo practitioner will be the one who actually prepares your returns, but it may be harder to reach the advisor during the height of tax season, and the advisor may find it difficult to get a second opinion on tricky issues or issues outside her core areas of expertise. On the other hand, although the collective expertise of a larger practice may exceed that of even a very talented advisor practicing on her own, it may be more difficult to ensure that your return is prepared personally by your advisor. Finally, think about whether you want to work with a tax advisor who is already part of your social network, or who has been referred by a trusted family member or friend. On the one hand, having the seal of approval of someone you know and trust may help to assure you that the advisor is right for you. On the other hand, consider whether it will be harder to part ways with the advisor down the road if she fails to meet your standards. 3. Evaluate the cost of the tax advice. The final issue you’ll want to think about is cost. Tax preparation services are a low margin business (particularly with the competition that tax preparers face from low cost software), but you can expect to pay more for tax planning services or advice. The best cost structure is one where the tax advisor charges for her time or for the specific forms that the advisor completes and files. By paying for the advice itself and not a particular outcome, this cost arrangement properly aligns the incentives between your tax advisor and you. Be wary of compensation structures that create the potential for conflicts of interest between you and and your tax advisor. For example, some tax advisors may try to earn additional revenue from you by selling other services or financial products along with tax preparation. Ultimately, when it comes to cost, your goal should not be solely to minimize your combined out of pocket cost to the IRS and your advisor for this year’s tax return. Rather, you should take a longer term view, recognizing that good, personalized tax advice can help you to structure your financial life in a tax-efficient way that can pay dividends for years to come.