Are Mutual Fund Management Fees Tax Deductible

In practice, asset-based investment advisory fees (i.e., an annual fee of 1% of assets under management, usually billed monthly or quarterly) are paid „on autopilot” by extracting them directly from the accounts to which they are attributable. For example, an individual`s AKI fees are recovered directly from their IRA account, and expenses attributable to their taxable account are recovered directly from their taxable account. This is undeniably permitted under Treasury Regulations 1.404(a)-3(d). Alternatively, the IRS has always authorized the payment of investment management fees based on assets under management (but not commissions) attributable to traditional IRAs and/or ROTH IRAs to be paid with „external” funds. For example, a customer could pay traditional IRA fees by simply writing a cheque for that amount to the AIR. Or, if the customer had a taxable account with the same AIR, the AIR could „charge directly” the taxable account for traditional IRA fees. In this situation, Agnes is clearly better off from a tax point of view by using The Funds of Action C in her planning. Her tax savings, if she goes in that direction, will be equal to her tax rate multiplied by the $10,000 less income on which she has to pay taxes. In addition to the potentially prohibitive operational issues and costs associated with the „solution” of mutual funds and ETFs, there are other potential issues that turn a company`s model into a mutual fund. For many equity funds, the main fee is the management fee that the fund company pays into its performance.

These fees, usually referred to as the expense ratio, come directly from the top of what the fund earns. If you have an investment in an equity fund that generates a return of 9% per year and the expense ratio is 1.15%, you will get a return of 7.85%. The IRS only taxes you on what you actually do, so you`re only taxed on the 7.85% return without having to ask for deductions. Many of your other investment costs are deductible as other expenses as long as you enter your deductions in Schedule A. You can also write off legal and accounting fees related to the investment. However, you can`t amortize the cost of traveling to attend seminars, conventions, or even shareholder meetings related to the investment. In addition, with your other individual deductions, you can only amortize the portion of your capital expenditures that exceeds 2% of your adjusted gross income. If your AGI is $200,000, your capital expenditures are $5,500 and you have no other deductions, you can claim an amortization of $1,500, which is more than $4,000 (2% of the $200,000 AGI). Hybrid advisors (i.e., those with an RIA and broker/broker affiliation) may also want to reassess whether it is in a client`s best interest that they pay for the advisor`s services with advisor fees rather than commissions. Ironically, while the financial advisory industry has gradually moved away from commissions and fees, the Tax Reductions and Employment Act gives a separate tax preference to pay advisors over commissions over fees! Although commissions are not deductible per se, they can increase the cost base of a position (e.B.

a commission paid for the purchase of a single security), reduce the proceeds of a sale (p.B a commission paid for the sale of a single security) or reduce the amount of taxable income generated by an investment (p.B the 12b-1 fee commission paid by mutual funds) before the income is passed on to the investor again. All these means are more advantageous from a tax point of view to compensate a financial professional than consulting fees. This means that consulting firms considering the path of converting a range of model portfolios into a range of mutual funds or ETFs should be prepared to create multiple funds to meet a typical range of client models and allocations. with costs even higher than „just” the cost of creating a single fund. You could hire a fee-based investment advisor who uses low-cost index funds to build the portfolio instead of using actively managed funds. These funds have low expense ratios, some of which can be as high as 0%. You may be able to get much more personalized advice at about the same cost by structuring services in this way. Alternatively, some consulting firms may consider limited partnerships as another possible method to mitigate the loss of the deduction for consulting fees by retrying their claim for the RIA fees as a „management fee” for the firm rather than as the investment company`s transfer costs. Although the question of whether or not such a partnership would be considered a genuine company – as opposed to an investment – would be of paramount importance (since the expenses of the company without corporate status would again be considered non-deductible personal investment expenses) and is unfortunately a very grey area. A clearer path would be for consulting firms to instead choose to be remunerated as a general partner through a „vested interest” that is effectively treated on a pre-tax basis for the client. Except in the best-case scenario, these partnerships would likely function as private securities (limiting their availability to high net worth and other qualified investors), and by definition, a deferred interest payment is a performance-based commission (which most consulting firms don`t want to work with at all?). In particular, however, there are growing regulatory concerns about holding significant amounts of C shares over long periods of time, and in recent years, a number of asset managers have begun to automatically convert long-term C shares to A shares (thereby reducing fund costs, but also the advisor`s follow-up income), under the auspices that a leveled commission for an initial sale (which is functionally that, which is a C-share fund) should not be continued indefinitely after the one-time sale.

Therefore, advisors considering this option should check with their compliance department to understand their protocols and policies for using C actions. While these stocks can be used over a longer period of time, advisors should carefully document the reason for their use compared to other potential investments. A „simple” way to help clients maintain the tax nature of consulting fees is to find a good faith way to continue deducting expenses. For example, although consulting fees are only deductible from various individual deductions, a company`s ordinary and necessary expenses are still deductible under Section 162 of the IRC. For example, for clients who are small business owners, a portion of the total consulting fee may be deductible as a business expense, at least to the extent that business-related advice (i.e., succession planning, pension benefits, business-related tax strategies, etc.) has been provided. .