The Rules for Deducting Investment Management Fees
Investment management fees and financial planning fees were tax-deductible until 2017. They fell under the category of miscellaneous itemized deductions that were eliminated by the Tax Cuts and Jobs Act (TCJA) that took effect in 2018.
But not everything is lost if you could claim these fees and didn’t. You can go back and amend your tax return for three years from the date you filed it, or for two years from the date you paid any tax resulting from it, depending on which is closer. The three-year deadline has passed, but you can still amend the return if you made a last tax payment on it in the past two years.
Paying Fees from a Traditional IRA
You can pay investment management fees or financial planning fees that are based on a percentage of assets directly from the managed account. This is not considered a withdrawal from an Individual Retirement Account (IRA) when the fees are paid this way. It is an investment expense, so you are paying the fees with pre-tax dollars.
It makes sense to pay the fees directly from existing individual accounts where possible, as the money in an individual retirement account will ultimately be taxed. So, if you pay the fees from this type of account instead of your taxable income, you are avoiding income tax on that portion.
Unfortunately, you can only pay a portion of the fees due from that individual account. If you have $500,000 in an individual retirement account and $100,000 in a non-retirement account, and if you are paying 1% annually in fees, you can deduct the $5,000 attributed to the individual retirement account from the account, but you cannot deduct the $1,000 attributed to the non-retirement account.
Paying Fees from a Roth IRA
You are not required to pay fees from a Roth IRA because withdrawals from these accounts are tax-free. Contributions to Roth accounts are made with after-tax dollars. You will want to allow the money to grow tax-free in a Roth IRA for as long as possible.
Internal Mutual Fund Fees and Trading Costs
Mutual fund fees are charged as an expense ratio. This cost is deducted from the fund’s return before your share is distributed. This is a return or profit that has not been reported to you because that portion was used to directly pay expenses.
You do not have to add up the total mutual fund fees and claim them as a deduction for this reason.
Paying Fees for Advice
Some financial advisors offer financial planning services in addition to tax preparation services. These services are usually offered as part of a bundled service offering and are billed based on a percentage of assets under management. You may find that these services are surprisingly reasonable when you look at the costs on an after-tax basis for the tax years in which these costs can be deducted.
Due to the cost of actively managed mutual funds, a team of research analysts may be employed to study stock market data in an attempt to achieve higher returns. Paying the cost of this team of research analysts is more expensive, so actively managed mutual funds have higher fund fees, sometimes reaching up to 0.71% annually.
You can hire a fee-only investment advisor who uses low-cost index funds to build the portfolio instead of using actively managed funds. These funds have low expense ratios, and some funds charge zero fees. You may be able to obtain much more personalized advice at a similar cost by organizing services this way.
Accounts
Separate Accounts for Managed Assets
Many financial advisors recommend using separate accounts for managed assets instead of mutual funds for high-net-worth families that have a large number of invested assets. You own the stocks directly, so there are no expense ratios. Instead, all fees are paid in the form of investment management fees that are deducted from the account.
The fees due from the individual retirement account (IRA) are paid with pre-tax money. Eligible fees for itemized deductions are subject to the 2% limit, prior to 2018.
Frequently Asked Questions (FAQs)
What is the difference between a Roth IRA and a Traditional IRA?
The main difference between a Roth IRA and a Traditional IRA lies in the tax treatment of your contributions to each. You can claim a tax deduction for the money you contribute to a Traditional IRA, but it is taxed when withdrawn. Contributions to a Roth IRA are made with after-tax money because there is no tax deduction available for these accounts; however, the money can be withdrawn and grow tax-free in retirement if it is a qualified distribution. For this reason, it doesn’t make much sense to pay advisory fees from a Roth IRA.
Can I still deduct financial and investment advisory fees if I’m self-employed?
You can deduct fees you pay for legal and professional services on Schedule C, Profit or Loss from Business, if you are self-employed. But check first with a tax professional to ensure that the fees you want to claim meet the requirements.
Thank you for reviewing this information! We hope you found it helpful. For more reliable and accurate information, please refer to the sources mentioned above.
Source: https://www.thebalancemoney.com/tax-deduction-for-financial-advisor-fees-2388664
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