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Wirehouses and BDs Could End Up on ‘Short End’ of Tax Cuts

By Murray Coleman December 14, 2017

With reconciliation of the House and Senate tax cut plans nearly complete, tax-savvy advisors closely watching the Capitol Hill tug-of-war see winners and losers forming within their own industry.

For affluent clients, much of any final outcome will depend on how their wealth is generated and where it’s dispersed. But wealth managers themselves face uncertainty about how their practices and income might be impacted as they wait to see the bill's final language.

Optimistic views by wealth managers surveyed by FA-IQ expect Republican leaders to produce wording by Friday with a vote coming next week.

Chris Cooke, an advisor in Indianapolis whose team manages $1.7 billion at David A. Noyes & Co., is concerned that like many lawyers and accountants, advisors will be left out of getting any preferential corporate rate cuts. Those rates are expected to drop from today’s 35% to 21%, according to a report Wednesday by the Financial Times.

Cooke figures that instead of setting up one large corporate shell, advisors might find splitting different portions of their practices into separate entities to be most beneficial.

“If you have a technology staff, for example, it might be wise to form a service corporation where you pay a separate fee instead of paying employees directly,” Cooke says.

Also, he sees breaking out real estate holdings, either in the form of rental services or direct ownership of a building, as another possible tax-favored opportunity for advisors to consider in the future.

Staffing and alternative equity investments are also areas in which Cooke expects new legislation to spur more activity by advisors splitting up traditional business models.

“This is something that a smaller RIA might find hard to do,” he says. “But practices with scale and strong annual revenues might find it worthwhile to do more complicated corporate engineering of their business structures – if, that is, tax rates on financial services firms remain at ordinary income levels.”

Bill Wednieski, controller of LJPR Financial Advisors, says he’s also bracing for reconciliation of competing proposals from the House and Senate to leave “our industry on the short end of any tax breaks.”

The Troy, Mich.-based CPA points out that the Senate’s version appears to hold more generous breaks for pass-through income generated by a wealth management firm like LJPR, which manages about $785 million.

“I’m not going to look a gift horse in the mouth – this industry looks to still come out a net winner,” Wednieski says. “But it’s looking more likely that we won’t be as big of a winner as many other types of businesses.”

A possible near-term loser in any pending reform movement could be advisors working through banks and broker-dealers, suggests Jim Gambaccini, managing partner at Acorn Financial Services in Reston, Va., which manages about $860 million.

“If someone clears through one of these types of entities (a bank or broker-dealer), then under the Investment Act of 1934 they’re likely issued a 1099 form and paid directly,” he says.

That means, according to Gambaccini’s reading of reconciliation proposals, an advisor working at a broker-dealer or bank might wind up being taxed at personal income rates of as much as 37% instead of a much lower corporate tax rate.

Christopher Cooke

“If these tax cuts go the way they appear to be headed now,” Gambaccini says, “the onus will be on broker-dealers and big banks to take a hard look at how they structure their compensation for advisors.”

As a result, Gambaccini predicts more executives at BDs and banks will consider restructuring their wealth management units so that advisors can enjoy more favorable tax treatment.

By comparison, he sees RIAs as better-positioned compared to wirehouses and BDs to take advantage of any looming tax cuts.

“Since independent registered advisors aren’t governed by the 1934 Act, an argument might be made that a group of individuals can form an RIA and be considered as part of a separate company,” Gambaccini says. “Potentially, that could be a big advantage under these tax reforms – an independent advisor could be taxed significantly less.”

Anjali Jariwala, founder of FIT Advisors in Redondo Beach, Calif., isn’t so sure RIAs will be big tax cut winners relative to wirehouses and other types of BDs.

Advisors working at BDs who receive 1099 forms at year’s end are technically not considered as employees, points out the CPA-turned-advisor. Rather, they’re considered as independent contractors, says Jariwala, who works on retainer.

As a result, she figures such FAs could conceivably structure their practices as C corps to get the corporate tax break. “They could also set up their legal status as a pass-through limited liability or S corp,” Jariwala says.

Losers might be independent contractors who make more than $250,000 individually and work as advisors at broker-dealers, she adds. “But they could still decide to become C corps and get taxed at the corporate rate,” Jariwala says.