Transcript

Steven Jarvis:

Welcome to the next episode of the Retirement Tax Services podcast, Professionals Edition. I’m your host, Steven Jarvis, CPA, and in this show, I teach financial advisors how to deliver massive value to their clients through tax planning. On today’s show, I’m lucky enough to be interviewing Ethan Pepper, a financial advisor who has his own firm in the Bay Area, we were having a conversation about a recent situation – he’s currently dealing with a client that checks so many boxes on different tax complexities, that I really wanted to have him come on and talk about and how he’s approaching working with this client. So, Ethan, welcome.

Ethan Pepper:

Thank you. Thanks for having me.

SJ:

Yeah, I appreciate you being here. So we started talking about it before we hit record, but give me a little background on this client’s situation you currently find yourself dealing with.

Ethan Recounts The Case of A Client With Layered Tax Complexities [1:17]

EP:

Yeah. So a client that contacted me, actually last year, and company went public and decided to re-engage early in the beginning of this year. So, young client, you know, in her late thirties, has a long-term boyfriend and they live together and I mention that because it adds to the complexity. [Laughs] Yeah. So she was granted a mix of non-qualified stock options and incentive stock options and she had done some early exercises on the ISOs and then she’s got ESPP as well and now she’s starting to be granted restricted stock units RSUs. So from an equity compensation perspective, this is a sort of a typical client of mine that I see in Silicon Valley, not so much anymore with the stock options but definitely with the RSU, most of the publicly traded tech companies are RSU heavy, but they don’t come across like a client that we’re discussing today that’s got a mix of ISOs and non-quals and now it used to and RSUs and so there’s a little bit more of a complexity to the tax planning side.

SJ:

Yeah, you’re checking so many boxes on different types of compensation and it’s really important that people know those distinct buckets for clients because they have their own treatments. So before we go further into this particular client, you mentioned it, this is pretty typical for clients you work with, if we rewind a little ways to the maybe one of the first times you came across someone with this acronym soup and just how you approach it, one of those first time to say: okay, how do I even sort this mess out?

EP:

Yeah and so that’s actually why a lot of clients come to me because they don’t understand how all this stuff works or even how to organize this. So typically the first step I’m going to take is organize all of the grants that they have; really understand the grant date, you know, the investing schedule, how many shares were invested, how many shares invested on each investing date, in terms of options, understanding the strike price, if it’s a non-publicly traded company, understanding the 498 valuation price, which is important for establishing a AMT preference item income. So it’s really just getting them organized, clear delineation between non-qualified stock options, incentive stock options, you know, putting the RSUs on it on a different tab in the Excel document, so it’s clearly organized again with total number of shares granted, vesting dates, number of shares that will vest on that grant date or that vesting date. And then with ESPs understanding the value on the purchase date versus the fair market value on the grant date versus understanding sort of what that discount looks like, so that we can establish and understand any potential disqualifying disposition with regards to the ESPP shares.

SJ:

Yeah because when we’re dealing with equity compensation, this is a whole different ball game than getting a W2 or a 1099, this isn’t ‘hey, I get a simple form that tells me how much I made and how much is taxable.’ You did a great job of listing out a lot of those details in there, but there’s so many different moving pieces and each company construction them however they want and so you can’t even just make a blanket assumption that, ‘oh, they have incentive stock options, so here’s what that must mean’ – no, that’s not how it works, you need to look at those agreements, you look at those details and see, okay, what does that mean in this situation?

EP:

Yeah. So it’s really first – it’s really getting them organized and then providing them an education on what this stuff means and how it works, without drowning them in the details. That’s really the first step – collecting all of that data or sitting on a Zoom meeting and having the client share their e-trade account so then I could go copy the data into my own Excel spreadsheets. That’s typically where I start.

SJ:

Okay. Yeah, I think that’s really helpful. Could you maybe just give one example of what you commented on – trying to get your clients to understand this without overwhelming them, so if you just pick one of those things, I mean, what is your, let’s explain this in crayon for ESPP or ISOs?

Ethan on How To Simplify Stock Options for Clients [5:09]

EP:

Yeah. The typical one is RSU. So the easiest one to explain is RSUs and the way I explain it, I tell clients is it’s just another form, think of it as another form of a cash bonus, you know, you get granted a thousand shares of the best over four years and you know, maybe each quarter, that portion of the shares, you invest. And so, you know, let’s just say that 250 shares are going to invest on July 1st and they will pull back 50 shares to cover taxes and then you get 200 shares that are available for you to do with ever that you want. And so what I generally tell clients to do is sell them right away and re-deploy the cash into other goals, you know, assuming that there’s no trading window or whatnot. So I try to explain RSUs just like, it’s just a different form of cash bonus, with you know, potentially some upside, if you decide to hold the shares after they vest and let them ride a little bit, but that’s the simplest way to explain this concept of an RSU to a client.

SJ:

Okay. Yeah, I like that. And you said that in your experience more recently, that’s what you’re seeing a lot more of, as opposed to the different types of stock options.

EP:

Yeah, specifically on Silicon Valley, with the tech companies there, I would say 95% of them are RSU-based, in terms of granting equity compensation and then of course the employee is allowed to participate in the employee stock purchase plan if they want and you know, the stock options are typically seen with non publicly traded companies, private companies, or, you know, C-level type of execs is where we see stock options as well.

SJ:

Great. That’s really helpful background for a lot of the listeners. Okay. So let’s go back to this specific client situation that brought this conversation up. So she’s got all of these different types of compensation. So what else we need to know about her?

EP:

Yeah. She has a dual citizenship between here and another country and she sold a house in the other country in Italy. [Laughs] So that she’s had for, you know, over 10 years, because she’s a dual citizen, that throws a wrench into the situation; her and her long-term boyfriend are thinking about getting married this year, so there’s potential change there from tax perspective. They’re also looking at buying a house, so now she’s thinking about doing a same-day sale and some are non-qualified stock options to raise some cash, to put as a down deposit on the house. So that throws a bit of a complication and really kind of where, the most complicated planning comes into play is – she had exercised incentive stock options, paid cash for them because they were, you know, pennies to exercise, and so they were a different 409A valuations at those various exercises, and so the 409A valuation when she has privately traded or non-public company is, is really the value of the stock and so, you know, if her exercise prices at a dollar and the value of the stocks at 10, the spread is nine and so you multiply that by the shares is an exercise in that triggers, that results in alternative minimum tax preference items. So it’s really understanding, you know, where her aim, where the AMT gap is and what her AMT tax liability is going to be versus her regular tax liability. And so now you throw all these complications in there about wanting to do some same-day sale exercises and so that pushes around the AMT liability and then of course, you know, wanting to buy a house that there may be some mortgage interest deduction that would be available to her and then her filing status may change as well, single to married filing jointly. [Laughs] So it’s been an interesting case.

SJ:

[Chuckles] Yeah, Ethan, that’s an impressive list of complexities. Just for any of our listeners who don’t have to deal with AMT or Alternative Minimum Tax too often, because depending on your client base, that you might not be real familiar with that – the way I usually think about it is the IRS likes to get their share and they like being creative about how they get it and so essentially in certain circumstances, Alternative Minimum Tax is just that – it’s a different set of rules that you have to look at to say: ‘well, should I have – does the IRS expect more from me?’ And it does just, it just adds complexity. So great, we have this whole soup of acronyms and different complexities going on, and this is something you deal with on a regular basis, maybe not quite this level, but at least some of those acronyms you deal with on a regular basis. So, I mean, what does this approach look like for you, of how you go about, well, maybe, two questions:
how do you go about making sure that this gets handled correctly? And then what’s your kind of evaluation as you look at something like this to say: ‘yes, I can handle this, this is something I can do for our client, I feel confident to deliver value’?

How To Navigate Tax Complexity The Right Way [9:38]

EP:

Yeah. So her situation – when it comes to this level and complexity, well, let me back up and say, she’s a relatively new client, you know, this year, she’s working with H&R block and [laughs] no, not to diss H&R block but what I generally find is that some of those mass production tax firms are quite involved in their client’s lives as we would prefer them to be, whereas we as advisors are, so they don’t necessarily know what’s going on and so they’re just typically there to prepare the returns in this particular client situation. There’s so many moving parts that we want to make sure that we’re not paying too much in the way of tax and that we really set expectations and we really understand, you know, try to optimize her situation. So when it comes to this level of complexity, you know, generally I would look to partner with a tax expert because there are so many moving parts that I want to make sure that the advice I’m giving checks out with someone who does this on a daily basis. So in this particular situation, you know, I would probably partner with a tax advisor who’s familiar with stock options, particularly to make sure that we’ve all of it, the I’s are dotted and the T’s are crossed for this client. But generally speaking, you know, with cases that aren’t as complex, I’m very comfortable with running plead as the tax advisor, I might not do the tax preparation, but I’m very comfortable with just leading us as the main tax advisor.

SJ:

Well and for you, part of that comfort comes from the fact that you’ve prepared taxes before you’re actually an enrolled agent, so you, I mean, you’ve clearly committed a lot of time to getting to this point, but even with that background, if I was to understand that correctly, when you get into these situations, this isn’t – “all right, Ms. Client, you go deal with this tax advisor and let me know how it works out” – you’re working hand in hand to make sure that ultimately you’re responsible for the client getting maximum value out of this.

EP:

That’s correct, yeah. I want to make sure that we’re driving as much value to their situation as possible, so in that case, you know, partnering with a tax advisor who does this day in and day out, I think adds a lot of value to the client.

SJ:

Yeah and I feel like for advisors, regardless of where they’re at in their experience with taxes, that’s such a great approach to making sure that the client’s taken care of and really can be a great way for advisors to continue to learn and build their skill-set. If it’s something that you aren’t comfortable with yet, honestly, I mean, just be transparent with the client – “hey, here’s, you know, we talked about ESPP and ISOs and RSUs, I know there’s tax complexity related to that, I know some great tax advisors that I’d love to work with you and them to make sure this gets addressed.” Don’t pretend to be something you’re not just learn along the way and take ownership for making sure it gets ultimately resolved correctly.

EP:

Yeah and that’s exactly what I’ve told this client, I said, this has become, this has reached a level where this it’s over and above sort of my comfort level and so I’ve told her that, hey, we’re going to partner with an advisory, a tax advisory firm that just specializes in these types of super complex option issues and yeah, she’s totally comfortable with that.

SJ:

So one question on that, I was recently on a Q&A Webinar with members of Retirement Tax Services and one of the questions that came up was – “okay, how does this work when, as an advisor, I’m recommending that a client go and use a different financial professional, as far as who pays for that additional service?” – So how do you structure that when, when you’re saying, “hey, this is at this level that I can’t handle at all you should go work with this person” – is that part of the fee you charge them already? Is that an additional fee? How do you, how do you structure it?

EP:

Yeah, that would be an additional fee that I’d have that a third-party advisor charge that client directly. So I’m not set up to, to absorb that fee with the fee structure of my process.

SJ:

Sure. Well, this sounds like a pretty complex situation, it’s probably more than a 10 minute conversation.

EP:

[Laughs] Yeah, and so I’m just not set up that way to absorb that fee, because this particular case is a little bit different, but in this particular client situation that could be thousands of dollars. Yeah, to run that analysis because analysis, it’s not just the one time ‘set it and forget it’ – there’s a lot of future tax issues that are popping up for this client, so this may be two or three conversations through the end of the year and then the actual tax preparation, you know, March-April of 2022.

SJ:

Yeah because with a lot of these equity awards, there’s going to be several decision points for the client and whatever they feel right now that might change in six months or a year and so like anything, it’s hard to really know exactly what’s going to happen in the future. Because sometimes when I talk to advisors, I’ll encourage them to, especially with the less complex issue, that either they’re using relationships they have with CPAs to get value to the client or to even offer, to pay for the tax repairs time on simpler issues; but I’m totally with you that, especially on complex situations like this, or as long as you’ve been transparent with the client and they understand their value out of it, there’s nothing wrong with having the client pay for that service – it’s just, I think really getting clear on the expectations and making sure they understand – ‘here’s why you’re paying for it and here’s what you’re getting out of it.’

EP:

Yeah, absolutely, absolutely and then, you know, I think a value add to that particular situation is coming to that tax advisor with very clear, detailed information, you know, presenting him or her, the Excel spreadsheet that I’ve built that has, you know, the vesting dates, the number of options, the strike price, the unvested amounts, all of the vesting dates, the 409A – if that’s all clearly laid out so that the tax advisor it doesn’t have to recreate the wheel and create their own form of organization – I think adds a lot of value to the tax advisors side of it as well as the clients side.

SJ:

Well, it’s going to make their job easier, it’s going to make the communication with the client more effective and honestly, it’s probably going to save your client money because that’s now work that the tax advisor doesn’t have to do, right?

EP:

They’re on the clock, on the tax advisors clock, you know, recreating the wheel with, with some of this stuff. Um, I’ll also provide, sometimes I’ll provide, in this client, I’ll provide the tax advisor a bit more information on just sort of the financial value of this stuff, so that they have some vision into, or some foresight into, you know, what this might look like in the future. So I might run a stock off their report, for our client and provide that report to the tax advisors so that we can, you know, we can sort of look out into the future and say, “okay, what if, you know, what if the stock price doubles in value, what’s the tax impact?” or “what if it falls in value as well, right, what’s the tax impact?” So I think that would be helpful in working with an outside party as well.

SJ:

Yeah, the more information you can share and really taking that mindset of ultimately we’re all trying to help the same client – that this isn’t ‘is Ethan smarter or is the tax advisor smarter’ – this is we’re all going to work together to try to get to the right answer.

EP:

Absolutely, yeah.

SJ:

You had made a comment before about advisors really knowing more about their client’s lives than a CPA might or a tax preparer might, can you talk a little bit more about your experience with that, of kind of how you’ve seen that play out – because I happen to agree with you, but I’d like to hear other people’s perspectives on this?

Ethan On An Advisors In-Depth Relationship With Their Clients [16:45]

EP:

Yeah. You know, I think at least in my practice, I’ll speak for myself, you know, I dig, um, when I first engaged with a client, I take them through a life planning process. I’m a registered life planner and so I’ll dig into their life a little bit more to understand sort of the value set and money history, you know, what’s what gets them, what gets them up in the morning and makes them drive, you know, for some its money and for others it’s not, it’s different. So it’s just really understanding their life and what’s important to them and really understanding sort of what their current goals are and you know, what does retirement look like and “are you here in California or are you somewhere else” um, you know, “is that age 62 or is that age 55 or something in between?” I want to understand the dogs name and the kids names and their sports activities and all that other stuff, of course, I’m sure every other advisor does, but then, you know, looking at the cash flow and, and looking at the complete balance sheet and reviewing their homeowner’s policy and what type of auto coverage have and how they’ve done their estate planning and what’s their portfolio like. And I just don’t, I just don’t see — what I generally find is that tax preparers are not set up — their business is not set up to have those conversations. They’re set up to do a transaction. They’re set up to get the return done and get paid for the return. Uh, but they just, they can’t get compensated on their time, even though they may want to have those conversations, their business structure doesn’t allow them to be compensated to have those conversations or for their time. And so, whereas, you know, we’re charging a client AUM fee or an hourly fee or maybe a flat fee, you know, we dig into knowing that information and so, you know, we just generally know more about the clients than, um, than most tax preparation firms do and so we can have, you know, we can say – “hey, you know, tax preparer, you know, don’t forget about that the client did a Roth conversion and oh, and they bought a house, so they’ll have, you know, maybe they’ll itemize this year and oh, they had a child, so maybe there’s a child tax credit or dependent care credit and so on…when they gave a big, you know, they made a big donation out of their donor advise fund or contribution to their donor advised fund” I should say. So all of these questions that they may not ask that we can bring to the table and say “don’t forget” and it’s good for the tax advisor because they don’t look like they forgot a bunch of – you know, a bunch of things to ask the client come tax time.

SJ:

And in defense of tax preparers, it’s just a different model because sometimes they ask and you talk to the client about it last March, and now it’s the next March and the client’s like, “oh no, I didn’t do any of that kind of stuff” – they’re probably not going to forget that they had a kid, but they might forget about the donor advice fund contribution or they might forget about the Roth conversion, they might forget that you told them there’s tax impacts of other things they were doing. Yeah, so the more you can do as an advisor to share that information with the tax preparer – we really encourage advisors to send a year-end tax summary letter or a 1099 letter to say, “hey, here’s the things that went on during the year” because this isn’t “hey, I’m an advisor and I know more than the tax preparer” – there are different models and you’re both trying to work together to serve the client. And as long as you keep that mentality, the client’s going to win.

EP:

Yeah, I’ve heard of this, um, backstage pass about the year-end 1099 letter I have not done that yet, but thinking about, you know, what’s happened or occurred in a client’s life during the year that the tax advisors should know about? Yeah, little Johnny was born, they bought a house, they re-filed the house twice, don’t forget to include the two final closing statements from the, for the three, from the purchase and the two re-files, as well as the 1099 from Schwab and, you know, whatever documents the advisor has access to this. So yeah, I love that idea, I just haven’t implemented it yet.

SJ:

Well, I’ll be sure to send it to you after this so that you have it right at the top of your inbox. And as I talk to tax preparers I know, most of them have never seen something like that, but they love the idea of that, I mean, they jump at it – because tax preparers also realize that advisors tend to spend more time with their clients during the year than the tax preparer does; and part of that is, again, the model, since tax preparers are more associated in clients’ minds with paying the IRS, they put off providing their documents, they put up going and seeing them and so taxpayers end up with this crazy time crunch in February and March and April, where they’re just trying to get those transactions done to your point. Whereas when you’ve kind of, in a less stressful way, met with the client throughout the year, you are in a better position to learn all that information and then the client is the one who wins, if you aggregate that information and send it to the tax preparer.

EP:

Absolutely.

SJ:

So, Ethan, I really love all this conversation. This is great context for advisors listening. We like to make sure that we include action items so that everything we talk about gets turned into – okay, what can I do about this? So whether you look at this current situation you’re dealing with or other ones similar to this, what’s something that you can recommend to an advisor who comes across these complexities, as what systems they should have in place or first steps they should take when this all comes up?

Ethan’s Actionable Advice For Advisors Dealing With Tax Complexities [23:44]

EP:

Yeah, great question! First one is get organized, so specifically, if you have a client that has any form of equity compensation, either, you know, they participate in the employee stock purchase plan, they have some sort of options, or they have some sort of restricted stock units – just really helped that client get organized. Let’s just call it, dump it all into an Excel document, get it organized and that’s going to allow the client to understand what they have and when it vests and it’s going to allow you to understand what they have and what they’ve asked. So it’s really number one, get organized. It’s number two, ask for the most recent paycheck stub, the paycheck stub is going to tell you a ton of information about what the client is doing, not just from a compensation perspective, but an employee benefit perspective as well. I always ask clients for their most recent paycheck stubs because I’ll come through it and, you know, I might realize that, hey, they’re not maxing out their 401k, or, you know, they’re contributing half to rough 401k and half to the pre-tax 401k – is there a reason, are they maxing out their health savings account? Are they maxing out their dependent care FSA? So there are other reasons to get the paycheck stub and by recognizing these issues and communicating that to the client, I think that’s a way to add value to the client. So organization, most recent paycheck stub, and for some clients, I will give them a heads up of when their RSUs or stock options are vested. What I often find is that clients, you know, they’re so busy with their work and their lives, that they don’t realize that, “oh, I’ve got a thousand shares vesting tomorrow, maybe I should do something about that” and so I will send emails to clients saying: “hey, don’t forget you got X amount of shares vesting tomorrow, you’re in a trading window, so if you want to have a conversation, let’s have a conversation, but just wanted to give you a heads up.” And so that they find valuable as well. And that’s, you know, there are various pieces of software that you can do that, I know on e-money there’s a trigger for that and I think there are some other software’s where you can alert a client about upcoming investments.

SJ:

Yep. What a great way to add value to the client. I mean, you’ve already taken all that information from them anyways as you were working with them on this financial plan or a tax plan, and then it can’t take very much time from you or your team to send a note or an email to say, “hey, this is coming up”, but I can only imagine how appreciative clients are to know that you’re really looking out for them.

EP:

Yeah and for those advisors who don’t, you know, don’t dabble in tax – don’t be afraid to ask for the paycheck stub because you don’t need to have a tax background to just add value, but by reviewing the paycheck stub; don’t be afraid to log into each trade with a client so that you can get all of the data to fill in that Excel spreadsheet, that adds a tremendous amount of value to the client. And then, kind of lastly, you know, in terms of continuing education, there’s a bunch of Free Cal CPA as an example, you can download a bunch of free content and just learn about super complex tax issues to the basic stuff and so there are a ton of free resources to just get started, learning more about tax it, you know, if the advisor chooses to do so.

SJ:

Yeah. I mean, for those advisors out there whose clients don’t pay any taxes, you can disregard that last piece or for the vast majority of us who have clients who do in fact pay taxes at some point, yeah, that consistent commitment to learning more and progressing wherever you’re currently at, the other action item we always throw out on here is to make sure you’re getting tax returns and reviewing them, which fits right in with what you’re talking about – you don’t have to be an ex tax expert right now to ask a client for tax return, make sure they know what you’re going to do with it, make sure that they know that – “hey, this is a new service we’re adding, so here’s the 10 things we’re going to look for and we’ll let you know if there’s any issues.” Don’t leave it open-ended and let them think that you’re going to fix everything that’s ever gone on with the tax return, but set those expectations and start that process. Start building those reps so that you are building your expertise in that area. Well, Ethan, this has been great conversation, I really appreciate you coming on today. And for everyone listening, just make sure that you go back and listen again to those action items, Ethan really spelled out – ‘okay, here’s how you can approach complex situations’ – really whether its equity compensation based or not, that general framework will apply for any complex situations. So make sure you go back through those, take what you can to apply to your own practice and till next time, good luck out there and remember to tip your server, not the IRS.