How to Generate Alpha from Clients’ Tax Returns

Clients are surprised when I request copies of their tax returns. But when they see the process I use to save them money – tax “alpha” – they often wish April 15 came more often.

I explain to them that reviewing their returns is mandatory. Though, for security purposes, they must redact their Social Security numbers. I need the tax return to better design the plan. You don’t have to be a CPA to provide a ton of actionable and measurable results that add critical value to your clients.

Here are five areas to help clients and add that tangible and immediate value:

  1. Make the most of clients’ past losses. Do they have a capital loss carryforward? With markets nearing all-time highs again, you’d think this would be fairly rare, yet it’s not. I regularly see clients with huge tax-loss carry forwards and this provides two key insights. I ask where the loss came from. That can shed light on possible poor behavior such as panicking and selling during past bubbles. I suspect I’ll see some losses in more than a few 2020 tax returns for those who sold during the brief March bear market. I advise clients that their past behavior is a far better predictor of the decision-making than any risk profile questionnaire. Understanding the loss is critical for determining how much risk a client should and can take.

Second, if the client has a loss then it opens up possibilities to exit investments with high fees or that are otherwise undesirable, such as concentrated positions. I jokingly tell the client, “I’m sorry for your loss but let’s make the best of it.” I estimate how much in gains can be recognized without paying any federal income tax. That’s not to say I’ll use all of it up, because that loss carryforward has value in future years. And, of course, any unrealized losses can also be sold and used to offset gains or add to the tax-loss carryforward.