You can be forgiven if you didn’t read all of the 600-page tax bill that Congress passed last year. Most members of Congress probably didn’t read it all either. But there were provisions buried in there that matter to some investors.
One of those provisions relates to the investment expense deduction for separate accounts like those we use at Azzad. The bill repealed this feature of the tax code (though not for mutual funds, like the Azzad Funds).
This means that now, unlike investors in separate accounts, mutual fund investors are able to reduce taxable income by fees paid, because fees are netted against the fund’s distributable taxable income. Thus, theoretically speaking, mutual funds provide a tax advantage now compared to separate accounts.
But let’s not fret too much. Even though the IRS allowed a deduction for fees paid to manage investments, there were lots of limitations that prevented many–if not most–investors from getting a tax benefit.
First, only fees incurred to produce taxable income were deductible. This means that if you paid fees using IRA assets, those were non-deductible. Only fees paid from a taxable account that held taxable income-producing assets were eligible.
Secondly, the combined amount of miscellaneous deductions had to exceed 2% of adjusted gross income before they provided a benefit. That combined with the fact that miscellaneous deductions weren’t allowed under the alternative minimum tax (AMT), kept many medium-to-high income taxpayers from benefiting.
In other words, even under the old rules, investors might not have been able to use their fees to reduce taxes, making the repeal of the deduction a moot point.
And for many, separate accounts still offer advantages, chiefly the ability to harvest losses and manage taxes. This feature remains a significant advantage of separately managed accounts that could often outweigh the less favorable tax treatment of fees.
For mutual fund investors, it may still make sense to deduct your expenses from taxable accounts. Talk with your Azzad financial advisor to see if this strategy is right for you.