5 Things Advisors Should Know This Tax Season

With tax season upon us, we’re answering the top 5 questions that we’ve received from advisors to help you not only minimize the amount of taxes your clients owe, but to help achieve better after-tax outcomes come April 15 of next year.  

1.What happened to Capital Gains distributions in 2021? 

After years of raging bull market conditions, many Americans will be sitting on large unrealized capital gains in their mutual fund portfolios but those gains do carry significant tax risks. Capital Gains distributions were notably larger for mutual funds in 2021 than they have been in the past. Funds that invest in smaller and more growth-oriented companies generated the largest capital gains.

2. How can advisors help protect and grow client portfolios while maximizing tax savings?

With 90% of investors stating that taxes can eat at their portfolio and another 80% believing that their advisor should be focused on minimizing their capital gains liability¹, efficient investment strategies like direct indexing and tax managed solutions can provide material savings to investor returns.

Research has shown that “given long- and short-term capital gains tax rates of 15% and 35%, respectively we found that a tax-loss harvesting strategy yields a tax alpha of 1.08% per year from 1926 to 2018.”²

3. How does direct indexing help with tax efficiency?

Direct indexing is a process that seeks to replicate the risk and performance of an index by purchasing its underlying securities individually, rather than purchasing shares of the index, itself.  The investor gets the same kind of broad market exposure but with compelling advantages, including better after-tax outcomes: 

• Proactive Tax Loss Harvesting: Harvesting losses on an ongoing basis, instead of just at year end can result in an additional 1% return per year.³
• Integrate Legacy Holdings in Transitions: In transitioning legacy holdings into a new target strategy, you can incorporate some current holdings into your direct indexed portfolio to reduce unnecessary trades and expenses.
• Capital Gains Budgets: The maximum amount of capital gains the investor is either willing to absorb and pay the taxes on, and/or the amount of capital gains that can be triggered and absorbed in the current capital gains tax bracket without increasing them above the next threshold.
• Customization: Multiple factors can be used to customize direct indexes, including: ESG screenings, sector/security restrictions, capital gains restrictions, and buy/sell rule to get the precise exposure a client seeks.
• Accommodate ESG Considerations: Clients can align a portfolio with their environmental and social values through robust screening. 

A Tax Managed Solution can help you with many client and prospect situations. The following are just a few examples you can use: 

The Legacy Gain Prospect

You have a new prospect interested in consolidating their assets, however they are worried that the transition would result in the realization of large capital gains. With a tax managed solution, you can plan transitions over a specific timeframe based on the tax impact they may have, minimize capital gains when buying or selling within their portfolio, and proactively harvest tax losses on an ongoing basis. 

The Buy & Hold Investor

A long-term investor is looking for a low-cost, customized strategy. Show clients that through direct indexing, you can build a low-cost portfolio that customizes an index to match their unique needs and values, while proactively managing the taxes on their investments. 

 5. How can you start preparing to lessen your client’s tax burden next year?

Start taking action today: 

• Consider an alternative that can help you address the needs of clients with deeply embedded capital gains, concentrated positions and those seeking more tax efficient portfolios.
• Ask current and prospective clients for their 1099’s to address any surprises they may have experienced from their capital gains distributions.
• Ask for client statements and contact Orion to help provide analysis and advice on how to structure the portfolio in a more tax efficient manner.

How To Add Tax Management Into Your Practice

Find out how you can deliver proactive tax managed portfolios at scale.

¹Orion Research Initiative, 2021.

²An Empirical Evaluation of Tax-Loss Harvesting Alpha” Shomesh Chaudhuri, Terence Burnham, Andrew W. Lo

³Brinker Capital. Represents $1,000,000 investment over 20 year period at 6% and 7% after tax returns. After tax returns are not reflective of a tax rage but used to illustrate the hypothetical results of a 1% difference that efficient tax management may have on a portfolio.  Returns are hypothetical in nature and are intended for illustrative purposes only.