Investment Tax Management
Taxes Reduce Net Investment Returns
Forty-one states impose a tax on capital gains. Those rates averaged 6.37% for the 2020 tax year. But for investors residing in California, the maximum state capital gain rate was 13.30%. When these state taxes are combined with Federal taxes, the combined tax burden on investment returns can exceed 50%. Fortunately, there are resources available to investment advisors to mitigate this drag on investment returns. Simplicity Solutions can employ a number of different tax management techniques as a value-added service that can reduce or defer this tax burden.
Tax Loss Harvesting
Tax-loss harvesting has long been recognized as a way to increase after-tax returns in a portfolio. Advisors have traditionally examined gains recognized through the end of the tax year as part of year-end tax planning. Next, they look for unrealized losses that can be realized or harvested in offsetting transactions. Unfortunately, the optimal time to look for losses is often not at the end of the tax year. As the market cycles up and down throughout the year, there can be multiple loss harvesting opportunities.
While remarkable in many ways, 2020 was not unique in this regard. By continuously monitoring portfolios for loss harvesting opportunities, Simplicity Solutions was able to realize losses throughout the 2020 market cycle instead of at year-end when the market had rallied, and loss harvesting opportunities were scarce.
Wash Sale Monitoring and Avoidance,
While loss harvesting is simple as a concept, it can be challenging to implement successfully. Most advisors know that once a trade is placed to realize a tax loss, that the same security (or any substantially equivalent security) cannot be purchased for thirty days. These trades are called wash sales, and the losses realized are not available for tax purposes.
Further, the IRS views trades in related accounts – even those in tax deferred accounts to be no different for purposes of this elimination period. Wash sales may also be declared when the purchases are made in a spouse’s account or that of a corporation controlled by the investor. The complexity of monitoring all the trades across multiple managed accounts for wash sale violations can be daunting for the average advisor and impossible for individual SMA managers. Simplicity Solutions detects these wash sale violations before trade execution and then implements the trades in a manner that avoids the wash sale and preserves the investor’s tax loss.
Holding Period Monitoring and Management
Client positions may be comprised of securities with many different holding periods. Routine rebalancing can result in multiple tax lots of the same security. Simplicity Solutions monitors each tax lot and trade to determine if the net after-tax trade results can be improved by delaying sales to achieve a more favorable tax treatment.
Tax Lot Optimization
Ongoing trading in a client’s portfolio can create adverse tax consequences. Whether the trade is the result of a manager trimming a position or the raising of cash for a client’s income needs, selecting and trading the optimal tax lot can mean the difference between realizing a short or long-term capital gain – or even a tax loss. Simplicity Solutions is ideally positioned to provide this oversight because we are responsible for executing all manager trade requests as well as performing route portfolio administration such as re-balancing and cash management.
Tax Efficient Transitions
Tax-efficient portfolio management often begins before the first trade. Frequently accounts are funded with low-cost basis securities. And unless the client is willing to realize all their embedded capital gains, some or all of these holdings will need to be retained.
These legacy positions may create differences between the client’s actual portfolio holdings and those of the investment model selected for the client. These differences introduce a risk that the portfolio will perform differently than the investment model. Simplicity Solutions minimizes these risks with multifactor analysis to determine the optimal tradeoff between gain recognition, loss harvesting, and portfolio replication.
Clients frequently want to establish a tax budget. Whether as part of a portfolio transition strategy or routine portfolio management, clients use tax budgeting to eliminate unexpected year-end tax liabilities. Fulfilling these requests can be difficult as gains are often realized due to routine manager trades or re-balancing. Simplicity Solutions can utilize ongoing gain/loss matching to reduce the net realized gains from these trades while honoring the client’s tax mandate.
What’s the Next Step?
Simplicity Solutions employs a consultative process when onboarding new advisors to the platform. We will be happy to work with you in designing solutions appropriate for your practice and your clients. In addition, a quick demonstration of our Simplicity Solutions Proposal and Research Center (SPARC) will show you how easy it is to exceed your clients’ expectations with unified managed accounts (UMAs). To set up a meeting, click here:
Investment advisory and sub advisory services offered through Simplicity Solutions, LLC, a SEC Registered Investment Adviser. Simplicity Solutions is wholly owned by Simplicity Financial Marketing Holdings, Inc. and an affiliate of Simplicity Wealth, LLC, a SEC Registered Investment Adviser. Please review the ADV 2A for complete details. *TD Ameritrade, Inc. is one of the firms that we use to custody our client assets. TD Ameritrade, Simplicity Solutions, and the other entities named are separate and unaffiliated firms, and are not responsible for each other’s services or policies. TD Ameritrade does not endorse or recommend any advisor and the use of the TD Ameritrade logo does not represent the endorsement or recommendation of any advisor. Brokerage services provided by TD Ameritrade Institutional, Division of TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. Used with permission. *Salesforce, Salesforce.com and others are all trademarks of Salesforce.com and are used here with permission. Morningstar® Managed PortfoliosSM are model portfolios offered to Simplicity Solutions, LLC by Morningstar Investment Services LLC, a registered investment adviser and subsidiary of Morningstar Investment Management LLC. Morningstar Managed Portfolios are intended for citizens or legal residents of the United States or its territories and can only be offered by a registered investment adviser or investment adviser representative. Simplicity Solutions has full discretion to invest client accounts in accordance with a Morningstar Managed Portfolio model or to deviate from the model. In no way should the use of a Morningstar Managed Portfolio by a Simplicity Solutions client be viewed as advice or establishing any kind of advisory relationship with Morningstar Investment Services, who is not acting in the capacity of advisor to individual investors. Morningstar Investment Services is not affiliated with Simplicity Solutions, LLC. Morningstar Investment Services does not guarantee that the objectives of a portfolio will be achieved or that negative returns can or will be avoided in any of its model portfolios.
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