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By David GordonDirector, Eaton Vance Advisor Institute

While economists and pundits might disagree about whether it is here to stay, what the rate will be a year from now or how long it will last, inflation is back.1 After more than a decade of low inflation, a 5% year-over-year inflation rate is nothing to ignore. You don't need a crystal ball to ask your clients:

                "How do you feel about paying tax on inflation?"

Most advisors we know incorporate expectations for inflation into their growth modeling for clients, with the hope that investment recommendations will return more than the rate of inflation so that investors experience an increase in purchasing power.

If 5% inflation is our new reality, helping clients increase their real value purchasing power might be more difficult than ever — especially if two potentially costly developments occur simultaneously:

  1. Congress may increase capital gains tax rates at the Biden administration's urging even in the face of potential sustained inflation.
  2. Clients hoping to "wait out" any capital gains tax increase until some future administration reverses the tax increase may find that a significant portion of their subsequent capital gains are explained by inflation (a nominal increase in value) rather than growth (a real increase in value). They (or their heirs or estates) could owe taxes on inflation.

By helping clients understand how capital gains tax is calculated, the After-Tax Advisor® might open the door to conversations about asset location as a possible way to manage taxable capital gains.

Bottom line: Help clients evaluate portfolio adjustments based on what we know today, rather than hoping for a better tax climate in the future.