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By A.J. LeimenstollHead of Wealth Strategy Specialists – Wirehouse & Independent Channels

Boston - President Biden's latest tax proposals have garnered the utmost attention from investors, and rightly so.

While remaining aware that Mr. Market is always standing ready to provide lessons in humility, we find that more successful investors tend to concentrate their effort and energy on things they can control: stay focused on the horizon that matches your investment goals, rebalance accordingly, manage investment costs prudently and reduce tax drag proactively. Managing tax drag may very well take the lead in such an investor's mind in the coming months.

Reviewing Biden's latest tax proposal

History tells us that where policy lands is unlikely to be where the posturing begins. However, let's review some of the details from the Biden administration's most recent proposal:

  • Raise the federal long-term capital gains tax rate from 20.0% to 39.6% for earners above $1 million.
  • Keep the 3.8% tax on net investment income put in place during the Obama administration, for an effective capital gains tax rate in the highest income bracket of 43.4%, on a federal basis.
  • Reduce the favorable tax treatment on carried interest for investment managers,1 as capital gains tax rates could meet or even exceed the marginal tax rates on earned income.
  • Bring combined federal and state capital gains rates above 50%. For earners in the highest proposed tax brackets, the combined rate as proposed could reach 52.22% in New York and 56.7% in California.

Managing realized losses to offset capital gains

As we have seen the value of financial assets increase dramatically, a less acknowledged "asset" stands to appreciate dramatically in value over the coming months and years: realized losses.

Net realized losses can have distinct financial value when used to offset capital gains. No client seeks losses as an investment goal, but high net worth investors recognize the value that can be created by proactively harvesting losses when market volatility presents opportunities to do so.2

Under this tax proposal from President Biden, the value of a dollar of net realized losses would increase in direct proportion to the increase in taxes on long-term capital gains. Boosting the federal rate from 23.8% to 43.4% would represent an 82% increase in the value of an offsetting tax loss against a long-term capital gain.3

For example, under current law, an investor offsetting long-term capital gains with $100,000 in net realized losses could reduce their tax bill by $23,800. Under Biden's proposal, the potential federal tax savings would increase by 82% to $43,400.

Bottom line: We believe that investment strategies capable of maintaining exposure and risk targets, while actively and opportunistically harvesting losses, will only become more advantageous to clients — regardless of where the tax policy posturing ultimately finds its footing in Washington. We rarely hear investors bragging to their friends about the losses their portfolios realized, but the math could certainly justify it.

The adage, "a penny saved is a penny earned," might be an appropriate line of thinking. Given the potential consequences for investors, however, speaking in terms of "pennies" may be difficult to defend.

  1. Carried interest is a share of private equity or fund's profits that serve as compensation for fund managers. Considered a return on investment, carried interest has been taxed at a capital gains rate, not an income rate.
  2. Tax loss harvesting is a strategy for managing taxes in an investment portfolio. Selling a security that's trading at a loss creates a realized tax loss, which can be used to offset a capital gain realized in the same year.
  3. Percentage increase calculated as the difference between the effective proposed long-term capital gains rate and the current rate, divided by the current rate, or (43.4 - 23.8) / 23.8 = 82%.

tax forward

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