You say “volatility.” I say potential “tax opportunity.”

March 17, 2016 Categories: Portfolio Corner
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1099-div tax form

I have two pieces of good news to share related to taxes. Most unusual, I know: “good news” and “taxes” in the same sentence.

Good news item #1: April 18 (and 19) is the new April 15 in 2016

This year, everyone gets a few extra days to prepare their taxes. According to IRS publication 509, the general tax filing date for 2015 taxes is April 18th this year due to a Washington DC holiday (Emancipation Day). Residents of Massachusetts and Maine benefit from an additional extension (the Patriots Day holiday), so their filing deadline isn’t until April 19th this year.

Good news item #2: Market volatility can have a silver lining

Concerns about an economic slowdown in China, Fed tightening and soft corporate profits that increase market volatility – like we saw earlier this year and Russell Investments’ strategists are expecting more of throughout this year – can actually present potential opportunities to improve after-tax outcomes for your taxable clients.

Let me explain:

  1. Volatile markets can help create deferred tax benefits

If you see someone grinning like a Cheshire cat during periods of market volatility, it’s very possible that investor is tax-sensitive. Like any other investor, tax-sensitive investors very much want stocks that go up in value. But this breed of investor also has great use for stocks that decline in value (which tends to happen more broadly during periods of market turmoil) because it creates the opportunity for tax loss harvesting, which can potentially help reduce the investor’s overall investment tax liability.

Tax loss harvesting can be instrumental for tax-managed portfolios with a long-term focus. Minimizing the tax liability keeps more of the portfolio’s value inside the portfolio – or in the client’s pocket, rather than in the IRS’s pocket. More value in the portfolio means more potential opportunity for that value to compound over time.

  1. Volatile markets can create opportunities to transition assets to tax-managed vehicles, as appropriate

For those investors not yet in tax-managed portfolios, periods with higher volatility could be an opportunity to begin transitioning assets from a legacy portfolio to a tax-managed portfolio. Here are a couple of strategies to consider for suitable accounts. These two steps could potentially result in almost 20% of a client’s assets moving to a tax-managed investment solution and a deferred tax benefit being created.

In an earlier blog post I discussed specifically how newly created shares from reinvested capital gains and dividend/income distributions can be used to lower the overall tax burden. I’ll recap here how these new shares can be used in combination with volatility-created capital losses to potentially further lower the tax burden of a transition to a tax-managed portfolio.

            Step 1: Review new shares from 2015

First take the shares hypothetically created in vintage year 2015, when the average equity mutual fund distributed 9.7% in capital gains. If the market, and as a result quite possibly the client’s portfolio, is down since the distribution occurred, that represents both

  • a loss that can be harvested
  • shares that can be immediately moved to an investment option that could make more sense for a taxable investor.

Step 2: Review shares from 2014

Let’s take this one step further and look at vintage year 2014. The average equity fund distributed 9.0% in capital gains that year. Take a look at those shares and see what the realized capital gain would be if you sold those shares outright. They may have a small gain or even a loss attached to them

The bottom line

Helping your clients benefit from techniques and steps like tax-loss harvesting and transitioning distributed or possibly even reinvested capital gains can help set you apart from your peers. Seizing these opportunities during this period of uncertainty and volatility can help provide your clients and you with the confidence that you are helping them grow their after-tax wealth.

The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.

Russell Investments is a trade name and registered trademark of Frank Russell Company, a Washington USA corporation, which operates through subsidiaries worldwide and is part of London Stock Exchange Group.

Copyright © Russell Investments 2016. All rights reserved.

This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.

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