The Biden Administration has proposed raising the top long-term capital gains tax rate, from 23.8% to 43.4%.1 There’s a lot of uncertainty here: the law may not pass, it would only affect investors with more than $1m in income, we don’t know about phase-ins and we don’t know about exemptions. Only about 0.35% of Americans earn more than $1m, so this isn’t a mass-market concern.
Still, we can ask “how might this hike affect advisors?” We think the answer is pretty straightforward: tax management will become more important, and it will make advisors who excel at tax management more valuable.
How much more valuable?
Last year, the average taxes saved through active tax management across all taxable accounts managed on the Smartleaf platform was 2.44% of portfolio value (See 2020 Taxes Saved Report). We can calculate what this would have been if (rather improbably) all of our taxable clients were subject to the new tax regime. Deferring the sale of short term positions until they’re long term would no longer save taxes, so we actually end up losing one element of the taxes saved report. But we win big time on tax-loss harvesting of long-term positions and the deferral of long-term gains (SeeGains Deferral: The Core of Tax Management).2
Recalculating last year’s Taxes Saved numbers with the new proposed tax rates, the revised Taxes Saved comes to an impressive 4.45%. In practice, we’d expect this number to be even larger since with higher tax rates, our algorithm would be more aggressive in its tax management recommendations.
Still, saving clients 4.45% of portfolio value in taxes is pretty good. We don’t know whether this tax hike will take place, and if so, what form it would take. And we won’t opine on whether it’s good social and economic policy. However, we can confidently assert that the change would be good for financial advisors (at least those who are good at tax management).
We’re pretty sure long term tax rates won’t actually double for most of your clients (unless you’ve got an ultra, ultra-high-net worth client base), but tax rates are likely to increase somewhat, which means your value to clients will go up.
1 43.4% includes the top tax bracket of 39.6% plus the 3.8% Medicare surcharge.
2Tax-loss harvesting gets most of the attention when it comes to tax management, but in the long term tax deferral is the more important component.