Taxes in Focus: The BEAT Q4’25

Transcript

Well, the books are closed on the 2025 tax year. Whatever will be will be. We had a lot going on in the landscape of taxes last year. If you rewind a full calendar year, I was discussing the considerations that the numerous provisions of the Tax Cuts and Jobs Act that were set to sunset at the end of 2025 were going to be for individual investors.

We were reviewing things like how changes to marginal tax rates and a potential increase there would impact individual filers, how standard deductions might be getting cut in half, how changes to itemized deductions might change your filing. The gift and lifetime exemption potentially getting cut in half, as well as changes to AMT.

In the middle of the year, over the summer in July, we got some clarity with the One Big Beautiful Bill Act. We understood then what the potential planning narrative was going to be with majority of those provisions being permanently extended. So the conversation shifted pretty substantially as going into the end of the year as we were reviewing philanthropy opportunities. The one thing that I was really hammering going into the end of the year were the changes that were being implemented through the One Big Beautiful Bill Act, such as that in 2026, we now have an increase, or actually I should say a, a decrease in the economic relief that an itemized deduction will provide for folks that are in the highest tax bracket.

So the highest tax bracket at 37% in itemized deduction only provides relief up to 35%. We also introduced a 50 basis point floor on itemized deductions. So now that we are in the new year those are tax law. That’s something we need to plan for in the year ahead.

The next thing on the horizon in 2026 is we need to keep an eye on the midterm elections. That’s something that you’ll see more commentary on as those approach. So thinking about this new year as a clean slate for tax management, it’s the perfect opportunity to reflect on the impact that tax erosion and tax management can have on long-term wealth accumulation.

Let’s take a look at this illustration on screen. This is looking at a million dollars with and without tax management. So the orange line in the center here shows a million dollars as your starting value. It shows a static compounding rate, so this looks at an 8% annualized return over a 20-year period. In a vacuum, that million dollars has the ability to grow to 4.7 million.

Now, let’s bring that investment into the real world, where there are tax considerations. First, let’s look at the lines below the orange line. This is the impact that tax erosion or tax drag or tax friction, however you’d like to articulate it, this is the impact that taxes can have. If we reduce the annualized return from 8% to 7%, so a 1% tax drag, that million dollars’ compounding potential is stunted to 3.9 million.

If we implemented 2% tax drag, that million dollars is now only growing to 3.2 million. So showing that incremental tax erosion has a really, really significant impact. On the flip side, implementing tax management, introducing tax alpha to your investment approach, has the ability to increase that compounding return rate.

That $1 million, introducing tax alpha to a magnitude of 1% or 2%, turns that compounding growth potential, dials it up to 5.6 million or even 6.7 million. So this just highlights the importance of why taxes matter.

So let’s shift to the next slide As a client’s tax forms start trickling in over the next weeks and months, I challenge you to scrutinize 1099s and Schedule K-1s. Try to identify the root cause of taxes that a client is going to owe. Did they come from capital gains? Did they come from mutual fund distributions? Were they stemming from distributions of investment income? There are so many potential sources of investment tax friction.

One of the biggest offenders is often turnover. Let’s look at a couple examples of how turnover can impact a client.
The first form of turnover is security rebalancing. This is when we adjust individual security weights. So as we start seeing a proliferation of a handful of stocks having superior growth to their peers, we need to pare those back and keep them at a prudent weighting within the client portfolio. When you are selling your winners and rebalancing to the underperformers, that inherently creates tax friction.

The next example we’ll look at is asset allocation rebalancing. This is the same concept, but looking at asset class sleeves. So, if large cap growth is outperforming large cap value, if midcap is outperforming small cap, if developed international is outperforming emerging markets, in order to maintain that target asset allocation, we have to create turnover within the client portfolio. That is a prudent decision to create that turnover to keep them in line, but that creates tax friction.

The next one would be changing asset class strategy. This might be making a wholesale change to a particular asset class if we wanted to potentially fire an underperforming manager, or if we wanted to just make a tactical pivot in a different direction. Eliminating investments from the client’s portfolio to move in a different direction is going to trigger capital gains. And then the last one is withdrawals and distributions.

For clients that need capital from their portfolio, if they have an unforeseen liquidity event or they’re just trying to create income from their portfolio, this is also going to create tax friction.

So, I challenge you, as I mentioned, to look at your clients’ tax forms and diagnose where did that particular investor’s tax friction come from and then we should think about were there opportunities for us to have offset the out-of-pocket tax cost through tax management. So as we move to the next slide, throughout the remainder of the year, we’re going to be reviewing the different opportunities to incorporate tax management into a client’s investment thesis.

We have our Tax Forward 365 monthly planner, and we also have our Tax Forward investing center. We cover themes throughout the year to look at optimizing asset location, making sure that as we’re looking at these different asset classes as well as the different investment vehicles, that we’re optimizing where a client holds them based on their tax profile.

We’re going cover the importance of incorporating systematic tax loss harvesting within both a client’s equity and fixed income sleeves. On the topic of fixed income, it’s also really important to make sure that we’re reviewing after-tax yields, looking across the different asset classes within fixed income and optimizing to make sure that we have the best possible allocation.

Whether you’re making transactions in the client portfolio or a manager is making changes to a client portfolio, it’s important that they’re monitoring for things like wash sale, that they’re managing at the individual tax lot level, and that they’re deferring the recognition of capital gains when possible.

In that same theme of deferring capital gains when possible, also making sure that we’re monitoring for holding period. If we need to raise capital from a client’s portfolio, we want to make sure that we’re not selling an asset that we’ve held for 360 days and held just a few more business days would have been eligible for long-term tax treatment.

Just being really thoughtful and mindful around how taxes are going to create implications for the investor at the end of the year. So first, look in the rearview mirror. Look at what the outcomes of 2025 were and then we can think about how to action 2026. If you are going to make an allocation change, whether that be tactical or potentially changing managers, be really thoughtful about the transition process.

Money in motion typically creates tax drag, and running a thoughtful transition analysis for the investor can make sure that you and they understand all of the considerations of making that change. And then typically towards the end of the year, that’s where we start thinking about how philanthropy and an itemized deduction might be able to offset or manage some of the taxes and tax triggers that were created throughout the calendar year.

And then the last one, of course, that is always important is to make sure that we’re being thoughtful about estate planning. To the extent that investors may want to set up a transfer of assets to the next generation, or as they’re thinking about that multi-generational and gift and estate tax limit considerations, think about how turnover, capital gains, and tax deferral can fit into that strategy.