Tax Alpha

Taxes are the most important drag on today’s investment returns ‐ greater than inflation, transaction costs or even management fees. Recent studies performed showed that taxes reduced returns by up to three percentage points. Recent tax increases should also increase these percentages significantly, making it more important than ever to manage tax drag and create positive “Tax Alpha” for clients.

With the recent tax changes and introductions of the 3.8% NIIT tax (net investment income tax), 20% capital gains rate, 39.6% income tax rate, and personal exemption and itemized deduction limitations, America has shifted from a two dimensional tax system to a five dimensional system. Virtually every financial decision now needs to be analyzed through this prism. The complexity of going from a two dimensional system to a five dimensional system is exponential, not linear, which requires a quantum leap in tax analysis methodology, tax strategy and tax planning software tools. The increased value created in an investment portfolio by understanding tax saving strategies we call “Tax Alpha”

There are now seven different ordinary income tax brackets – 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%, and three different capital gains tax brackets from 0% to 20%. Furthermore, if you combine these tax brackets with the new 3.8% NIIT, there are even more possible tax brackets; i.e., some high income taxpayers may be subject to a 43.4% tax rate on ordinary investment income and a 23.8% tax rate on long‐term capital gains.  When taking into account the phase‐out of personal exemptions (PEP) and limitations on itemized deductions (Pease) as income rises above the applicable threshold amounts, the tax rates increase even further. (

The increased value created in an investment portfolio by using tax saving strategies our office uses is described as “Tax Alpha” Put another way, it is your after‐tax excess return (after‐Tax Alpha) minus your pre‐tax excess return (pre‐Tax Alpha) based on the appropriate benchmarks.

Generally, an index is used as the appropriate benchmark (e.g., the Russell 1000 for U.S large cap stocks). Research indicates that many portfolios don’t consistently beat their benchmarks on a pretax basis, often producing negative alpha on an after‐tax basis. That is why creating Tax Alpha is important. If pre‐tax alpha is positive, tax planning can increase the excess.

Given the growing realization of the power of “Tax Alpha”, is your advisor providing it to your portfolio?  My office has over 50 different Strategies working with:

  1. IRA & Roth IRA
  2. Capital Gain/Loss
  3. Dividend Income
  4. Option
  5. Qualified Plan Distributions
  6. Charitable Planning
  7. Strategic Planning
  8. Tactical Planning
  9. Trusts & Estates

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