You may be hearing a lot about pending tax legislation and, while all the provisions are still being debated, we think the discussion and key proposals highlight the importance and value of a systematic tax-management approach all year long.
What We Know
The U.S. Senate and the House of Representatives have proposed separate tax bills, with an aggressive timeline – proponents have targeted many of their provisions to be effective January 1, 2018. Yet, last time we checked, amendments were being made multiple times a day. As debate continues, timing and content of the proposed bills could vary.
One of the tax-law changes proposed in the Senate bill, but not included in the House bill, would require investors to use first in, first out (FIFO) accounting methodology for tax lots when calculating capital gains taxes. If this remains in any bill ultimately adopted, it will impact the way portfolios are currently tax managed.
Why Is This Happening?
The sponsors of this bill assert that this change would raise an estimated $2.7 billion in tax revenues over ten years. This sounds like a lot, right? Well not really, when you consider that this is just a small drop in the $1.5 trillion in tax revenues that are projected to be lost over the same time frame as a result of the overall tax proposal.
What It Means
FIFO takes away some flexibility—instead of having the option to choose the most favorable tax lot to sell, investors will need to sell the oldest tax lot first. A FIFO requirement adds a constraint that makes it important for tax management to be done professionally to coordinate multiple risk and return considerations.
We feel prepared for this legislation, however it takes shape, because we have navigated multiple tax-code changes for our clients since 1992. In preparation for any potential tax reform, we have been following and researching the potential for FIFO legislation for much of 2017. As part of our disciplined approach, our Research and Investment Strategy teams have been testing various scenarios. So, if FIFO is enacted, our team and proprietary systems are ready to manage any changes.
Of note, our modeling so far has shown very little change in standard after-tax results in a FIFO environment relative to current rules. Other proposals included in this legislation raise tax rates for many investors. When we take this all into consideration, any tax-code changes would likely make overall tax management even more important for investors.
If FIFO is enacted, tax management, including loss harvesting, will remain a very valuable component of what we offer our taxable clients. Parametric is ready to maximize clients’ after-tax performance in a FIFO environment.
Paul Bouchey, CFA - Chief Investment Officer
Mr. Bouchey leads Parametric’s investment, research and strategy activities. His research interests include indexing, tax management, factors, and rebalancing. Paul earned a B.A. in mathematics and physics from Whitman College and an M.S. in Computational Finance and Risk Management from the University of Washington. He holds the Chartered Financial Analyst designation.
Parametric does not provide tax or legal advice. Prospective investors should consult with a tax or legal advisor before making any investment decision.
The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Parametric and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Parametric are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Parametric strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results. All investments are subject to the risk of loss.