In our view, 2025 reinforced a familiar conclusion that tax management remains as relevant as ever, even though tax policy may no longer be a moving target.
The One Big Beautiful Bill Act (OBBBA) of 2025 has resolved many policy debates into a more stable—but no less complex—tax landscape. At the same time, equity markets are coming off three exceptionally strong years, which could leave investors optimistic yet cautious about what lies ahead.
Let’s review what we now know about relevant tax policies, what we see as prevailing market conditions, and how to consider the role played by tax management in this environment.
Tax policy more certain after OBBBA
The most consequential outcome is permanence, locking in the 10% to 37% individual income tax brackets that were introduced under the 2017 Tax Cuts and Jobs Act (TCJA). This has removed the looming uncertainty of potential rate resets and allowed for more durable long-term planning.
The higher standard deduction introduced under the TCJA is also permanent and inflation-adjusted beginning in 2026, with an additional temporary deduction for individuals aged 65 and older through 2028. While beneficial for some taxpayers, these changes tend to be less impactful for higher-income investors who already itemize.
Another temporary change is the increase in the state and local tax (SALT) deduction cap from $10,000 to $40,000 starting in 2025. The cap will be indexed modestly for inflation, as before, but phased out for households with modified adjusted gross income above $500,000. Then the cap reverts to $10,000 in 2030.
Estate and gift tax planning also received clarity. The elevated exemption amounts—$15 million for individuals and $30 million for married couples—are now permanent and will adjust for inflation beginning in 2026. While this eliminates the urgency many families felt to act before a potential sunset, estates above these thresholds still face complexity that requires careful planning.
Equity market environment
Markets entered 2026 with notable momentum. US equities have delivered double-digit returns for three consecutive years, producing a cumulative three-year gain of more than 88%. Yet much of that performance has been concentrated in a narrow group of mega-cap stocks. Without the so-called Magnificent 7, returns would look meaningfully different over both the past year and the past three years.
Late 2025 offered a reminder that volatility has persisted. December finished nearly flat, as investors appeared to balance optimism around earnings and AI investment with concerns about consumer affordability, labor market softness and the sustainability of capital spending. Sector leadership rotated, market breadth narrowed and investors locked in gains as the year ended.
History suggests that caution is warranted. Four consecutive years of double-digit S&P 500® Index returns have occurred only three times since 1926, most recently in the late 1990s. History doesn’t repeat itself, but it often rhymes, and we think investor nervousness following such strong performance would be understandable.
Consider the potential benefits of active tax management
Role of tax management
Against this backdrop, we believe tax management through loss harvesting remains one of the most durable tools available to investors. Even in relatively flat or upward-trending markets, short-term volatility and dispersion may create potentially meaningful opportunities to offset realized gains with losses.
Active tax management approaches, such as direct indexing, are designed to systematically capture opportunities in the market while maintaining portfolio exposure aligned with the chosen benchmark. This matters in both up and down markets. During brief periods of volatility—like the pullback around the “liberation day” tariff announcements in 2025—losses can be realized and reinvested without materially altering portfolio risk, potentially helping to improve after-tax outcomes.
Permanently elevated estate and gift tax exemptions may offer welcome certainty, but that doesn’t eliminate complexity. Large estates still require careful coordination across trusts, gifting strategies and investment funding decisions. In this context, tax-efficient portfolio construction could play a supporting role.
Direct indexing can potentially serve as a flexible funding mechanism for trust structures commonly used by HNW families. By emphasizing after-tax outcomes, investors may improve the efficiency of assets earmarked for long-term planning objectives, without sacrificing market exposure.
The OBBBA also raised the stakes for some institutional investors. Certain large endowments now face excise tax rates of up to 8% on net investment income. While the law currently affects a limited group, other institutions may also feel the impact as their assets grow. Here again, direct indexing can play a role by seeking to generate losses to offset gains—something commingled vehicles cannot do.
The bottom line
For 2026, tax policy certainty should be helpful to investors, but the impact of taxes on long-term returns remains significant—particularly for higher earners, large estates and institutions facing new excise taxes. At the same time, markets enter the year with strong momentum but persistent sources of risk and volatility.
In our view, this reinforces a simple conclusion: Tax management is a core component of prudent portfolio construction, not a tactical add-on. Through tax loss harvesting, gain deferral or thoughtful portfolio design, active tax management seeks to help investors keep more of what they earn—regardless of what markets or policymakers deliver next.
Parametric and Morgan Stanley Investment Management do not provide legal, tax or accounting advice or services. Investors should consult with their own tax or legal advisors prior to entering into any transaction or strategy.
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 Morgan Stanley Investment Management and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions are based on many factors, may not be relied upon as an indication of trading intent on behalf of any 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. All investments are subject to the risk of loss. Please refer to the Disclosure page on our website for important information about investments and risks.
01.27.2028 | RO 5162324
