My home state of Illinois has been in the headlines recently over finally passing a budget for the first time in over two years. In order to help balance the $36 billion budget, lawmakers agreed to increase both individual and corporate taxes as the main sources of revenue. Even though there was a tax increase, many financial service professionals breathed a sigh of relief as bill SB-1719, also known as the ‘privilege tax,’ did not make its way into the budget.
Bill SB-1719, which passed the Illinois Senate in May, proposed a 20% tax on fees earned via the performance of investments within a fund. The tax was directly focused on attempting to close the current carried interest tax loophole. Currently, the loophole treats carried interest by private equity and hedge funds at lower capital gains rates rather than ordinary income rates. Originally this bill was much broader and included all investment management firms, but shifted to primarily target private equity funds and hedge funds.
Illinois has not been the only state to propose this type of legislation. Other states with major financial hubs, including New York, New Jersey, Massachusetts, and Connecticut have also contemplated similar measures to increase tax revenue.
With heightened focus on potentially tapping into the financial services industry for an increased tax contribution, it becomes even more important to manage investment portfolios in a tax aware manner. Below are some concepts that can be particularly helpful to financial service professionals with potentially larger future tax bills:
Tax Loss Harvesting: No one enjoys having an investment lose money, but as they say ‘when life hands you lemons…’ Taking advantage of investments that drop in value can be quite a valuable tax asset to help offset future capital gains. There is no limit to the amount of tax losses you can take and you can use them at any time in the future.
Asset Placement: Owning certain types of securities in specific accounts can help to increase the tax-efficiency of the overall portfolio. We recommend placing assets that create current income into tax advantaged accounts, while placing assets that create capital gains into taxable accounts. Utilizing this approach can help lower the tax bill annually.
Tax-Efficient Strategies: Taking advantage of tax-efficient strategies such as municipal bonds or tax managed equity products can help to limit the total taxable income that is reported annually. Investing in these can maintain the correct risk exposures while limiting the tax bill within taxable accounts.
We are not sure where any future tax legislation will end up, but we do know that financial service professionals are potential targets for future tax revenue. Being as tax-efficient as possible in your investment portfolio will allow you the ‘privilege’ of keeping as much of your hard earned money as possible.
Matt Kocanda, is a Senior Advisor at BDF and a member of the Investment Committee. The investment committee develops BDF’s overall investment strategy. Matt focuses on advising Financial Service Professionals through their complex needs – including cash flow, tax, or estate planning. Matt received an undergraduate degree in Finance from Indiana University.