Marcus Invest’s Tax-Smart Portfolio Management

As an investor, it’s important to understand some of the key factors that can affect your overall investment returns. Portfolio construction, investment fees and your time horizon are just a few examples that come to mind. 

One factor that many people tend to overlook is taxes. Hey, we get it – taxes aren’t exactly the most exciting or fun part of investing, but they can have a significant impact on your overall return. And that’s why smart tax management is critical when you invest. 

At Marcus Invest, we take a tax-smart approach to investing. In other words, we build and manage your portfolios while keeping the impact of taxes in mind. 

Portfolios are developed by our investment strategy and portfolio management teams in a tax-aware manner. When we invest your deposits or rebalance your account, our portfolio management professionals look for ways to be tax-efficient. 

Keep in mind that while we could help you invest in a tax-efficient manner, it is no substitute for working with a professional tax advisor when it comes to your overall tax planning strategy.

How do we do this? 

Tax efficiency is a focus of our investment offerings. 

We offer individual retirement accounts (Traditional IRA, Roth IRA and SEP IRA), as well as individual and joint investment accounts to help you plan and reach your investment objectives in a tax-efficient manner. 

Retirement accounts

You may have heard IRAs being referred to as “tax-advantaged” accounts. That’s because they offer potential tax benefits that could help your money grow tax-deferred or tax-free over time. 

Individual and joint investment accounts

For our individual and joint investment accounts, our tax-smart management includes building our portfolios using municipal bond ETFs for our bond allocations, which generally provides federal tax-free income. 

Additionally, for our taxable investment accounts, our tax-smart portfolio management relies on a tax-lot relief methodology called “MinTax.” Basically, this is where we sell the assets with the lowest taxable gains first to help you minimize this year’s tax bill.

If this is starting to sound like a foreign language, don’t worry – we’ll break it down for you later in the article. 

Short-term vs. long-term capital gains and losses

Before we take a closer look at our approach to tax management, let’s quickly review the difference between short-term and long-term capital gains/losses. (If you don’t need a refresher, feel free to skip ahead!)

The federal tax rate you pay on realized capital gains depends on how long you’ve held onto your investments. Long-term gains are usually taxed at a lower rate than short-term gains. 

• Long-term capital gains. Gains on investments held for more than a year are subject to a 0%, 15% or 20% federal tax rate based on your level of taxable income. (Note: There are a few exceptions where capital gains may be taxed at rates greater than 20% – see IRS Topic 409 for details).
• Short-term capital gains. Gains on investments held for one year or less are taxed at your ordinary income rate, which, generally, can be higher than the long-term capital gains tax rates.

It can be a little tricky trying to figure out your potential capital gains tax. You usually have to keep track of details like how long you held onto the assets, cost basis (generally speaking, this is how much you originally paid for the assets) and net gains/losses. 

If you have an investment account with us, your account custodian, Apex, will send you tax documents with information about your holdings each year, summarizing your reportable gains and losses, which you could then use to help file your taxes with the IRS.

Keep in mind that Marcus Invest doesn’t provide tax advice. Consult with a tax professional if you have any questions about your investments and personal tax situation. 

Good to know: Generally speaking, capital losses could be used to offset capital gains or other income earned during the year. Consult a tax professional for information about realizing losses and the IRS wash-sale rule (see IRS Publication 550).

Tax efficiency in our individual and joint investment accounts

Marcus Invest delivers tax efficiency in our investment account portfolios in two key ways. The first is by investing in municipal bond ETFs. The second is through our tax-lot relief methodology. 

Smart tax management with municipal bond ETFs

For our individual and joint investment accounts, as part of our overall tax management and asset allocation strategy, we look to invest in municipal bond ETFs. 

Why? That’s because municipal bonds (commonly referred to as “munis”) can provide potential federal tax-free interest earnings. They are generally exempt from federal income tax. And depending on where you live, interest earnings from municipal bonds might also be exempt from state and local taxes.

Is there anything I need to do? When Marcus Invest puts together your taxable account portfolio where there is a bond allocation, we generally include municipal bond ETFs. 

Our tax-lot relief methodology sells the assets with the lowest taxable gains first to help you minimize this year’s tax bill

First things first – what exactly is a tax lot? 

Each time you purchase a share(s) of a security, a tax lot is created. The tax lot is a recording or accounting of that particular transaction. And it’s a way of tracking that purchase for tax purposes. A tax lot usually includes the following types of information: date of purchase, number of shares purchased, cost basis and unrealized gain/loss.

Let’s look at a basic example of how tax lots work..

• In 2018, you purchased one share of a security for Company X. That purchase created your first tax lot (tax lot #1). 
• In 2019, you purchased another share for the same company, creating a new tax lot (tax lot #2) that’s separate and distinct from tax lot #1. 
• In 2020, you purchased one more share for the same company – this creates tax lot #3.

As you can see, even when you buy additional shares of a security that you already own, each purchase creates a new tax lot.

You may be wondering why this even matters. Remember when we talked about short-term vs. long-term gain/loss? Tax lots basically help us see the tax implications of selling particular assets. Based on the date of purchase and cost basis, you can see whether you’ve held the asset for more than a year and whether you’re dealing with a potential gain or a loss when you sell it.

Still with us? You’re doing great. Let’s keep going.

What do tax lots mean for your portfolio and year-end tax bill? Whenever you make a withdrawal, make a deposit, change your asset allocation or rebalance your portfolio, we buy and sell certain assets to adjust your portfolio holdings. When it comes to selling your assets, we do so in a specific order to help you minimize this year’s tax bill. There are several different methods in determining that order.

Some investment firms use the FIFO (first in, first out) method. As the name implies, the shares that were purchased first (the oldest ones in your portfolio) are sold first. Sticking with the example we used in the tax lots discussion, here’s the selling order under the FIFO method. 

FIFO is a common method because it’s relatively straightforward: The selling order is based solely on the purchase date. If you have long-term assets, those are sold first, which could help minimize your year-end taxes. 

FIFO, however, doesn’t take into account whether the sale of an asset or a particular lot will result in a gain or loss. But this detail is important! Because one potential way to help minimize your year-end tax bill is by realizing losses, which could be used to help offset your gains or other income earned during the year. 

This is why instead of FIFO, we use a specific tax-lot relief methodology called “MinTax.” 

Under this method, we sell the tax lots with the lowest taxable gains first to help you minimize your year-end tax bill. In other words, we don’t just look at the purchase date – we also take into account the potential gains and losses that would be generated from a sale. 

Put another way, this tax-lot relief methodology is based on selling all losses before any gains, regardless of when the purchase was made, beginning with short-term losses and ending with short-term gains. So under this method, tax lots are sold in the following order:

• Short-term capital loss, from the biggest loss to the smallest
• Long-term capital loss, from the biggest loss to the smallest
• Short-term zero gain/loss
• Long-term zero gain/loss
• Long-term capital gains, from the smallest gain to the biggest
• Short-term capital gains, from the smallest gain to the biggest

If we apply the MinTax tax-lot relief methodology to our previous example, here’s the new selling order (see the last row).

To help show you the potential tax impact, let’s say we wanted to sell just ONE share of your security from Company X on October 1, 2020…

• Using FIFO, tax lot #1 would be sold. You’ll realize a $10 gain, which is taxable.
• Using Tax-Lot Relief, tax lot #3 (a short-term loss) would be sold. You’ll realize a $10 loss. Realizing this loss could help minimize your tax bill this year. 

What if we wanted to sell TWO shares?

• Using FIFO, tax lots #1 and #2 would be sold, realizing a gain of $5, which is taxable.
• Using Tax-Lot Relief, tax lots #3 (a short-term loss) and #2 (a long-term loss) would be sold, realizing a loss of $15, which could be used to help minimize your tax bill this year.

An important detail: You may have noticed that using the MinTax tax-lot relief method simply rearranges the order in which the tax lots are sold. But it does not actually change the actual tax status (or tax liability) of individual lots. If you were to sell all three shares from our example above – whether using FIFO or MinTax – the tax implications would be the same. In other words, using tax-lot relief can help for when you realize gains, but it doesn’t help you to avoid gains. 

The bottom line

Smart investing includes a smart approach to taxes. We include municipal bond ETFs in our bond allocations, which can provide federal tax-free income. We also apply the tax-lot relief methodology, selling assets with the lowest taxable gains first to help you minimize this year’s tax bill.

While being tax-smart in our portfolio management is important, this isn’t our only focus. 

Making sure that your investments are aligned with your investing goals and that your portfolio’s risk is managed according to your selected objectives is also a top priority for us. Tax-smart management and proper risk management go hand in hand – whether we are investing your deposits or rebalancing your portfolio. 

Be aware that each person’s financial and tax situation is different – consult a tax advisor if you have any questions or concerns about the tax implications of your investments.