Estimated tax impact – Frec

How does the estimated tax impact feature work?

The estimated tax impact feature is a way for you to see approximately how much in taxes you might owe or save from certain actions you take on Frec that may result in a stock sale. It takes your tax lot information (stock quantity and cost basis) and current market prices and runs a simulation of our direct indexing algorithm to see what would happen if you took this action. Keep in mind that this is an estimate, and not a guarantee of what your tax liability may actually look like in the future.

For every result, you’ll either have an outcome of “Potential taxes owed” or “Potential taxes saved” depending on whether the stock sale incurs net gains (taxes owed) or losses (taxes saved). You can see a breakdown of short term and long term gains or losses and how these translate to taxes owed or saved based on respective tax rates (we set default tax rates, which you can update - see below). Keep in mind that these estimates are specific to the trades resulting from this action and do not account for other gains or losses you've incurred on or off Frec.

Where will I see estimated tax impact?

You’ll see your estimated tax impact whenever an action you take may result in a stock sale, which could realize gains or losses from the sale. Currently this includes:

Setting up a new direct index with stocks
Moving stocks in or out of a direct index
Editing customizations of a direct index
Withdrawing from a direct index

What does the loss harvest potential mean?

Loss harvest potential is how much you could harvest in losses by the end of the year if the cash proceeds from the stock sales were reinvested back into direct indexing. It’s based on the average harvesting potential reported in our white paper, and prorated for the remaining months of the year. These losses would be considered short term losses.

You can see how the loss harvest potential could reduce your short term gains by comparing what would have been your total short term gains before applying the losses (indicated by the gray crossed out number) and your short term gains after applying the losses (indicated by the black number). You can also choose to turn off the loss harvest potential if you’d like to see your result without applying losses from the loss harvest potential.

Note: As of 09/19/24, loss harvest potential will only show up for the S&P 500 and CRSP US Large Cap indices because the average harvesting potential used is based on a simulation of the S&P 500, which is a large cap US index. This potential may differ for other indices.

The tax loss potential simulation results are from Frec’s direct index model tracking the S&P 500 index. The results are hypothetical, do not reflect actual investment results, and are not a guarantee of future results. The simulations were run to tax loss harvest on a weekly basis in a ten-year time frame of ninety-day increments from 12/17/2003 - 06/10/2022 with a one-time $50,000 deposit. The data used is based on an average of those results and does not include Frec’s 0.10% AUM fee.

How are estimated taxes calculated?

Since short term and long term gains are taxed differently, we break down estimated taxes into short term and long term. We use default tax rates to start, which you can update to reflect a more accurate estimate for your tax situation.

Default tax rates:

Federal income tax rate: 37%
- Used to calculate your short term gains/losses
Long term capital gains tax rate: 20%
- Used to calculate your long term gains/losses
State capital gains tax rate: 12.3%
- Applied to both short and long term gains/losses if applicable

What does the outcome "potential taxes saved" mean?

Seeing an outcome of “Potential taxes saved” means that the stock sale from this simulation resulted in a net loss overall. And since losses can be used to deduct against gains (thus reducing your overall tax liability), we frame these as potential taxes saved. This assumes that you have enough in capital gains to fully deduct the losses against, and it also assumes that short term losses are used against short term gains and long term losses are used against long term gains.

What happens if stocks have wash sale restrictions?

When you move stocks in or out of your direct index, they may have wash sale restrictions if you or the direct index algorithm traded the stock in the last 30 days. Our direct indexing algorithm takes wash sales into account to maximize the tax losses harvested and will avoid trading stocks with wash sale restrictions. Once the wash sale restrictions expire, our direct indexing algorithm may trade the stocks you’ve moved in or out of your direct index, resulting in a capital gain or loss. Therefore, for the purposes of estimating your tax impact, we run a simulation of our direct indexing algorithm with wash sale restrictions turned off for the stocks you’ve moved in or out. This gives you a clearer picture of the tax impact that may occur once the wash sale restrictions expire.

See also Frec's Help Center Article, "What is a wash sale"

Does Frec consider wash sales when calculating estimated tax impact?

No, we do not consider wash sales for the stocks you're moving in or out of your direct index when showing you the potential estimated tax impact from moving stocks. This means certain stocks shown as sold in your potential tax estimate information may not be sold or a different amount may be sold once the wash sale holding period has ended. This could result in an increase or decrease to the estimated tax savings estimate.

What happens if stock I move into an index causes an overweight allocation of that stock?

If you move a stock into your direct index that causes it to become two times (2x) or greater than its target allocation percentage, then we will show you the estimated tax impact if we were to sell the position back to a maximum of 2x its target weight.

For example, if you have a S&P 500 direct index and hold 5% of AAPL with a 5% target weight and you move in more AAPL causing your weight to become 20% instead of 5%, we will show you the estimated tax impact if we were to sell AAPL down to two times (2x) its target of 5%, which would bring it to 10% in this example.

We show you the most likely tax impact estimate based on the information as of the day you move your stock into the index. However, our algorithm tends to sell out of overweight positions over time and not immediately. Therefore, your tax impact may be more or less depending on when your position is eventually sold out of its overweight allocation.

What happens if I move stock out of a direct index without excluding it from the index?

If you move stock out of your direct index without excluding it from the index, we will show you a tax estimate that attempts to maintain a minimum of 0.5 times (half) that stock’s target weight. We implement this restriction to attempt to replicate how our direct indexing algorithm will treat this action over time. The algorithm will attempt to buy back into the position at a minimum of 0.5 times (half) the stock’s target weight after you move stock out, but may attempt to purchase more or less of that depending on the stock and its weight in the index. Therefore, your estimated tax impact may differ from your actual tax impact as our algorithm tends to buy back into underweight positions over time and not immediately.

For example, if AAPL’s target weight in a S&P 500 direct index was 5% and you select to move your entire AAPL position out without excluding AAPL from the direct index, we will estimate the tax impact to show results based on the algorithm buying back into 0.5 times (half) of the target weight, or 2.5% of AAPL in this example.

If you want to move a stock out of your direct index and don’t want the algorithm to buy back into it, then you will need to exclude the stock from your direct index. This is done by selecting the “Exclude {symbol} from my direct index as well” option when moving a stock out.

How do I reduce my potential taxes owed?

If you’re moving in large quantities of stock outside of your direct index or stocks with significant capital gains, our direct indexing algorithm will sell off these stocks over time in a tax optimized way to bring your holdings to the correct allocation. Try selecting stocks within your direct index or stock lots with less capital gains to reduce your potential taxes owed.

If you’re moving stocks out of your direct index without excluding it from the index, you can deposit more cash so our algorithm can buy back into the positions you’ve moved out without selling your other positions to fund the purchase.

Frec is not a tax adviser and does not provide tax advice. We recommend consulting with a tax adviser on your specific tax situation.