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 (or end of prior market day prices) and runs a single 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. It will also show up for the 140/40 Long Short strategy based on historical simulations of the 140/40 Long Short strategy benchmarked to the Russell 1000. This potential will differ for other indices.

The tax loss potential simulation results for the S&P 500 and CRSP US Large Cap indices 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.

The tax loss potential simulation results for the 140/40 Long Short strategy is based on an average of 41 simulation runs between 04/01/2005-02/13/2025 of 10-year periods. The calculation assumes a short-term tax rate of 42.3% and long-term tax rate of 28.1% and includes a 1% fee. Results are based on a one-time $1 million investment into a 140/40 long short direct index portfolio benchmarked to the Russell 1000 with a value factor tilt. The results are hypothetical, do not reflect actual investment results, and are not a guarantee of future results.

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 in your account settings 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 estimated tax impact from moving stocks. This means certain stocks shown as sold in your 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 index causing it to be overweight, we will show you the estimated tax impact of the move based on a single direct index simulation. The results shown will be accurate as of the time you're shown the information and for a single trading day. 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 trade your portfolio in a way that brings that position back to its target weight. This may cause positions to be sold with gains or losses. Additionally, this simulation is showing a single run, there may be additional trades made to bring your position back to its original target weight during future trading days.

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.