The Tax Benefits of Direct Indexing, and How They Are Affected by the Biden Tax Plan

The Journal of Index Investing, Forthcoming

59 Pages Posted: 10 May 2021 Last revised: 24 Sep 2021

See all articles by Nathan Sosner

Nathan Sosner

AQR Capital Management, LLC

Michael Gromis

AQR Capital Management, LLC

Stanley Krasner

AQR Capital Management, LLC

Date Written: May 7, 2021

Abstract

Direct-indexing strategies realize tax benefits by harvesting losses on individual stock positions. Some investors might benefit from this powerful tool for growing after-tax wealth significantly more than others. An important determinant of the tax benefits of direct-indexing strategies is the tax rates applicable to gains from other investments. We argue that high-net-worth investors with allocations to hedge funds and derivatives are the most likely investors to have systematic short-term capital gains and, therefore, derive the highest tax benefits from direct-indexing strategies. We use a long history of U.S. stock returns to estimate the level of tax benefits offered by direct-indexing strategies under different tax rate assumptions, including the proposed Biden Tax Plan. We show that investors, even those without short-term capital gains in their portfolios, can significantly increase the tax benefits of direct indexing by regular capital contributions and charitable giving of appreciated stocks. A character-deferral decomposition of the tax benefits helps explain what drives this result.

Keywords: Direct Indexing, Loss Harvesting, Tax Benefits, High-Net-Worth Investors, Charitable Giving, American Families Plan, Biden Tax Plan

JEL Classification: G11, H24, K34

Suggested Citation

Sosner, Nathan and Gromis, Michael and Krasner, Stanley, The Tax Benefits of Direct Indexing, and How They Are Affected by the Biden Tax Plan (May 7, 2021). The Journal of Index Investing, Forthcoming , Available at SSRN: https://ssrn.com/abstract=3841727 or http://dx.doi.org/10.2139/ssrn.3841727

Nathan Sosner (Contact Author)

AQR Capital Management, LLC ( email )

One Greenwich Plaza
Greenwich, CT 06830
United States

Michael Gromis

AQR Capital Management, LLC ( email )

Two Greenwich Plaza, 3rd Floor
Greenwich, CT 06830
United States

Stanley Krasner

AQR Capital Management, LLC ( email )

One Greenwich Plaza
Greenwich, CT 06830
United States

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