Exposition: A Financial Advisor’s Peculiar Interest in Tax Code
We once heard a story about a financial advisor who always traveled with the latest edition of the U.S. Master Tax Guide. They liked to spend their travel time looking for obscure benefits and potential breaks for their clients. It may have also been the primary method they employed to ensure they caught up on their sleep during frequent flights between LAX and JFK. Although, if the stories are true, and knowing this particular individual, we’re pretty sure they are, we doubt they found the tax code boring at all.
…with topics like 1256 contracts and the benefits of the 60/40 tax rule, how could you not want to stay awake the entire trip?
In fact, with topics like 1256 contracts and the benefits of the 60/40 tax rule, how could you not want to stay awake the entire trip? 🙂 Especially if you’re interested in more liquid options for investing in alternative investments and the potential tax benefits.
Rising Action: Section 1256 Contracts and the 60/40 tax rule. A Mid-Flight Revelation
We imagine that somewhere over Nebraska, our purely hypothetical traveler is reminded that Section 1256 contracts, as defined in the U.S. tax code, include various types of derivatives such as regulated futures contracts, foreign currency contracts, non-equity options, dealer equity options, and dealer securities futures contracts. These contracts are unique in their tax treatment, being marked-to-market at the end of each tax year—meaning they are taxed as if they were sold for their fair market value on the last day of the year. And because they’ve been known to dabble in their own futures trading, our frequent-flying imaginary advisor also remembers the 60/40 tax rule related to these contracts.
60% of any gains from 1256 contracts are treated as long-term capital gains, regardless of the holding period, while the remaining 40% are taxed as short-term gains.
60% of any gains from 1256 contracts are treated as long-term capital gains, regardless of the holding period, while the remaining 40% are taxed as short-term gains.
This, they realize, could be potentially advantageous for their clients from a tax perspective, especially for those in higher tax brackets, as the blended tax rate under this rule can be significantly lower than the rate for ordinary income.
Climax: Elevating Client Portfolios with Liquid Hedge Funds
Here is where the story gets really interesting. Because while the person in the seat next to them is maximizing their in-air cocktail consumption rate and re-watching episodes of Breaking Bad on their iPad, our advisor realizes there’s an angle they hadn’t considered before.
Typically, commingled funds that trade commodities and futures pass any 60/40 tax benefits onto investors indirectly in the form of added returns. A managed account structure, where the individual client accounts are LLCs (pass-through entities) investing in liquid hedge funds, could directly pass through these potential benefits—offering lower tax rates on any gains compared to ordinary income taxation.
A managed account structure, where the individual client accounts are LLCs (pass-through entities) investing in liquid hedge funds, could directly pass through these potential benefits—offering lower tax rates on any gains compared to ordinary income taxation.
Falling Action: Deep knee bends and deeper contemplation.
The advisor notices the fasten seatbelt sign is off and, thankful for the aisle seat—because the person in the seat next to them is completely passed out now—decides to stand and stretch their legs a little. They attempt a couple of deep knee bends. Our high-flying advisor knows the potential tax benefits for their clients would not be insignificant, especially for those clients in elevated tax brackets. Not to mention, they imagine, this may also be something to help differentiate their offerings from competitors and help them attract new clients.
Not to mention, they imagine, this may also be something to help differentiate their practice from competitors and help them attract new clients.
However, they realize more exploration is needed.
Resolution: What’s next?
Fortunately, our advisor’s flight arrives safe and sound at JFK. Now brimming with freshly earned insights, they contemplate their next steps. If only they knew of a firm specializing in helping financial advisors access alternative investments for their clients, a firm of highly experienced alternative investment professionals dedicated to making it super easy for them to build alternative investments into their practice, someone they could have a detailed discussion with about the potential tax benefits of investing in liquid hedge funds, and help them navigate the industry without worrying about whether or not they are competing for their clients.
If only such a firm existed. Particularly one with expertise investing in liquid hedge funds that invest in assets that qualify as Section 1256 contracts 🙂
Disclaimer:
This article is for informational and educational purposes only and should not be construed as providing tax or legal advice. It does not take into account the specific investment objectives, financial situation, or particular needs of any reader. Readers should consult with their own tax, legal, and financial advisors to determine the appropriateness of any investment strategy or approach mentioned herein.
