April 27, 2023: A family office’s tale of tax troubles

Bob.Allen
Apr 28, 2023
11 months ago
Josh_Kanter

PEER-TO-PEER INSIGHTS: Josh Kanter, leafplanner

Josh_Kanter

Josh Kanter started leafplanner, a software-as-a-service (SaaS) platform based in Salt Lake City, to organize and share information about a family enterprise. He based his work on his decades-long experience handling his own family’s income- and estate-tax controversies in the wake of his father’s death, a process that involved rebuilding his single-family office and balancing the interests of three generations of 15 family members. Kanter sat down with Crain Currency to share his journey. 

How did your personal family-office experience morph into the launch of leafplanner?

My father was a world-renowned trust and estate lawyer who represented a who’s who of corporate America from the 1960s through the 1980s, such as the Pritzkers, Sam Zell, Chuck Dolan. When he got sick in 2000, I left my career as a lawyer to help my family manage what would end up being 33 years of complex tax litigation.

The experience raised a lot of questions for me: How do you think about estate planning and an investment portfolio when you’re dealing with a multigenerational framework? 

What leafplanner does is to enable customers to apply a family-office lens to their own family. It’s a digital document and information-sharing platform for estates and family offices.

How was your family’s wealth created?

My dad was a classic deal junkie. He would go into everything. So we had literally a pasta manufacturer in New Jersey, we had a chip manufacturer that made one of the navigation chips for the original cruise missile, we had a handwriting technology company that was way before its time. But most of our success came from health-care-related ventures. We were early investors in Soniccare toothbrush; in Clarisonic facial brush; some biotech and life sciences, too. And we still invest in the health care space.

What were the main challenges you faced when you and your brother took over the business?

The most difficult thing was knowing what was in my dad’s head. How did all these pieces of his empire fit together? And that’s really where the leafplanner story came from — because I realized that our family was surrounded by a bunch of smart advisers, but nobody had the whole picture. How do you pull all these pieces together? And if something happens to me, how does the rest of the family pick up the enterprise? 

We’ve reported that family offices are often slow to adopt new technology. Is that true in your experience?

Actually, I think they’re getting much better at adopting new technology. The coordination of information is really getting critical because there’s just so much damn information out there. And there’s a need for more engagement, which more family offices are realizing. They say that baby boomers are set to pass their children more than $68 trillion, the biggest wealth transfer in history. Technology is essential to help them plan for that future.

Random Walk’s Malkiel offers tips on tax-loss harvesting

Burton_Maikel

Burton Malkiel is known as an advocate of low-cost, passively managed portfolios. But when it comes to boosting after-tax returns, he favors an active approach.

Malkiel, author of the investing classic A Random Walk Down Wall Street, is a believer in the power of tax-loss harvesting, and particularly the software developed by robo-adviser Wealthfront, where he is chief investment officer.

The program harvests losses from portfolios throughout the year to help offset capital gains in other investments, while maintaining a portfolio’s asset mix and risk level.

Many investors were shocked when they received big capital-gains distributions from actively managed mutual funds that suffered double-digit losses in 2022. The tax bills came after a volatile market forced active managers to reposition portfolios to meet redemptions. And after a long bull market, even stocks down sharply for the year can bring big gains when sold. 

Many robo-advisers — including Schwab Intelligent Portfolios, Betterment and SigFig — offer automated tax-loss harvesting programs. In March, Vanguard expanded its tax-harvesting service to clients of its digital-only product. 

Malkiel, 90, described tax-loss harvesting in a recent blog post as “the only reliable way for investors to outperform the market,” because it allows them to do so on an after-tax basis. He spoke with Bloomberg about this and other investing topics. His comments have been condensed and edited for clarity.

Many people don’t think of portfolio returns in after-tax terms. How does taking that into account make active funds more or less attractive?

I start with saying that buying and holding passively managed funds is a strategy that’s performed better than 90% of active funds over the long run. Then you realize that not only does indexing beat most active managers, but active results are even worse after taxes. 

We started out at Wealthfront doing tax-loss harvesting with ETFs. So if part of your portfolio was in emerging markets, you might, if emerging markets were down, sell an MSCI emerging markets ETF and buy one from Vanguard.

You’d maintain the exposure to emerging markets, but switching between those ETFs isn’t considered a “wash sale” by the IRS, because the funds track different indices. (Note: The IRS wash-sale rule doesn’t allow an investor to book a loss and then buy the same or a “substantially similar” security 30 days before or after the sale.)

After that product, we asked ourselves, how much better could you do if you could have a software program to do tax-loss harvesting within markets like the S&P 500. Because it may be that the broad market was up, but some stocks were down. 

With the S&P 500, you’d use an optimization program that holds a portfolio of about 250 of the S&P 500 stocks. You choose stocks so that you have the same size, industry, growth and value composition of the index to minimize tracking errors. Then you can look at industries that might be down, and if it’s autos, sell GM and buy Ford; or if pharma was down, buy Merck and sell J&J. (Note: Wealthfront’s service is designed to mirror the holdings in the broader Vanguard Total Stock Market ETF.)

There’s a lot more bang for the buck in realizing capital losses when you do it this way, through direct indexing.

Wouldn’t someone run out of losses to harvest, since as you sold and replaced securities, the cost basis would be higher? 

The chances of getting losses diminishes over time, particularly on original investments, but they don’t disappear and are still substantial. Part of that is because of how volatile the market has been.

Another reason it seems to work well is that often people saving for retirement are putting in money periodically. So even if opportunities from original investments may be less, you’re putting in new money. And even if you don’t add new money, you’re reinvesting dividends. 

What broader tax considerations should investors consider?

For most people, a Roth account is the best way to go. When young people ask me what kind of IRA they should have, boy, I’m 100% Roth. (Note: Roths are funded with after-tax dollars, which grow tax-free and aren’t taxed on withdrawal.)

What are some overall lessons investors can benefit from?

I recommend dollar-cost averaging when you’re in the accumulation phase, but people drawing down money later in life do not want to do that. If you dollar-cost-average when pulling out money, you’re selling more shares when the market is falling.

I’m in the position now of having to take required minimum distributions (RMDs), and I’m having all my dividends sent into Treasury bills. I want the total amount of my RMD for 2023 in one-year T-bills, and the same for 2024. I want them in absolutely safe securities.

One of the most important lessons is that the lower the expense ratio paid to the purveyor of the investment service, the more there will be for you. As the late Jack Bogle said, “In investing, you get what you don’t pay for.