Tax alpha: Five questions every CCO should ask

By Lindsay Burckett-St. Laurent, Senior Managing Director, Regulatory Compliance, U.S.

Tax alpha is becoming a compliance issue, not just an investment issue

Tax efficiency is not new to investment management. What’s changing is the prominence of tax alpha as a quantifiable investment outcome.

Direct indexing, systematic tax-loss harvesting and more sophisticated long/short strategies give advisers additional tools for managing taxable portfolios. They also create new questions for CCOs responsible for reviewing how those strategies are calculated, communicated and marketed.

In my conversations with investment advisers, I’m seeing tax alpha move beyond the portfolio management team. It’s becoming a marketing review, performance governance, disclosure and examination-readiness issue.

That shift matters because, unlike portfolio returns, tax alpha does not have a universally accepted definition or calculation.

The same strategy may produce materially different results depending on assumptions about tax rates, wash-sale restrictions, transaction costs, holding periods, loss utilization and portfolio liquidation. The variability is not merely theoretical. Research published in the Financial Analysts Journal found that estimated tax alpha outcomes changed materially when wash-sale constraints were incorporated into the analysis, illustrating how seemingly modest changes in methodology can affect reported results.

In my view, tax alpha itself is not the compliance concern. The risk arises when an adviser cannot substantiate what a tax alpha claim represents, how it was calculated and whether it reflects a realistic investor outcome.

That leads to a simple but important question:

Tax alpha for whom, calculated how and under what assumptions?

Why tax alpha deserves closer scrutiny

Most advisers aren’t asking whether they can discuss tax alpha – they’re asking how to do so responsibly.

Questions we frequently hear include:

• Can we market tax alpha without treating it as performance?
• How much methodology should we disclose?
• Can we use a standardized tax rate when actual client circumstances differ?
• Does a modelled comparison create hypothetical performance?
• How should we distinguish tax savings from tax deferral?
• What records would be needed during a Securities and Exchange Commission (SEC) examination?
• Who owns the calculation: portfolio management, performance, tax, marketing or compliance?

These questions reflect a broader governance challenge.

A tax alpha figure may originate with an investment team, be calculated by a third-party platform, appear in marketing materials and ultimately require compliance approval.

Without clear ownership and review standards, it becomes difficult to determine whether the claim is being presented consistently and fairly.

The IQ-EQ five-part tax alpha review framework

When reviewing tax alpha claims, we encourage CCOs to focus on five key questions:

1. What does the firm mean by tax alpha?
2. How was the result calculated?
3. How should the claim be treated under the Marketing Rule?
4. Can the firm substantiate and reproduce it?
5. Does the strategy support the client’s overall economic outcome?

1. What does the firm mean by tax alpha?

One of the most common issues is that firms use the following terms as though they’re interchangeable:

• Tax alpha
• After-tax alpha
• Tax savings
• Tax benefit
• Tax optimization
• Enhanced after-tax returns

In practice, they often are not.

Tax savings may suggest a reduction in tax liability. Tax deferral may simply postpone when a tax liability is recognized. Tax alpha may represent the difference between an actual tax-managed portfolio and a benchmark or counterfactual portfolio.

The problem is a quantified figure can appear precise even when the underlying term has not been consistently defined.

CCOs should ask:

• Has the firm formally defined each term?
• Is the definition used consistently across products and communications?
• Would a reasonable investor understand what the term means?
• Does the language distinguish between tax deferral and tax elimination?

Tax deferral is not necessarily tax elimination

Many tax-management strategies create value by deferring taxes rather than eliminating them altogether. Deferral can produce meaningful economic benefits because capital remains invested for longer. However, investors should understand that deferred tax liabilities may still exist in the future.

2. How was the result calculated?

A tax alpha claim is only as credible as the methodology behind it.

Consider the differences between these statements:

“Our strategy incorporates tax-loss harvesting.”

This primarily describes an investment management process. The adviser should provide the service it claims to provide.

“Our strategy seeks to generate tax alpha through systematic tax-loss harvesting.”

This introduces an expected investment benefit. The firm should define the term, explain material limitations and present the potential benefit fairly.

“Our strategy historically generated 150 basis points of annual tax alpha.”

This presents a quantified historical benefit. Methodology and substantiation become central compliance considerations.

When reviewing a quantified claim, CCOs should understand:

• What benchmark or counterfactual produced the result?
• What federal, state and local tax rates were assumed?
• Were harvested losses assumed to offset short-term or long-term gains?
• Did the assumed investor have sufficient gains to use the losses?
• Were transaction, financing and implementation costs included?
• How did the calculation treat the lower cost basis of replacement positions?
• Did the calculation assume eventual portfolio liquidation?
• Was the result based on actual client circumstances or a standardized investor?
• Does the calculation rely on actual, modelled or back-tested information?

The assumptions are not merely technical details. They may be material information that investors need to evaluate the claim.

The more precise the number being presented, the more transparent the methodology should be.

3. How should the claim be treated under the Marketing Rule?

Rule 206(4)-1 under the Investment Advisers Act of 1940, as amended, commonly called the Marketing Rule, provides a natural framework for evaluating tax alpha claims, even though the rule does not specifically define tax alpha.

The key question is not what the firm calls the metric but rather how a reasonable investor is likely to interpret it.

Depending on the methodology and presentation, tax alpha could potentially be viewed as:

• A portfolio or investment characteristic
• A historical performance result
• Hypothetical performance
• Another quantified investment benefit subject to the rule’s general prohibitions

This assessment should be documented rather than assumed.

One area that deserves particular attention is hypothetical performance.

In some cases, tax alpha calculations compare an actual portfolio with a hypothetical version of what might have happened without tax-management techniques. Where a result depends in part on modelling or counterfactual assumptions, firms should carefully evaluate whether the Marketing Rule’s hypothetical-performance provisions may apply.

Not every tax alpha calculation will constitute hypothetical performance. However, firms should be able to demonstrate that they considered the issue before approving the communication.

4. Can the firm substantiate and reproduce the claim?

One of the most effective ways to test a tax alpha claim is to ask a simple question:

Could the firm recreate the result if an examiner requested it tomorrow?

If the answer is unclear, governance may need strengthening.

CCOs should expect the firm to be able to:

• Recreate every advertised result
• Retain supporting calculations and assumptions
• Understand third-party methodologies
• Document methodology changes
• Maintain appropriate review and approval records
• Identify where claims have been used

This becomes especially important when third-party technology providers perform the calculations.

Outsourcing the calculation does not outsource responsibility for understanding or substantiating the resulting claim.

Substantiation should happen before publication, not after an examination request arrives.

The SEC has already demonstrated its willingness to scrutinize tax-related investment claims. In its 2024 enforcement action against Global Predictions, the Commission alleged, among other things, that the firm misrepresented certain tax-loss-harvesting capabilities, advertised hypothetical performance without implementing the required policies and procedures, and could not substantiate certain advertised results upon request.

While the case was not specifically about tax alpha, it serves as a useful reminder that regulators expect firms to support quantitative investment claims with evidence that is accurate, consistent and readily available.

5. Does the strategy support the client’s overall economic outcome?

One of the risks in any tax alpha discussion is focusing too heavily on the metric itself.

Maximizing tax alpha is not necessarily the same as maximizing client outcomes.

Tax-managed strategies may introduce:

• Tracking error
• Portfolio concentration
• Increased turnover
• Transaction costs
• Financing costs
• Leverage and short-selling risks
• Restrictions on future trading
• Additional operational complexity

Research has also highlighted just how dependent tax outcomes can be on investor-specific circumstances. A 2024 Journal of Asset Management study examining tax-managed 130/30 strategies found that the although leverage increased loss-harvesting capacity, the value of the strategy depended heavily on whether the investor could utilize the losses, whether the portfolio was ultimately liquidated, and the costs and fees involved.

The broader lesson is an important one for compliance teams: a higher reported tax alpha figure does not automatically translate into a better overall client outcome.

What I’m increasingly seeing is firms becoming more sophisticated in measuring tax benefits. The next challenge is ensuring those benefits are evaluated alongside investment risks, costs and broader client objectives.

For CCOs, this is where compliance and fiduciary oversight intersect. A tax benefit may be real and measurable, but that does not necessarily mean the overall strategy is in the client’s best interest. A strategy that generates additional tax alpha while increasing costs, introducing concentration risk or constraining portfolio construction may not ultimately improve the client’s net outcome.

A CCO should therefore ask:

• Can the intended investor use the harvested losses?
• Are tax benefits evaluated alongside investment risks and costs?
• Could efforts to maximize tax alpha conflict with the client’s objectives?
• Does the strategy introduce concentration, leverage or liquidity risks?
• Do disclosures make clear that results will vary by investor?
• Is the strategy’s suitability or appropriateness assessed using relevant client information?

Ultimately, tax outcomes should support the client’s financial goals, not become a goal in their own right.

The examination question CCOs should ask today

When reviewing tax-managed strategies, one internal request can be remarkably revealing:

Show us every communication in which the firm represents that its investment process generates tax alpha, tax savings or enhanced after-tax returns, together with the supporting methodology, assumptions, approvals and substantiation.

Could the firm respond confidently?

If not, that is the compliance issue.

The most useful compliance question may not be whether a firm’s tax alpha methodology is sophisticated, but rather whether the firm could clearly explain and defend that methodology during an SEC examination.

My perspective as a regulatory compliance specialist

I don’t believe that tax alpha creates an entirely new category of regulatory risk. Existing requirements concerning marketing, substantiation, performance, books and records and fiduciary duty already provide a framework for reviewing these claims.

What makes tax alpha challenging is that it often appears to be a precise number while depending on assumptions that are highly variable and investor-specific.

As tax-managed investing continues to grow, the firms best positioned to discuss tax alpha will be those that can clearly explain what the metric means, how it was calculated, what assumptions underpin it and where its limitations lie.

For CCOs, that is the real governance challenge – not whether tax alpha exists, but whether the claim can withstand scrutiny.

How IQ-EQ can help

Our U.S. regulatory and compliance team helps investment advisers evaluate Marketing Rule requirements, review performance and hypothetical-performance presentations, strengthen advertising controls and prepare for regulatory examinations.

For firms developing or expanding tax-managed strategies, an early compliance review can help identify methodology, disclosure, governance and recordkeeping issues before claims reach prospective or current investors. Get in touch today to talk to our team.

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