Taxes cannot be an afterthought in investment management.After asset allocation and fees, taxes most dramatically affect your investment returns. Every step of the investment process - from initial portfolio construction through ongoing portfolio management to realizing portfolio returns - implicates taxes. With tax season upon us, here's a basic primer on how taxes might interact with your portfolio. Tax Deferral in Portfolio ConstructionThe taxable status of your investment account(s) is a central portfolio decision. You can use a taxable account, a tax-advantaged (deferred) account, or some combination of taxable or tax-deferred accounts as vehicles to allocate and manage your investment portfolio. A separately managed account (the standard investment vehicle for families and small institutions) is typically taxable. IRAs, 401(k) s, investments held in certain types of trusts, and deferred annuities are common tax-deferred or tax-advantaged investment vehicles. Your choice of investment vehicle should reflect your marginal income tax bracket, level of investments, investment horizon, liquidity needs, and purpose of investment proceeds.The basic tax issue in portfolio construction is the timing of the tax incidence: tax is payable upon realized gain in taxable accounts, but is deferred in time or otherwise offset in tax-advantaged accounts. Relative to taxable accounts, tax-advantaged accounts often place significant limitations – as caps on investment value, limits on withdrawals, and/or narrowly defined uses for withdrawals – upon the account holder, which may limit their use for any particular investor or portfolio. Violations of these limitations may cause a tax-advantaged account to lose its tax-deferred (or other special) status and become taxable. Tax-deferral can be a valuable boost to your investment portfolio.Assuming your portfolio experiences a constant rate of growth, the present value difference between deferring and realizing gains as accrued can be over 10% in value after 10-15 years of deferral. The difference continues to grow with longer deferral horizons.By investing in a tax-deferred account you are also showing an implicit preference for being taxed at future, rather than at current, tax rates; the preference is reversed if you choose to invest through a taxable account. So if you expect your marginal income tax rate in the future (say, during retirement) to be much lower than your present rate, tax-deferral may become especially attractive. But if tax rates rise substantially over the course of your investment horizon, the benefits of tax-deferral may be significantly eroded.Given the limitations of use on tax-advantaged accounts, a basic principle of tax-efficient investing is to make tax-efficient investments through taxable accounts, and tax-inefficient investments through tax-advantaged accounts. A taxable account is typically suitable for investments in individual stocks and bonds held for over a year; stocks or funds that pay qualified dividends; municipal bonds (generally exempt from federal tax); or “tax-managed” stock or bond funds. On the other hand, tax-advantaged accounts should be generally reserved for securities held for less than a year; bonds or funds that generate high yields or non-qualified dividends; actively traded funds; and income from pass-through entities like LLCs or REITS. [Click here to learn more about where tax-smart investors place their investments.] Tax Implications of Portfolio TurnoverThe taxable status of your investment account also matters when rebalancing your portfolio to maintain a target allocation across different asset and sub-asset classes. Rebalancing essentially entails selling 'outperformers' and buying 'underperformers,' incurring long or short term gains in the process. To offset this, you should rebalance as far as possible in a tax-deferred account, or 'rebalance' by using new capital infusions to selectively buy 'underperformers.' Similarly, actively-traded investments and strategies (generating short-term gains) should ideally be pursued through tax-advantaged accounts. [Click here for more on active versus passive asset management styles.]More broadly, the timing of investment gains dramatically affects your realized portfolio return. Investment gains are typically classified as Long-term Capital Gains (selling an asset owned for longer than 12 months for profit), Short-term Capital Gains (selling an asset owned for less than 12 months for profit), Ordinary Income (typically includes interest payments and unqualified dividends), and Qualified Dividends. [Click here to learn more about the taxable status of different investments.] Tax rates on investment gains vary based on your income tax bracket and marital status. At the top income bracket, Long-term Capital Gains and Qualified Dividends are currently taxed at 20%; Short-term Capital Gains and Ordinary Income at 39.6%. The implication here is clear: if you're generating a lot of interest income and short term capital gains in your portfolio (on which you're paying twice the tax you otherwise might pay!), it better make sense as part of your larger financial goals and investment approach. Wealth and Income Effects of Changing Tax RatesFinally, here's a little thought experiment on changing tax rates and your psychology as an investor. Changing tax rates are known to affect your savings and investment choices through the Income Effect and the Wealth Effect.If tax rates rise, your disposable income reduces, which might force you to reduce the amount you customarily save and invest. To maintain your original expected 'payoff' at retirement, you now invest in riskier assets to offset the reduction in initial investment. You're effectively trying to do more with less – this is the Income Effect at work. On the other hand, rising taxes (and lower after-tax income) might make you feel 'poorer' and less secure about your retirement. In other words, you become more risk-averse. To compensate, you invest more conservatively because you now have less 'wealth to lose' – this is the Wealth Effect at work.How these two opposing forces play out is a function of your wealth and income levels, your ‘marginal utilities’ of wealth and income, and their sensitivity to changing tax rates. Your investment adviser, who should have a through grasp of your risk tolerance and future cash flow needs, can help you anticipate and address the effects of changing tax rates on your portfolio. The Bottom LineTaxes should be a primary and ongoing focus of every investor. Consistent with your investment goals, liquidity needs, and risk profile, you should strive to maximize your after-tax returns. And your investment adviser's tax sophistication is central to your portfolio health.