When tax season rolls around, it is easy to become overwhelmed with all the different forms you need to gather.
Investing is no different and poses an extra bit of paperwork and possibly stress if you aren’t familiar with the taxes associated with each investment.
You’re not alone in your worry about taxes in regard to your investments.
It is a very common concern amongst both new and experienced investors.
This time around we are going to be taking a look at the Betterment platform and how it relates to your taxes. They have a number of features related to investment taxes, even some that help you cut down on taxes.
In this article, we will aim to provide you with everything that you will need to know about your taxes and Betterment.
There are laws in place requiring Betterment to report your investment activity to the IRS. However, you most likely will still have to take steps and file your own taxes for your investments.
This involves inputting the correct information on the correct forms. Something that can become quite tedious and stressful if you are not familiar.
To make things easier for you when it comes to taxes Betterment has opted to include a feature to import your taxes into popular tax software systems these include:
This can save you a lot of time and frustration when it comes to filing your taxes as you will not have to input your information manually.
Betterment will also go the extra mile here and allow you to predict what kind of taxes you may be looking at leading up to tax season with Tax Impact Preview.
This feature does what the name implies and gives you an estimate of what a particular action you are taking may do to your taxes.
They will also automatically use something called tax-loss harvesting to minimize the amount of taxes you will have to pay by selling an asset that has had a loss.
They will then acquire a new asset that is similar in order to maintain a balanced portfolio structure. By doing so, they can recognize a loss that can be used to offset future capital gains.
This is a great feature for cutting down on your tax bill at the end of the year!
The tax forms that betterment will send you will be completely dependent on the type of accounts that you hold with them.
If you hold a retirement account with Betterment and have received a distribution of over $10 you will be receiving a 1099-R.
To make things more concise, you will be receiving a 1099 consolidated form. This will include all 1099-B for broker transaction, 1099-DIV, and 1099-INT for dividends and interest respectively.
Form 5498 is a form that you will receive a copy of if you have an IRA. You do not have to file this form with the IRS as that is the responsibility of your IRA trustee.
Betterment will send you an email when your forms are ready so that you may view and download them for your own tax purposes.
Your best bet is to keep all forms and taxes sent to you for your tax advisor to look over.
Betterment offers a number of different account types. Some are fully taxable while others are not. As a result, the taxation is different for each account type.
Betterment offers Traditional, Roth and SEP IRA account types in their platform.
Traditional and SEP IRAs are considered tax-deferred accounts.
This means that you will defer the taxes on that income until you take distributions from your retirement account.
A Roth IRA is not considered tax-deferred because you will have paid taxes on any of the income you deposit into your account.
The advantage of the Roth IRA is that qualified distributions are tax free.
So all of the earnings in your account (capital gains, interest, dividends) will never be taxed as long as you take a qualified distribution.
This would be a good time to mention that some of the IRA options you have will have additional penalties when it comes to taxes.
When you withdraw money from your retirement account before the age of 59 and a half years, you will be charged a 10% penalty.
Individual Retirement Accounts (IRAs) have unique exceptions to the 10% penalty.
All of the exceptions to early IRA and Qualified Plan withdrawals are outlined here by the IRS.
As stated above Roth IRAs have different rules when it comes to withdrawals.
You may take out your contributions to your Roth IRA after 5 years with no penalty. But any disbursed earnings in your account will be subject to penalty and income tax.
Betterment supports opening trust accounts.
Most of the time the trust must pay a tax on any income that it generates. However, it is possible to have the income is creates paid out to the beneficiary. In this case, the trust is able to reduce its tax liability by distributing it to the beneficiaries.
Any income that is remaining will get taxed to the trust at that point.
Your beneficiaries will pay taxes on the distributions that they receive from the trusts generated income. But they will not have to pay taxes on distributions from the principal of the trust.
When you have a sell or trade that experiences a gain or a loss, you will incur a taxable event.
Capital gains are taxed in two different categories:
Short term gains: taxed at your ordinary income tax rate.
Long term gains: taxed at either 0%, 15% or 20% which is determined by your ordinary income bracket.
Capital losses can be used to either offset capital gains or ordinary income taxes up to a $3,000 threshold.
Any losses above this threshold will be carried forward to future years.
Betterment also has a feature called tax-loss harvesting that makes use of capital losses in this way automatically so you do not have to worry about it for investing purposes.
You must be aware of something called a Wash Sale when dealing with an investment loss.
A wash sale is what happens when someone sells a security for a loss and then try to buy said security back within a 30 day period.
It is important to remember that the IRS will deny any loss that is bought back during this time frame. You will not be able to use this loss to offset other income if you get caught up in this process.
However, the Betterment tax-loss harvesting feature is designed to avoid wash sales, meaning all losses are valid.
A dividend is taxed in two different ways depending on the type of dividend that it is.
The first type is an ordinary dividend. These dividends are taxed at your ordinary-income rate.
The second type is what is called a qualified dividend. This version of a dividend comes from US companies that have qualified to be taxed at the lower long term capital gains rate.
Certain accounts you may be holding are going to accrue interest. For example, Betterment offers a high yield online savings account.
Any interest income that you collect will be taxed at your ordinary income tax rate.
There is an exception to this rule in the form of municipal bonds. This is a bond issued by a local government or territory. Their interest is tax-free on the federal level and may be in your state as well depending on where you live.
Betterment’s Portfolio Strategy is “tilted toward municipal bonds” in order to take advantage of their special interest tax-free nature.
They do this for people who live in places like New York and California that have the highest tax rates. The goal here is replacing the bonds with something that is more specific for those states and saving the investor money in the future.
If you invest with Betterment they are required by law to disclose your tax information to the IRS. Therefore this will be something that you need to pay attention to when tax season comes around.
If you have experience filing your taxes with a service similar to Betterment, the process is likely going to be very similar.
Betterment does employ a tax-loss harvesting feature when you invest with them. The goal here is making use of any capital losses that they can find for you.
However, this does not mean you will not owe any taxes.
There are a few different accounts that are tax-deferred such as Traditional and SEP IRAs. You can make use of these to get a deduction off your taxes each year.
Municipal bonds are tax-free by the federal government. Check your state tax laws to see if they are exempt from taxes there as well.
Any account that is taxable that experiences a capital gain, dividend, or any interest will be subject to their respective taxes. It is important to bear this in mind when doing your taxes and in your financial plan in general.