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Written by Ed Canty, CFP® on January 2, 2022
Category: 
FTC Disclosure

Betterment Taxes Explained 2022: How Are Investment Taxes Handled?

Betterment is required by law to report your investing activity to the IRS. However, that does not remove you from your obligation to file your own taxes for your investments.

This involves inputting information on the forms sent to you from Betterment. 

To make things easier for you when it comes to taxes, Betterment allows users to import their taxes into popular tax software systems.

These platforms include:

  • TurboTax
  • H&R Block
  • TaxAct

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 simply does what the name implies and gives you an estimate of how a certain action would impact your taxes. You can use this before you decide to switch asset classes or liquidate your accounts.

In addition, Betterment automatically uses something called tax-loss harvesting to minimize the amount of taxes you will have to pay. Losses are captured by selling off one asset and purchasing a similar one.

These losses can offset your capital gains from other investment activities. 

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Betterment Tax Forms

The tax forms that Betterment will send you will be completely dependent on the type of accounts that you hold with them.

Betterment will be releasing these documents in Mid-February.

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 for the rest of your non-retirement account investment activity. This will include all 1099-B for broker transactions, 1099-DIV, and 1099-INT for dividends and interest respectively.

If you use Betterment for their checking account or savings account, you will receive a 1099-INT assuming you earned more than $10 in interest income.

If you have an IRA, you should also expect to receive Form 5498. 

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Taxes On Capital Gains

In a regular taxable brokerage account, any sell trades resulting in a gain or loss will incur a taxable event.

If you profit on the sale of the security it will result in a capital gain.

If there is a loss then you will have a capital loss.

There will be tax implications either way. Capital gains are subject to taxation, and capital losses can be used to offset gains or even offset ordinary income as a write-off.

First, all capital losses are used to offset capital gains, assuming there are excess gains then you will have to pay taxes on that income.

If you had $5,000 of capital gains and $3,000 of capital losses, you would now have just $2,000 of capital gains to pay taxes on.

Capital gains and losses are categorized by short-term and long-term.

Short-term gains will be taxed at your ordinary-income tax rate.

Long-term gains are taxed at either 0%, 15%, or 20% depending on your ordinary income tax bracket.

In a nutshell, you pay less in taxes by holding investments longer. Short-term capital gains are from investments you own for 1 year or less. Long-term capital gains are for investments you own for over 1 year.

If you initiated any sells out of your Betterment account, you will have gains or losses to report. If you didn't sell anything or take any money out, you won't have any gains or losses to report. However, you will still have dividend activity to report.

Taxes On Dividends

With Betterment, you can earn both ordinary and qualified dividends.

Ordinary dividends are taxed at your ordinary-income tax rate.

Qualified dividends are certain dividends from US companies that qualify to be taxed at the long-term capital gains rate. You also have to meet a minimum holding period. A few common investments that DO NOT qualify for this are REITs and MLP's. These have their own unique tax treatments.

Index funds that own most dividend paying stocks will earn qualified dividends if held for at least a few months. However, if any funds hold REITs or MLPs, these will be ordinary dividends.

How To Locate Betterment Tax Documents

In order to locate your tax documents, you will need to log on to your Betterment account on your computer.

  • You are going to want to find the Documents section within your Betterment account.
  • After that, click on Tax Forms to view any tax documents associated with your Betterment account.

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Conclusion

As mentioned previously, if you invest with Betterment, they are required by law to disclose your tax information to the IRS. This is something to be aware of when tax season rolls around. It is always best to be honest with your gains and losses as the IRS already has a record of all your investment outcomes.

Betterment's use of tax-loss harvesting is a huge benefit to efficiently use capital losses to offset your tax liability. However, this does not mean you will not owe any taxes.

Any account that is taxable and 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.

There are a few different accounts that are tax-deferred such as Traditional and SEP IRAs. When you contribute to these, you can get a deduction against your income 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.

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Article written by Ed Canty, CFP®
Ed is a CERTIFIED FINANCIAL PLANNER™. At his day job, Ed helps clients plan for retirement, manage their investments, and navigate their tax situation. In his free time, Ed enjoys golfing, traveling, fishing, and wrenching on his old car.

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