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Written by Ed Canty, CFP® on March 25, 2020
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M1 Finance Taxes 2021: Step By Step Guide For Tax Season!

If you are new to M1 Finance and the world of investing, you may be wondering “does M1 Finance have tax-loss harvesting?” or “how do taxes work on M1 Finance?”

Kudos to you for planning ahead and anticipating the taxes associated with your investment.

When you sign up for an M1 Finance account, you have to give them certain information like your name, address, and social security number. This means that they are in fact reporting your investment activity to the IRS, which they have a legal obligation to do.

That being said, it is important to understand and report all investment activity.

On a surface level, you either pay short-term capital gains or long-term capital gains on your investment income.

As far as dividends go, you have both ordinary dividends and qualified dividends.

Oh, and here's how dividends work with M1.

M1 Finance gets a little more complicated than your run-of-the-mill tax situation.  For starters, the rebalancing feature can result in a taxable event. Also, M1 has some built-in tax minimization features that you should be aware of. 

In this article, we will explain everything you need to know about taxes on M1 Finance. 

Below is a video on this topic, and here is our full review of the M1 Finance investing app.

How Do Taxes Work On M1 Finance?

Any time there is a purchase or sale in your account, as long as it's a regular taxable brokerage account, there may be tax implications. Retirement accounts are treated a bit differently, more on that later.

Dividends and interest earned in an M1 Finance taxable account will be subject to income taxes. Capital gains may also be realized and cause tax implications as well. 

If you invest in one of the expert pies, and if that pie pays a dividend, you will pay taxes on those dividends. When you earn dividends, if they are ordinary dividends, they will be taxed at the same rate as your normal income. If these are qualified dividends, which in most cases they are, they are taxed at a lower rate.

If you build a pie or invest in a pie that does not pay dividends, you won't pay taxes until you sell and have capital gains. You don't pay capital gains taxes until you sell, even if you are up overall on the investment. So even if you had a great year investing on M1 Finance, you might not owe much in taxes if you didn't sell much.

M1 Finance Free Training

We put together a free 30 minute video training that walks you through the entire process, step by step. This training will help you get up and running in no time at all.


M1 Finance Tax Minimization

M1 Finance has a feature called tax minimization which aims to move money in and out of your account in the most tax-efficient manner.

Tip: If you want to invest tax-sheltered, consider the M1 Finance Roth IRA.

When you withdraw money from M1, they sell stocks/ETFs prioritizing them by:

  1. Losses that offset future gains 
  2. Lots that result in long-term gains 
  3. Lots that result in short-term gains. 

If you earn interest or dividends, you will have to pay taxes. Also, if you sell and recognize capital gains, you will be responsible for the tax bill on that. However, M1 does help you minimize your tax bill with the above strategy. 

If you are looking for tax-loss harvesting strategies, then we recommend checking out the Betterment robo-advisor. This is a strategy that goes above and beyond, where the investing algorithm actually sells securities for a loss and buys similar ones to create artificial losses. It is totally legal, and a way to offset capital gains. M1 Finance does not offer tax-loss harvesting.

However, a big difference between M1 and Betterment is that Betterment charges an asset management fee and M1 Finance is 100% free.

Dividend & Interest Income Taxes

Through the M1 investing app, 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. Most other companies qualify.

Interest income is taxed at your ordinary-income tax rate.

However, there are some exceptions such as municipal bonds, which earn interest tax-free from the US Government.

They could also be tax-free within your state, but that obviously depends on individual state laws.

This can be a great legal loophole for avoiding taxes. Before you purchase municipal bonds, always calculate the tax-equivalent yield first.

M1 Finance Retirement Account Taxes

Unlike traditional brokerage accounts, taxes on retirement accounts are not incurred on a buy and sell basis. Dividends and interest will also not be taxed at the time they are received. 

The only time a taxable event occurs within a tax-deferred retirement account is when money is distributed (taken) out of the account. 

Once funds are distributed to the account owner, the taxpayer must pay tax on those funds as ordinary income.

At the end of the year, you will receive Form 1099-R for any funds that have been taken out of your retirement account(s).

A copy of this form is sent to the IRS to ensure proper reporting of the income.

As for Roth IRAs, any funds distributed out of the account will not be subject to income tax as long as it is a qualified distribution.

Since the funds in a Roth IRA have already been taxed before they were deposited in the account, there will be no tax liability if funds are withdrawn provided it is a qualified distribution.

Retirement Account Early Distribution Tax Consequences

Early distributions out of any type of retirement account before age 59 1/2 will be subject to a 10% penalty.

There are some exceptions to this 10% penalty rule such as first-time home buyers, disability, medical, and higher education fees. 

You may also withdraw contributions out of a Roth IRA tax-free at any point. It's only when you get to the earnings that you might run into tax consequences.

Any earnings within a Roth IRA cannot be withdrawn before age 59 1/2 without the 10% penalty. 

You will also receive Form 1099-R for any distributions from a Roth IRA, however, the form will be coded as a non-taxable distribution (if you meet the age and distribution requirements).

Consult a tax professional for guidance on your specific tax situation. 

Capital Gains Taxes

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 held for 1 year or less. Long-term capital gains are for investments held for over 1 year.

This is why M1 Finance's tax minimization strategy can be helpful. M1 will attempt to minimize taxes by incurring more long-term gains, rather than short-term gains which will result in a lower tax liability. 

What Is A Wash Sale?

When you sell investments at a loss, you need to be careful of something called the wash sale rule.

A wash sale occurs when an investor sells a security for a loss and then attempts to buy it back within 30 days of the sale.

In an effort to reduce artificial losses for tax purposes, the IRS disallows any wash sales.

If you attempt to sell a security for a loss then buy it back within 30 days the IRS will deny this loss. You cannot offset gains or deduct them from your own personal income. 

M1 Finance Tax Forms

M1 will send you an email with your tax documents within the first couple of months after the end of the calendar year, depending on your account type.

Your tax documents will always be available through the M1 website and mobile app. 

Here are the dates you will receive your tax documents by:

January 31st: 1099-R for SEP, Traditional, and Roth IRA forms are available.

February 15th: Consolidated 1099 for all individual, joint, trust, corp, LLC, custodial, and partnership accounts are available.

May 31st: 5498 forms become available for contributions made up to the April 15 deadline.

What Is Form 5498?

Form 5498 is provided to any retirement account holder who has made retirement account contributions in the prior year.

Form 5498 states how much you contributed to your retirement account.

This form is issued to the IRS and a copy is sent to you for your records. Form 5498 is not required to file your tax return. 

Keep in mind that you will not receive any paper tax forms from M1 Finance. This is one of the ways they cut down on expenses and provide a free platform.

M1 Finance Tax Software Integration

M1 integrates with multiple tax preparation vendors and software to help make tax reporting easier.

The following all integrate with M1 Finance, you may import tax information into any one of these 3 vendors:

Even if you are using a tax preparation service that does not directly integrate with M1 Finance, you can use the documents they send you to file.

M1 Finance Taxes: Closing Thoughts

Depending on the type of account you create on M1 Finance, you may have tax implications when investing your money.

Since this information is being reported to the IRS, it is important to be aware of it and understand what taxes you might incur before they happen.

Within a taxable account, you will have to pay taxes on your capital gains as well as dividends and interest income. It is possible to reduce your tax liability by making sure you incur long-term capital gains and not short-term capital gains.

You can also pay less in taxes by making sure your investments qualify as qualified dividends.

Certain investments, like municipal bonds, are exempt from federal taxes, and in some states the state taxes as well.

Finally, tax-sheltered accounts like the Roth IRA are helpful for avoiding taxes altogether if you are comfortable putting your money away for retirement.

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M1 Finance Taxes Explained
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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