Filing Taxes

What Should I Know About Taxes on My Investment Accounts? An informed and educated investor can make better decisions if they know the unique tax attributes of each type of investment account. In the US, 33% of households have a taxable investment account—often referred to as a brokerage account—and 89% of those households also have at least one retirement account, like an IRA or an employer-sponsored retirement account. We know that the medley of account types can make it challenging for the average investor to decide which account to contribute to or withdraw from at any given time. Further, the factors that might inform this decision don’t necessarily align with a straightforward, black-and-white rubric. Taxable Accounts Taxable investment accounts are typically the easiest to set up and have the least amount of restrictions. Although you can easily contribute and withdraw at any time from the account, there are trade-offs. A taxable account is funded with after-tax dollars and any capital gains your incur by selling assets, as well as any dividends you receive, are taxable on an annual basis. While there is no deferral of income like a retirement plan, there are special tax benefits only available in taxable accounts. Any gains avoid taxation until they are realized, or in other words, sold. Investments held for over one year qualify for long-term capital gains treatment, so those gains are taxed at a lower rate than investments that have been sold before being held for a year. There is an additional exception for an investor who holds investment assets until death: their cost basis is “stepped-up” (reset) to the market value on the date of their death. This means that the original cost of the assets is now considered to be the current value, and gains on any growth during their lifetime are avoided. Note too that inherited assets, when sold, are always taxed at the lower capital gains tax rate for long-term gains. The term dividend is frequently used in a broad sense but can ultimately be referring to distributions from a variety of investment activities. Qualified dividends paid from the the earnings and profits of corporations are taxable at the reduced long-term capital gains rates. Foreign taxes paid on dividends from non-US investments may be eligible for a foreign tax credit—to partially or fully offset taxation in the US so you aren’t paying double taxes. Dividends paid from taxable bond investments are taxed at ordinary income tax rates. Dividends paid from municipal bond investments are generally tax-free. Main Considerations for Choosing a Taxable Retirement Account You would like the option to withdraw at any time with no penalties. You have already contributed the maximum amount to all tax-advantaged retirement accounts. Traditional Accounts Includes Traditional IRAs, Traditional 401(k)s, Traditional 403(b)s, Traditional 457 Governmental Plans, and Traditional Thrift Savings Plans (TSPs) Traditional type investment accounts for retirement are generally funded with pre-tax dollars. The investment income received is deferred until the time of distribution from the plan. Assuming all the contributions are funded with pre-tax dollars, the distributions are fully taxable as ordinary income. For investors under age 59.5, there may be an additional 10% early withdrawal penalty unless an exemption applies. There are a number of possible 10% penalty exemptions, such as death, disability, or taking distributions as an annuity stream—refer to IRS.gov for more information. Unlike a taxable account, retirement plans do not receive a step-up in cost basis upon death. Foreign taxes paid on retirement account investments are not eligible to be claimed as a tax credit. Main Considerations for Choosing a Traditional Retirement Account You expect your tax rate to be lower in retirement than it is now. You recognize and accept the possibility of an early withdrawal penalty. Roth Accounts Includes Roth IRAs, Roth 401(k)s, Roth 403(b)s, Roth 457 Governmental Plans, and Roth Thrift Saving Plans (TSPs) Roth type investment accounts for retirement are always funded with after-tax dollars. Qualified distributions are tax-free. For investors under age 59.5, there may be ordinary income taxes on earnings and an additional 10% early withdrawal penalty on the earnings unless an exemption applies. While there is no step-up in cost basis upon death, distributions made to beneficiaries after the account has been open for five years are automatically tax-free. Foreign taxes paid on retirement account investments are not eligible to be claimed as a tax credit. Main Considerations for Choosing a Roth Retirement Account You expect your tax rate to be higher in retirement than it is right now. You desire the option to withdraw contributions without being taxed. You recognize the possibility of penalty on earnings withdrawn early. Summary of Key Considerations Are the retirement account contributions pre-tax or post-tax? Are the retirement account distributions expected to be tax-free? Is there a 10% early withdrawal penalty from a retirement distribution? Is there potential for long-term capital gain tax rates and qualified dividend rates? Going the Extra Mile With Additional Tax Efficiencies Betterment can help you be a smarter investor, because we offer additional features — at no extra cost — to help you minimize taxes so that you can maximize your money. Tax Coordination can help increase your overall returns if you are investing in multiple types of investment accounts, because it allocates your assets within each account type as tax-efficiently as possible. Tax Loss Harvesting+ can be used to capture losses during market declines so that you can use them to help offset future gains or even lower your tax bracket. Learn more about how Betterment helps you maximize your after-tax returns. Betterment is a financial advisor, not a tax advisor—consult a tax advisor or IRS resources for additional guidance. Getting Started Within a Betterment account, we can provide additional advice regarding which accounts you should be funding and in what order. You can even sync up your 401(k)s and other accounts to see an overall picture your finances. Get started or log in to complete your retirement plan and see personalized savings advice.

What Is a Tax Advisor? Attributes to Look For Since Betterment isn't a tax advisor, we often suggest that customers see a tax advisor regarding certain issues or decisions. Who exactly is a tax advisor and how should you think about picking one? Tax season is now upon us. Now that you’ve probably received all of your tax forms, you may be facing a choice for how to proceed with filing: do it yourself with tax software or hire a professional tax advisor? Although it certainly will be more expensive than using tax software, hiring a tax advisor makes sense for certain individuals, depending on their financial circumstances. Here are two important factors to consider when deciding if a tax advisor is right for you: Time: Even with tax software guiding you, filing your taxes yourself can be time consuming. You’ll need to make sure that you’ve entered or imported the data from your tax forms correctly, which often takes at least several hours, and your time is worth something. Complexity: The more complicated your financial situation, the more a tax advisor may be able to help you. Have partnership income, or income from an S corporation? Been subject to alternative minimum tax in past years? Received or exercised stock options this year? Tax software can handle these issues, but it will take time, and the risk of mistakes (and even an audit) increases. If you decide that your situation warrants professional assistance, some further questions are worth exploring: what exactly is a tax advisor and how should you think about picking one? Who counts as a tax advisor? Anyone with an IRS Prepare Tax Identification number (a “PTIN” for short) can be paid to file tax returns on behalf of others. But merely having a PTIN doesn’t tell you much about the tax preparer; tax preparers have different experience, skills, and expertise. What you really want is a tax advisor, a professional with a certification and experience level that qualifies her not only to prepare your return, but to use her knowledge of the tax code to provide advice on your financial situation. There are three different professional certifications to consider, each of which qualifies a tax advisor to practice with unlimited representation rights before the IRS. This means that in addition to preparing returns, they also are licensed to represent their clients on audits, payments and collection issues, and appeals. Certified Public Accountants (CPAs) CPAs have completed coursework in accounting, passed the Uniform CPA Examination, and are licensed by state boards of accountancy (which require that they meet experience and good character standards). Some, but not all, CPAs specialize in tax preparation and planning. You can find complaints about CPAs either by searching records with state boards of accountancy and at Better Business Bureaus. Enrolled Agents Enrolled agents are licensed by the Internal Revenue Service after they have passed a three-part examination and a background check. The IRS maintains complaints about enrolled agents on the website of its office for enrollment, and you can also find complaints on the National Association of Enrolled Agents website. Licensed Tax Attorneys Licensed attorneys have graduated from law school, passed a state bar exam, and are admitted to the bar in at least one state. Some, but not all, attorneys specialize in tax preparation and planning. Many tax attorneys have completed an additional year of law school study in a master’s program in tax (called a Tax LL.M. degree). Disciplinary actions against attorneys can be found by searching the state bar associations with which the attorney is registered. How to Select a Tax Advisor or Tax Consultant No tax advisor with one of the certifications described above is necessarily better than any of the others in all situations. Rather, what matters most is: How the advisor approaches the tax preparation process, including the specific experience the tax advisor has with issues relevant to your particular financial situation. Whether you feel comfortable with the tax advisor. How the advisor structures their fees. You may be able to screen potential advisors along several of these dimensions based on information you can find about them online; for others, an initial meeting will be critical to determine if the advisor is right for you. 1. Assess your confidence in the quality of a tax advisor's recommendations, as well as their experience. Here are a few specific factors to consider carefully when assessing the potential quality of a tax advisor's work. First, you should try to identify a tax advisor who will act ethically and with integrity. Before scheduling a meeting with a potential tax advisor, check to see if the advisor has been subject to any complaints, disciplinary actions, or other ethical infractions. When meeting with the advisor, be on the lookout for outlandish promises: if an advisor guarantees you a certain refund without having first looked at your returns, you should be wary (any promise that sounds too good to be true probably is). If the advisor suggests taking a position on a tax return that strikes you as overly aggressive (because it is not grounded in your actual financial situation) or if you simply do not understand something the advisor is saying, make sure to ask, and keep asking until you are satisfied with the answer. Having a tax advisor prepare your returns does not take away your responsibility for the accuracy of your tax return. Of course, an advisor who knowingly takes an improper position on a tax return will face consequences, but it is your return, and you can too. A good tax advisor also should provide more value than simply filling out your returns. She should help you to structure your finances in an optimal way from a tax perspective. Not every tax advisor has expertise with every nuance of the tax code, and so you’ll want to make sure that the advisor you select has significant experience with the particular issues for which you’re seeking expert advice. Of course, there are certain common issues that every good advisor should know: for example, how to maximize the value and efficacy of your charitable contributions, how to weigh the tax tradeoffs between renting and owning a home, or how to save money for or gift money to family members. For other less common situations, however, you’ll want an advisor with specific experience. If you own a business or are self-employed, if you work for a startup and own a significant number of stock options, or if some portion of your income is reported on a K-1 (because you are a partner in a business or own shares in an S corporation), you likely will be best served by finding an advisor who has worked with a significant number of clients with these tax issues. Finally, maintaining the security of your personal information is more important than ever these days, and the inputs for your taxes is some of the most sensitive information you have. There will always be some risk of data breaches, but a good tax advisor will take steps to safeguard your information. Make sure that you ask about how the tax advisor stores your personal information and what methods she uses to communicate with you regarding sensitive topics. You also should ask about whether the advisor has ever been subject to a data breach and what steps the advisor is taking to protect against future ones. 2. Assess your comfort level with the working relationship. You want to make sure you have a good rapport with your tax advisor, and that you feel like you understand each other. At your first meeting, make sure to bring three years’ worth of old tax returns for your advisor to review. Ask if you missed any deductions, and if your old returns raise any audit flags. Consider the advisor’s responses. Does the advisor seem willing to spend time with you to ask thorough questions to fully understand your situation? Or does she rush through in a way that makes you feel like she might be missing certain issues or nuances? Does the advisor explain herself in a way that is understandable to you, even though you don’t have a tax background? Or does the advisor leave you confused? A tax advisor may work by herself or be a member of a larger organization or practice. Each approach has its benefits and drawbacks. You can be sure that a solo practitioner will be the one who actually prepares your returns, but it may be harder to reach the advisor during the height of tax season, and the advisor may find it difficult to get a second opinion on tricky issues or issues outside her core areas of expertise. On the other hand, although the collective expertise of a larger practice may exceed that of even a very talented advisor practicing on her own, it may be more difficult to ensure that your return is prepared personally by your advisor. Finally, think about whether you want to work with a tax advisor who is already part of your social network, or who has been referred by a trusted family member or friend. On the one hand, having the seal of approval of someone you know and trust may help to assure you that the advisor is right for you. On the other hand, consider whether it will be harder to part ways with the advisor down the road if she fails to meet your standards. 3. Evaluate the cost of the tax advice. The final issue you’ll want to think about is cost. Tax preparation services are a low margin business (particularly with the competition that tax preparers face from low cost software), but you can expect to pay more for tax planning services or advice. The best cost structure is one where the tax advisor charges for her time or for the specific forms that the advisor completes and files. By paying for the advice itself and not a particular outcome, this cost arrangement properly aligns the incentives between your tax advisor and you. Be wary of compensation structures that create the potential for conflicts of interest between you and and your tax advisor. For example, some tax advisors may try to earn additional revenue from you by selling other services or financial products along with tax preparation. Ultimately, when it comes to cost, your goal should not be solely to minimize your combined out of pocket cost to the IRS and your advisor for this year’s tax return. Rather, you should take a longer term view, recognizing that good, personalized tax advice can help you to structure your financial life in a tax-efficient way that can pay dividends for years to come.

How to Estimate Your Tax Bracket When Investing Knowing your tax bracket opens up a huge number of planning opportunities that have the potential to save you taxes and increase your investment returns. If you’re an investor, knowing your tax bracket opens up a number of planning opportunities that can decrease your tax liability and increase your investment returns. Investing based on your tax bracket is something that good CPAs and financial advisors, including Betterment, do for customers. Because the IRS taxes different components of investment income (e.g., dividends, capital gains, retirement withdrawals) in different ways depending on your tax bracket, knowing your tax bracket is an important part of optimizing your investment strategy. In this article, I’ll show you how to estimate your tax bracket and begin making more strategic decisions about your investments with regards to your income taxes. First, what is a tax bracket? In the United States, federal income tax follows what policy experts call a progressive tax system. This means that people with higher incomes are generally subject to a higher tax rate than people with lower incomes. Currently there are seven different tax brackets, ranging from 10% up to 37%. Below are the 2021 federal tax brackets if you are single or married filing jointly. 2021 Federal Tax Brackets Taxable Income Bracket: Filing as Single Taxable Income Bracket: Filing as Married, Filing Jointly Tax Rate $0 to $9,950 $0 to $19,900 10% $9,951 to $40,525 $19,901 to $81,050 12% $40,526 to $86,375 $81,051 to $172,750 22% $86,376 to $164,925 $172,751 to $329,850 24% $164,926 to $209,425 $329,851 to $418,850 32% $209,426 to $523,600 $418,851 to $628,300 35% $523,601 or more $628,301 or more 37% For example, if you are single and have taxable income of $75,000 this year, you fall into the 22% tax bracket. However, that does not mean that all $75,000 of your income will be taxed at 22%. Instead, tax brackets apply to each portion of your income, building up like a staircase. Here’s a visual to help explain. U.S. Federal Tax Brackets for Single Filers If you are a single individual with a taxable income of $75,000, the first $9,950 of your income will be taxed at 10%, then dollars $9,951 - $40,525 will be taxed at 12%, and dollars $40,526 – $75,000 will be taxed at 22%. If your taxable income were to grow, then dollars $75,001 — $86,375 would still be taxed at 22%, but after that, the dollars would be taxed at higher tax rates. Filing status (single, married, head of household, etc.) also affects your tax bracket. See the tax brackets for each filing status. How difficult is it to estimate my tax bracket? Luckily, estimating your tax bracket is much easier than actually calculating your exact taxes, because U.S. tax brackets are fairly wide. Just look at the 22% tax bracket. If you are filing as single, any income between $40,526 and $86,375 falls within that same tax bracket. That’s a big margin of error for making an estimate. The wide tax brackets allow you to estimate your tax bracket fairly accurately even at the start of the year, before you know how big your bonus will be, or how much you will donate to charity. Of course, the more detailed you are in calculating your tax bracket, the more accurate your estimate will be. And if you are near the cutoff between one bracket and the next, you will want to be as precise as possible. How Do I Estimate My Tax Bracket? Estimating your tax bracket requires two main pieces of information: Your estimated annual income Tax deductions you expect to file These are the same pieces of information you or your accountant deals with every year when you file your taxes. Normally, if your personal situation has not changed very much from last year, the easiest way to estimate your tax bracket is to look at your last year’s tax return. However, with the passing of the Tax Cuts and Jobs Act in December 2017, a lot of the rules and brackets have changed. Thus, it is wise for most people to estimate their bracket by crunching new numbers. Estimating Your Tax Bracket with Last Year’s Tax Return If you expect your situation to be roughly similar to last year, then open up last year’s tax return. If you review Form 1040, you can see your taxable income on Page 2, Line 43, titled “Taxable Income.” As long as you don’t have any major changes in your income or personal situation this year, you can use that number as an estimate to find the appropriate tax bracket on the table above (or the full set of tables provided by the Tax Foundation). Estimating Your Tax Bracket by Predicting Income, Deductions, and Exemptions Estimating your bracket requires a bit more work if your personal situation has changed from last year. For example, if you got married, changed jobs, had a child or bought a house, those, and many more factors, can all affect your tax bracket. It’s important to point out that your taxable income, the number you need to estimate your tax bracket, is not the same as your gross income. The IRS generally allows you to reduce your gross income through various deductions, before arriving at your taxable income. When Betterment calculates your estimated tax bracket, we use the two factors above to arrive at your estimated taxable income. You can use the same process. 1. Add up your Income. Add up your income from all expected sources for the year. This includes salaries, bonuses, interest, business income, pensions, dividends and more. If you’re married, don’t forget to include your spouse’s income sources. 2. Subtract Your Deductions Tax deductions reduce your taxable income. Common examples include mortgage interest, property taxes and charity, but you can find a full list on Schedule A – Itemized Deductions. If you don’t know your deductions, or don’t expect to have very many, simply subtract the Standard Deduction instead. For 2020, the standard deduction is $12,400 if you are single, and $24,800 if you are married filing jointly. By default, Betterment assumes you take the standard deduction. If you know your actual deductions will be significantly higher than the standard deduction, you should not use this assumption when estimating your bracket, and our default estimation will likely be inaccurate. The number you arrive at after reducing your gross income by deductions and exemptions is called your taxable income. This is an estimate of the number that would go on line 11b of your 1040, and the number that determines your tax bracket. Look up this number on the appropriate tax bracket table and see where you land. Again, this is only an estimate. There are countless other factors that can affect your marginal tax bracket such as exclusions, phaseouts and the alternative minimum tax. But for planning purposes, this estimation is more than sufficient for most investors. If you have reason to think you need a more detailed calculation to help formulate your financial plan for the year, you can consult with a tax professional. How Can I Use My Tax Bracket to Optimize My Investment Options? Now that you have an estimate of your tax bracket, you can use that information in many aspects of your financial plan. Here are a few ways that Betterment uses a tax bracket estimate to give you better, more personalized advice. Tax-Loss Harvesting: This is a powerful strategy that seeks to use the ups/downs of your investments to save you taxes. However, it typically only makes sense if you are in the 22% tax bracket or higher. For those in the 10% & 12% tax brackets, capital gains are taxed differently, which could make this strategy not beneficial. Tax Coordination: This strategy reshuffles which investments you hold in which accounts to try to boost your after-tax returns. For the same reasons listed above, if you are in the 10% or 12% tax bracket, the benefits of this strategy are reduced significantly. Traditional vs. Roth Contributions: Choosing the proper retirement account to contribute to can also save you taxes both now and throughout your lifetime. Generally, if you expect to be in a higher tax bracket in the future, Roth accounts are best. If you expect to be in a lower tax bracket in the future, Traditional accounts are best. That’s why our automated retirement planning advice estimates your current tax bracket and where we expect you to be in the future, and uses that information to recommend which retirement accounts make the most sense for you.In addition to these strategies, Betterment’s team of financial experts can help you with even more complex strategies such as Roth conversions, estimating taxes from moving outside investments to Betterment and structuring tax-efficient withdrawals during retirement. In addition to these strategies, Betterment’s team of financial experts can help you with even more complex strategies such as Roth conversions, estimating taxes from moving outside investments to Betterment and structuring tax-efficient withdrawals during retirement. Tax optimization is a critical part to your overall financial success, and knowing your tax bracket is a fundamental step toward optimizing your investment decisions. That’s why Betterment uses estimates of your bracket to  recommend strategies tailored specifically to you. It’s just one way we partner with you to help maximize your money. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a tax professional.