Filing Taxes

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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 ...
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 ...
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 ...
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.
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Put Your Tax Refund To Work—We’ll Show You How
Put Your Tax Refund To Work—We’ll Show You How You finally got your tax refund. Now what? We’ll show you how to put it to use so that you can get the most of your money. Today is the day you’ve been patiently awaiting. You’ve just received your tax refund. While some ponder a vacation on the beach, others—such as smart investors like you—think about how they can invest the funds for the long-term. There is no one right strategy on how to use your refund, but here are some smart money moves you may want to consider. Pay down high-interest debt. Credit cards and personal loans typically charge interest rates as high as 15% to 30% on outstanding balances. Using your refund to pay off this debt is a wise move because it helps you avoid future interest charges on your outstanding balance. Many customers ask us the question—should I invest, or pay off debt? Check out this article if you aren’t sure where paying off debt falls on your priority list. Build a rainy day fund Like it or not, rainy days happen—and we need to be prepared to weather them. That’s why most financial planners recommend having a short-term savings account that holds 3 to 6 months’ worth of expenses. Unfortunately, not all of us have that much cash readily available to immediately access, which can expose us to additional risks in the event of an unexpected major expense or the loss of a job. Consider opening a Safety Net to stash away cash for emergencies. Increase your 401(k) contributions. Although you generally can’t contribute directly to your 401(k) from your bank account, you can increase your contribution rate through your employer and use your refund to cover daily living expenses. First, make sure you contribute at least the amount that your employer will match, if they have a 401(k) matching policy. If your employer offers a Roth 401(k), still consider making contributions, which can provide tax-free income in retirement and a hedge against future tax increases. If you are able, consider contributing the maximum amount for the year. For 2021, if you are under 50, the maximum contribution amount is $19,500. If you are age 50 or older, the maximum contribution amount is $26,000. Contribute to your IRA. If you are looking for another place to grow your retirement investments with additional tax benefits, consider contributing to a Traditional or Roth IRA. If you’re unsure which type of IRA is best for you, we have a tools and resources that can help you decide. For 2020 and 2021, if you are under 50, the contribution limit is $6,000. If you are over 50, the contribution limit is $7,000. Remember that if you contribute earlier in the year, your future growth could be more than if you had contributed at the end of the year. Invest in education. Benjamin Franklin said it best when he stated, “An investment in knowledge pays the best interest.” Using your tax refund to save for education can turn out to be a wise decision. Tax-advantaged education savings accounts, like your state’s Section 529 plan, allow for your investments to grow tax-deferred. If the funds are used for qualified education expenses, you won’t have to pay taxes when you withdraw. Donate to charity. Giving feels good, but did you know it can also reduce your taxes? Donating to charity allows you to deduct your charitable contributions from your itemized taxes for 2020, while also contributing to causes you care about. You can read more about the rules for deducting charitable contributions on the IRS website. Make Energy-Efficient Home Improvements Using your refund to make energy-efficient upgrades to your home can help reduce your utility bills. The U.S. Government currently has a number of incentives to promote energy efficiency that you can take advantage of. The amount you reduce your utility bills by can then be saved and invested to help maximize the benefit. Good for the planet, good for your wallet—energy efficiency is truly a gift that keeps on giving. Get Started Ready to save? Get started or log in to set up a Safety Net, contribute to an IRA, or start giving to charity. If you plan to use your tax refund to save towards other financial goals, learn how to prioritize each goal. Please note that Betterment is not a tax advisor—please consult a tax professional for further guidance. -
6 Tax Filing Hurdles When Investing
6 Tax Filing Hurdles When Investing Taxes can be confusing, even for the most savvy investors. Enter Eric Bronnenkant, our Head of Tax, with six things to look out for when filing your taxes while investing. Whether you’ve been investing for years or not, holding money in an investment account can make your filing process a bit more complicated. I’m here to help guide you through that process with a few tips. 1. Haven’t taken a withdrawal from your taxable account? Still expect some taxable income. Even if you haven’t withdrawn funds from your account, dividends you’ve earned and capital gains from sales in your account may still be taxable. Sales that don’t result in withdrawals can come from rebalancing that helps keep your portfolio on track, as well as any allocation changes you might have made. The dividend and investment sales will be reported to you on a Form 1099-B/DIV. Interest on your Cash Reserve account will be reflected on a Form 1099-INT. Learn more » 2. If you only have IRA investments, your taxes may be simpler than you think. One of the key benefits of investing in an IRA is that all the income inside the account is tax-deferred. As long as you leave your funds in the IRA, you do not report any of the dividends or investment sales. If your only investments are within an IRA or 401(k), you aren’t typically required to report investment sales on Schedule D/Form 8949 (which you might experience as buying tax software that includes investments), so that may make your filing process more straightforward. Learn more » If you do take an IRA distribution (make a withdrawal), you should expect to receive a Form 1099-R from us. An IRA distribution may or may not be taxable, but it is always reportable. 3. A globally diversified portfolio is a good strategy. Know how it can affect your tax filing. Diversification is one of the key tenets of Betterment’s portfolio advice. International investments help decrease the risk of a portfolio heavily invested in U.S. stocks and bonds. Because of this, you should know that these foreign investments add a few steps when you’re filing your taxes. You’ll need to calculate the foreign tax credit to mitigate the double taxation between the US and foreign countries. Learn more » 4. Tax-smart investing starts with government bonds. Look out for reporting that income. To be as tax-smart as possible, you’ll want to take advantage of every tax benefit available to you. One benefit built into Betterment’s portfolios is income from government bonds, which is exempt from state and local income taxes due to federal law. It is common for investors to overlook this tax benefit and subject all of their taxable interest to state and local income taxes. Be more tax-smart by being sure to report income from government bonds on your state tax returns. Learn more » In addition, municipal bond income is generally exempt from federal income tax. The rules at the state level are a little more tricky. If your resident state has an income tax, it will tax all out-of-state muni income. Knowing what portion of your income falls into the in-state versus out-of-state is important to paying the appropriate amount of tax. Learn more » 5. 2020 markets were volatile, which means Tax Loss Harvesting+ was hard at work.1 Stock and bond markets are inherently volatile. While you hope that they appreciate in value over the long term, it is expected that there may be substantial fluctuations in the short term. Betterment’s Tax Loss Harvesting+ helps to take advantage of volatility by “capturing losses,”—selling investments at opportune times and buying similar replacement investments that do not violate certain IRS rules. These captured losses can then be used to help offset any gains you’ve recognized or against other income in the tax year up to $3,000. If there are any additional losses, they may be carried forward until used in a future year. Learn more » 6. We saw new tax legislation starting in 2019. This changed IRA contribution rules and required minimum distribution provisions. The SECURE Act, which was passed in late 2019, paved the way for retirement rule changes starting in 2020. Traditional IRA contributions have historically been limited to owners under the age of 70 1/2. The age restriction has been lifted starting for 2020 tax year, and even 100 year olds can now contribute to a Traditional as long as they (or their spouse) have “earned income”. Non-spouse beneficiaries of IRAs and 401(k)s historically had been able to withdraw funds over the beneficiary’s life expectancy. For deaths that occur in 2020 or later, the beneficiary is now required to completely distribute the entire account by the end of the 10th year after death. Learn more » Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional. 1Tax Loss Harvesting works automatically for customers who have elected the service in their accounts. -
3 Time-Sensitive Tax Moves to Consider this December
3 Time-Sensitive Tax Moves to Consider this December Tax planning can help you make the most of your hard-earned money, and December is a great time to do it. December is a great time to plan your taxes. Why? Because most of your 2018 numbers are now known, and you still have time to take actions that can reduce your tax bill come April. What’s different about 2018 is that it’s the first year after the tax reform bill, the Tax Cuts and Jobs Act of 2017. That means the experience of filing your taxes may feel different than past years. The good news is there’s no better time to plan your taxes than December, and most strategies still apply even after the reform. Here are three tax moves to consider this December. 1. Finish up your contributions to your IRA, HSA, 401(k), or 529 plans—better yet, max them out. For many taxpayers, the most straightforward way to lower your current year tax bill can be to contribute to a tax-deferred savings account such as a Health Savings Account (HSA), traditional IRA, 401k, or 403(b). If you aren’t sure whether or not you’ve hit the 2018 limits (up from 2017), however, check the rules twice. Did you reach the age 50 at any time during 2018? If you have, you get extra catch-up contributions to your retirement plan. For HSAs, you’ll have to wait until age 55. With 529 plan contributions, there’s no federal tax deduction, but you might get a break on state taxes. Either way, last year’s tax reform bill offers new incentives to consider a 529. Specifically, you can take a tax-free withdrawal of up to $10,000 annually for qualified elementary and secondary school costs. 2. Sell, convert, or gift your investment gains and losses, time shifting your taxable income. Time shifting taxable gains and losses on the sale of investments is another tax planning method to consider. When settling up your bill with Uncle Sam, it’s often a question of “pay me now or pay me later.” This strategy has you explicitly choosing now versus later depending on tax implications. Based off of your income this year, you might benefit from tax loss harvesting. This is the practice of deliberately selling losing investments in order to use the loss on that sale to help offset other income, thereby reducing taxes. Some services are even doing this automatically for you throughout the year. If you don’t use automatic tax loss harvesting, you have until year end to do it manually. If your taxable income is $38,600 or less ($77,200 for married couples), you might consider harvesting gains instead of losses. That’s because a portion of your profit may be subject to 0% long term capital gains tax rate. If you don’t qualify for the 0% rate and you have appreciated assets, your tax-planning options could involve transferring these investments to others. If you hold the assets for life, you could enable heirs to receive a step-up in basis. When they sell, they can avoid taxes on the gain the investments saw during your lifetime. Alternatively, you could donate the appreciated assets to a qualified charity or donor-advised fund, which may net you an immediate tax deduction. Since the charitable contribution is not subject to capital gains taxes, more of the value is preserved for the cause when the investments are sold. You may also want to consider doing a Roth conversion for time shifting taxes due on investment gains. Let’s say that over the years you’ve been contributing to tax-deferred retirement accounts. The usual course of action is to let these investments grow tax-free, and withdraw them in retirement when you expect to be in a lower tax bracket. But suppose your 2018 income is unusually low (e.g. you took unpaid leave). That—plus the generally lower rates of the tax reform bill—may mean you are subject to a low tax rate. This means that it may be to your advantage to convert some or all of your traditional retirement savings to Roth. It’s worth noting that in the past, investors had the option to change their minds and undo Roth conversions. With the new tax reform bill, however, Roth recharacterization is no longer permitted. 3. Shift your expenses to bunch your deductions. Investment gains and losses are not the only elements of the tax planning equation that can be time shifted. Delaying or accelerating other income and expenses is also a popular strategy. Examples include pushing bonuses to January, prepaying education expenses, and “bunching” itemized deductions. “Bunching” is the practice by which taxpayers consolidate as many deductible expenses as possible into a given year. The goal? To make the most of itemizing rather than taking the standard deduction. Historically, this meant controlling the timing of things like medical expenses, state and local taxes, mortgage interest, property taxes, and charitable giving. The new tax law is expected to change all of that since it nearly doubled the standard deduction. As a result, few will qualify to itemize going forward. Tax preparation may be simpler, but some taxpayers may end up owing more, including: Homeowners subject to new limitations on home mortgage interest deductions Residents with higher state and local tax rates, because the federal tax deduction for state and local taxes is now capped. Similarly, many miscellaneous itemized deductions have been disallowed. Bottom line: the benefit of bunching deductions has been severely curtailed. The exception, appropriately enough during this season of giving, is charitable contributions. Here, careful planning still has the potential to help ensure a happier holiday and tax time for you and the lucky recipient. Move quickly before the end of the year, but talk with a professional. It’s the most wonderful time of the year for income tax planning. But as we’ve seen, tax law changes, limitations, and interdependencies between provisions make it something of a tricky business. It’s crucial that you (or your tax advisor) run projections to help you see the intended benefits and quickly—like holiday sales, the window on this opportunity closes fast. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional.
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