Tax season is here, so I thought it might be a good idea to review the different tax treatments for a few common account types where stocks or other investments are held. We’ll also look at how the 1099 document can make your life easier when it comes time to file.
I’m going to keep this tax discussion high level, avoiding complexities. As usual when discussing taxes, I would caveat that I am not in the business of giving tax advice, nor should any part of this article be considered tax advice. It is always a good idea to seek a competent and qualified tax professional to assist with tax preparation.
We’ll cover two of the most common categories of accounts in this article:
Standard taxable accounts may be individually or jointly held, and do not by themselves bring the owner (or owners) any special tax benefits. Dividend and interest income is generally taxable during the year when it is received. Capital gains (these occur when an investment is sold for a greater amount than was initially paid) are generally taxed when the investment is sold.
Retirement accounts are owned only by individuals (unlike standard taxable accounts, retirement accounts cannot be jointly held). Retirement accounts are also treated differently for tax purposes than standard taxable accounts. As the category name suggests, they are designed for people saving up for their retirement years, and require special rules to be followed in order to obtain tax advantages.
Types of retirement accounts include:
Traditional IRAs, company 401k accounts, or other “qualified plans”
Roth IRAs and Roth 401k accounts
Traditional IRAs, company 401k accounts, and most other non-Roth retirement accounts are generally taxed the same way:
they are initially funded with pre-tax dollars,
grow tax-deferred for as long as the assets remain in the account, and
are fully taxable upon withdrawal (unless they are rolled over into another tax-deferred account).
Roth IRAs or Roth 401k accounts are taxed differently. These are generally:
funded with after-tax dollars,
grow tax-free while assets are in the account, and,
may be withdrawn tax-free as long as certain rules are met (no withdrawals before the owner is 59½, etc.).
Roth retirement accounts can be especially great savings accounts for earners in low-tax brackets, since tax is paid up front at lower rates and left to grow tax free.
Look for the 1099
Typically, around January or February, the financial institution holding the investment assets sends a document to the account owner called a 1099 (pronounced “ten-ninety-nine”). The financial institution also sends a copy of the 1099 to the IRS. It is important to look this document over, as they occasionally contain errors.
The 1099 contains important tax information that is generally used to complete the taxpayer’s return. There are different types of 1099s, depending on the type of taxable transaction being reported. For example, a 1099-DIV includes dividend income, a 1099-INT includes interest, a 1099-B includes basis and proceeds information related to a brokered investment sale, and a 1099-R includes information related to withdrawals from a retirement account, such as an IRA or 401k.
If you received dividends or sold stock last year, and did not receive a 1099, it may be because the investments were held in a retirement account. Retirement accounts will generally not send 1099s unless money is withdrawn from the account, since assets are generally not taxed for as long as they remain in the retirement account.
A couple keys to getting taxes right are:
Watch for the 1099s. If you think you should have received one and did not, contact the financial firm holding the investment assets.
Keep your own records (or work with an accountant), and compare your records with any statements and 1099s received from the financial firm holding the assets.