Perspective :

Six questions to help advisors prepare for the 1099 season

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Tis the season. Not the holiday season or Festivus, but the 1099 season. Most 1099’s are due to be mailed to investors by January 31st. Receiving a 1099 often sets off a series of questions from investors to advisors about what happened during the year. Why do some numbers appear high or low and what does it mean for their tax bill? Like all things related to the Internal Revenue Service (IRS), the answer is that it depends.

Six questions to prepare for the 1099 season
1. What is the 1099?

There are more than ten versions of the 1099. For investors in mutual funds and ETFs, the 1099’s that likely matter the most are the 1099-DIV, 1099-INT, and 1099-B.

  • 1099-DIV: Dividends, capital gain distributions, interest income from bond funds, and non-taxable income from municipal bond funds.
  • 1099-B: Sales of stocks, bonds, funds, and ETFS during the year to include holding period info, cost basis, and proceeds from sales.
  • 1099-INT: Interest income often from an institution such as a bank.
2. Do you need to know all the different 1099’s?

Not generally. Most Broker/Dealers or custodians will send a Consolidated 1099 that summarizes the information into a single document. Below is a sample 1099-DIV from a hypothetical Consolidated 1099.

1099-DIV from Hypothetical Composite 1099:

3. Are the amounts on the 1099-DIV good or bad?

Again, it depends. Understanding the size of the investments behind the amounts can provide perspective. Also, it is helpful to know if the investor has an income need. If income is a portfolio goal, the amounts may make more sense.

  • Line 1a Total Ordinary Dividends: Total amount of dividends and income received from mutual funds and ETFs. While the title says “dividends,” it also includes interest income from funds. But note that this line is not equal to the amount taxed.
  • Line 1b Qualified Dividends: Amount of dividends and income that qualify to be taxed at long-term capital gains rates, which can be materially lower than ordinary income tax rates.
  • Difference between 1b – 1a (Ordinary Dividends less Qualified Dividends): Generally, the difference between these two lines is taxed at ordinary income tax rates. This usually includes interest income and non-qualified dividends.
  • Line 2a Total Capital Gain Distributions: Total capital gain distributions from mutual funds and ETFs. This includes both long-term and short-term distributions. Is this amount the taxable amount? No! These amounts are only part of the story for capital gains and losses.
4. Why aren’t the capital gain distributions on the 1099-DIV the taxable amount?

The IRS allows for combining and netting capital gains with capital losses. The totals on the 1099-DIV are only part of the story. Within the Consolidated 1099, there is also the 1099-B, which details the capital assets sold during the year. These sales will be netted as totals for Short Term Capital Gains and Long-Term Capital Gains. The details will show up on IRS Form 8949 with the totals on Schedule D.

The Schedule D will net the realized gains and losses for the year. Any losses may be the result of tax-loss harvesting performed during the year. While 2023 capital market returns were positive across the major asset classes, there were opportunities to actively tax-managed portfolios. Recall that loss harvesting entails selling a capital asset for less than the adjusted cost basis of that security or fund. One area of the market that provided loss harvesting opportunities in 2023 was within fixed income funds due to potential loss of value resulting from the Federal Reserve’s strong rate increases in prior 18 month (Top 5 Loss Harvesting Mistakes). Any harvested losses are netted against any capital gains shown on the 1099-DIV.

5. Does the investor have a capital loss carryover from 2022?

The IRS allows investors to deduct up to $3,000 (married filing jointly) in capital losses from taxable income. What if the realized losses are greater than $3,000? The excess amount is carried forward into future years to be offset against future gains and/or deduct another $3,000 until the carry forward amount is taken to zero.  Loss carryforwards do not expire and they can’t be left to heirs. They are a “use it or lose it” tax asset.

The market volatility in 2022 provided many opportunities for tax-loss harvesting. For many investors, the year provided realized losses greater than the $3,000 threshold and created loss carryforwards (tax assets) for investors to take into 2023 – and beyond. How and where would you find this information? Go to Schedule D – specifically Page 2.

On last year’s Schedule D (2022), on page 2, assume line 16 and 21 are positive. Subtract 21 from 16. If positive, the taxpayer likely has a Capital Loss Carryover that can be used to offset capital gains in 2023. In the example below, the taxpayer deducted $3,000 from taxable income in 2022 and had an additional $7,000 of losses to carry into 2023 (a tax asset).

6. Lastly, are capital gain distributions necessarily a bad thing?

It depends on the materiality and goals of the investor. At Frontier, we believe the goal for taxable investors is to maximize after-tax wealth – not to simply minimize taxes. These two differing goals are often in conflict. As we wrote previously (Blog – defining the goal), there are examples of investments that create attractive pre-tax and post-tax returns—even in the presence of taxes. One cannot measure good/bad only on the distribution. You must understand the investment creating the distribution, the return, and the role in a properly diversified portfolio.

Frontier Asset Management in 2023

During 2023, we actively harvested losses throughout the year – not just at year-end. But 2023 was materially different than 2022, which afforded many opportunities to tax loss harvest. Investors should remember to review their Schedule D from 2022 to see if any loss carryforwards are applicable. It is very easy for investors to lose track of these tax assets.

Effective tax-management is not a “one and done” opportunity, but rather an ongoing, continuous total portfolio approach viewed through lifecycle of the investments. The goal is not simply trying to minimize capital gain distribution. The goal should be to invest in tax-smart manner across the total portfolio to maximize after-tax wealth. The amount after taxes (not before) help investors meet their financial goals.

If you have questions about 1099 season or how to better prepare for your client conversations, we’re happy to help. Schedule a call.

This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Past performance is not indicative of future results. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness. While Frontier Asset Management believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. The use of such sources does not constitute an endorsement. The views expressed represent the opinion of Frontier Asset Management. The views are subject to change and are not intended as a forecast or guarantee of future results.

Assumptions, opinions, and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell any securities, commodities, treasuries, or financial instruments of any kind. This material has been prepared for information purposes only and is not intended to provide, and should not be relied on for, accounting, legal, investment or tax advice

Frontier provides model strategies to various investment advisory firms and does not manage those models on a discretionary basis. The performance and holdings of model strategies may vary from strategies managed by Frontier. Tax management may be limited in certain aspects due to the nature of the relationship between firms.

 

Frontier Asset Management is a Registered Investment Adviser. The firm’s ADV Brochure and Form CRS are available at no charge by request at info@frontierasset.com or 307.673.5675 and are available on our website www.frontierasset.com. They include important disclosures and should be read carefully.

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