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Tax documents

Lesson in Course: Investing basics (advanced, 3min)

Investment income is taxable income. What should we expect at the end of every year?

Eureka!

What it's about: We owe taxes on the money we make from investing.

Why it's important: There are different tax forms for the different ways we can make money.

Key takeaway: Keep an eye out for the appropriate tax forms and consider professional help when filing.

Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes. - Benjamin Franklin

The worst feeling is being surprised by tax documents in the mail after filing our taxes. Let's review what we should expect to receive before April.  

What is taxable?

Short-term capital gains are taxed as income

Capital gains

Any money we make on our investments is taxed. We realize our gains when we sell our assets, and by locking in a profit, we create a taxable event. If we don't sell, the paper gains stay unrealized and non-taxable.

Realized tax example

We bought shares of AAPL at $90 per share. The current share price is $125, so we have unrealized gains of $35 per share. If we decide to sell, we would realize the profit of $35 per share and pay tax on that amount. 

Based on how long we've held the shares, tax rates on the capital gains will differ.

Income 

Outside of buying and selling shares, we can also earn income from our investments. These direct cash payments are also taxed. They can come from dividends, interests, and partnership distributions.

Tax Documents

Our brokerage prepares a 1099 form for each taxable year. The 1099 forms come in different flavors, and we may receive multiple. Below are the various forms explained and in order from most common to least common.

What is 1099-B?

The most common form is the 1099-B, which lists all of our transactions, including our total short-term and long-term capital gains and losses for the year. Some transactions it will include are sales, shorts, closing options, redemptions, tender offers, and mergers for cash.

What is 1099-DIV?

The 1099-Div totals the dividends or cash payments we receive for being shareholders. Dividends are a great way to build an income, and as long as we receive $10 or more, we should expect this form.

What is 1099-INT?

We'll receive a 1099-INT if we collect $10 or more from any interest-generating assets, such as bonds or money markets. The interest payments from investing in loans and bonds are different from a company's dividends.

What is 1099-MISC?

The miscellaneous income form serves as a catch-all for any other income. Examples include interest from stock yield enhancement programs or dividends received when shares are out on loan. We generally shouldn't expect a 1099-MISC if we keep our investments simple.

What is 1099-OID?

A 1099-OID is the rarest 1099 form we're likely to see. It covers original issue discounts on corporate bonds, certificates of deposit (CDs), collateralized debt obligations (CDOs), and U.S. government obligations of $10 or more. We receive a 1099-OID when we buy zero-coupon bonds or other types of debt that delay interest payment until maturity. For 99% of us, we will never see this form.

 

 

What is K-1?

A K-1 is a partnership statement. Certain real-estate investment trusts (REIT) or private equity funds function as partnerships. We become limited partners by investing in these types of funds, and we earn income from its operations. 

We should be especially mindful when selecting K-1 generating investments. They can be complicated, so it's beneficial to have an accountant or professional help us prepare our taxes.