What You’ll Need to File Taxes on Your Investing

This is easily my least favorite time of year: tax season. It isn’t that I mind paying for the goods and services that I use. (I’m not that big a fan of forced charity through taxes and would prefer something like The Conservative’s Welfare Plan to take care of those who fall into dire straights.) It is that I really hate the burden of pulling together the needed information and filing taxes. Still, until we finally get wise and get rid of the need for most people to file taxes using The Fair Tax, this will continue to be the season of headaches. In this article we will therefore discuss some of the things you need to know as an investor to be ready to file your taxes.

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FIREd by Fifty: How to Create the Cash Flow You Need to Retire Early

Should I use an accountant?

Filing with an accountant (a CPA, not some guy who works with a tax filing firm and gets a few hours of training) will run you $300 to $500. If your taxes are somewhat complicated, I would say that it is definitely worth it to have someone who really knows the tax codes preparing your returns. More importantly, a good tax person will know what you can be doing to reduce your taxes, both for this year and for the future. If you’re just working a job with a few stock trades and some interest and dividend income, tax software or a basic tax filing firm ( who pretty much just runs the software for you) will be fine. If you’re trading a lot, have several different accounts like IRAs, 401ks, and HSAs, plus things like dependents, real estate, a small business, etc…, an accountant can save you far more than they cost.

Taxes should not be a primary concern when it comes to fundamental decisions like, “Should I buy or sell this stock?” They should be taken into account, however, when making decisions like how you should be investing and in which accounts you should place stocks and funds that cast off a lot of dividends. Getting those things right will save you millions of dollars over your lifetime.

Things you’ll need to file your taxes

As an investor, you’ll need a few more documents and bits of information than you will if you’re just the standard wage earner with a W-2. You’ll need records to show your income (and perhaps losses) from investing. You’ll also need to file more forms than does the 9-5 employee (which is another reason to use a CPA) and you might need to be sending in tax payments for your investing income throughout the year. These include:

  1. W-2 Forms: If you have a job, your employer should provide you with a W-2 form. This will show all of the income you made and the taxes you paid. Taxes paid will include money that was withheld for state or federal taxes, social security taxes, and medicare taxes. It will also show if some of your income was protected from taxes with things like 401k payments and health savings account deposits.
  2. 1099 Forms: Each of the banks and brokerage firms with which you have an account should be sending you a 1099 form. This form shows your interest and dividend income, as well as capital gains distribution information for any funds that you own. You (or your accountant) will take this information from these forms and use it in preparing your tax forms.
  3. Record of closed stock trades: You’ll need to provide capital gain information for any positions that you close during the year. This means stocks, bonds, etc… that you have sold, leading to a capital gain or loss on the position. Today most brokerage houses keep information on the prices you paid (called your cost basis) and the amount for which you sold the securities and will provide your capital gain information for you with your 1099. There are times when they lose this info, however, and they could make a mistake, so it is best to keep a record of this yourself.
  4. K-1 forms: If you’re investing in limited partnerships or S-corporations, you’ll get a K-1 form from them shortly before April 15th. Because the partners/shareholders pay their portion of the company’s taxes with their taxes, these forms will provide you with the information that you’ll need to properly account for this income. You might also need to file one or more state income tax forms for states in which the company operates. For things like oil and gas pipelines, this can be a whole lot of returns to file. Note that this adds a lot of complexity, so you’ll probably want to put these types of investments in IRAs and other tax-sheltered accounts and/or use a CPA for your taxes.

Special notes about stock purchase information

As stated previously, most brokerage firms now keep records of your stock/fund purchases and cost basis information, but it is still a good idea to keep a record yourself. You’ll want to both keep a copy of the trade confirmations and a yearly record of closed positions for your taxes that year. In the past, brokers would send a paper trade confirmation slip for each trade. These provide information on the securities trades, the prices and commissions paid, and the date of transactions. This is just the information that you’ll need should the IRS come knocking asking for you to confirm your capital gains information.

When a paper copy was sent, you could keep the opening trade slips (buy confirmations) in a folder and then when you closed the position (typically by selling the stock) you could take the buy confirmation and the sell confirmation and put them together somewhere. Today, many brokerages only give you an online record. If this is the case, it would be wise to get into the practice of keeping screen shots of these confirmations and either printing them out to keep in a folder or, better yet, storing them somewhere somewhat safe from digital loss like a thumb drive or on online storage location.

Worse comes to worse, your broker can always research your positions and come up with cost basis information for you, so don’t lose hope if you lose records or have something like a fire that destroys your records. your broker may charge you a fee to find your records, however, so it is good to keep records normally and use the broker search as a last resort.

Good organization is the key

Remember that organization is the key when dealing with tax information. If you have everything together neatly, it will make it a breeze to both prepare your taxes correctly and provide the evidence needed should you ever be audited. Always do things in a way where you won’t need to remember what you did in future years. remember that the IRS can go back seven years after you file a return, so you might need to provide information on something you did up to eight years ago. Don’t plan to rely on your memory. Write things down and put things together neatly.

Another reason that you’ll want to keep your own records is that there are different ways you can choose to calculate your cost basis. Some of these will result in paying lower taxes, so you’ll want the flexibility to choose rather than letting your brokerage choose for you. Once you choose a method for a given position, you’ll need to stick with it for the whole position, so you’ll need to have good records. The methods are: 1) averaging, 2) first-in, first-out, and 3) versus purchase.

Averaging cost basis

Averaging is just like it sounds, where you take the average price per share that you paid. This is probably what your broker will do for you, and probably the worst way to calculate your cost basis from a tax standpoint. If you’re selling whole positions at once, it won’t matter, but if you’re selling off positions slowly, it can make a big difference.

First-in, First-out

In this method, shares are assumed to be sold int he order in which they were purchased. For example, if you bought 100 shares each in 1999, 2000, 2004, 2005, and 2008, then you sold 300 shares in 2015, it would be assumed that you sold the shares purchased in 1999, 2000, and 2004 and you’d use the cost basis for those years. This method has the advantage that it is most likely to result in long-term gains (gains for positions that are held for at least one year), which are taxed at a lower rate than short term gains, but it has the disadvantage that you’ll probably be selling the shares that have gone up the most. For this reason, this is usually a bad way to calculate a cost basis.

Want simpler taxes? Check out a strategy such as The Bogleheads’ Guide to the Three-Fund Portfolio.

Versus purchase

This takes a little more work on your part, but is the best way to set cost basis. When you’re putting in the order to sell the stock, you need to specify which shares you’re selling. For example, if you bought 200 shares in 2016 for $10 per share and then 100 shares in 2017 for $5 per share and you sold 200 shares, the averaging method would set your cost basis at $8.33. If you did a versus purchase and chose to sell the 2016 shares, your cost basis would be $10 per share, lowering your gain. Of course, when you finally sold the other shares, your cost basis there would be only $5 per share, but it is generally best to realize gains as late as you can. The rule is to delay capital gains into next year and move losses into the current year if you can.

(If you enjoy The Small Investor and want to support the cause, or you just want to learn how to become financially independent, please consider picking up a copy of my new book, FIREd by Fifty: How to Create the Cash Flow You Need to Retire Early  This is the instruction manual on how to become financially independent.)

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.


    • Thank you! Unfortunately, I’ve never been involved in real estate other than REITs and have never run a business. Maybe there are others out there though who will take up the challenge.

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