Announcer:
It’s time now on KROS for Financial Focus, brought to you by NelsonCorp Wealth Management. The opinions voiced in this show are for general information only and are not intended to provide specific advice or recommendations for any individual. Any indices mentioned are unmanaged and cannot be invested into directly. Registered representative securities offered through Cambridge Investment Research Incorporated, a broker dealer, member of FINRA, SIPC, investment advisor representative, Cambridge Investment Research Advisors Incorporated. A registered investment advisor, Cambridge and NelsonCorp Wealth Management are not affiliated. Cambridge does not offer tax advice. Now here’s today’s Financial Focus program.
Jake Woodcock:
Good morning, and welcome to this week’s Financial Focus brought to you by NelsonCorp Wealth Management here on KROS. This is Jake Woodcock. Regular listeners probably know that I’m a new voice here. This is my first time on the show. Some of the usual suspects that bring this to you every week, they’re traveling for the holidays. But I’ve been with NelsonCorp Wealth Management for 10 years, usually behind the scenes working on our investment strategies and other research endeavors. But thought this would give me an opportunity to get out from behind my computer and try something a little bit different.
Jake Woodcock:
To make sure things run smoothly today, we’ve got Mike Van Zuiden here from our tax department. He’s a regular on the show, so most people will recognize his voice. But how are we doing this morning, Mike?
Mike Van Zuiden:
Doing well. Glad to be here, staying warm.
Jake Woodcock:
Yeah, this is the last show of 2021. You ready to ring in the New Year and put 2021 behind us?
Mike Van Zuiden:
I am definitely ready to move on to the new year.
Jake Woodcock:
Yeah, 2021 certainly given us a lot to talk about. For today’s show, we were wanting to take advantage of Mike’s expertise and talk about the tax subject. David had an article in the Clinton Herald a week or so ago talking about mutual fund capital gains distributions that I think would be a great area to spend some more time in.
Jake Woodcock:
In the article, he laid out that this year’s pretty unusual, and what we’re talking about is most people probably know that when they buy something and sell it for a higher price later, that they had a gain that they’ll have to pay tax on. Throughout the year, they’re buying and they’re selling. They’ll get a statement at the end of the year showing them what their gain is and put it on their tax return.
Jake Woodcock:
Funds work the same way. Throughout the year, the fund’s buying and selling stuff and whatever gain they have at the end of the year, they’ll distribute out and investors will pay capital gains tax on. This year, after three years of a big bull market there’s quite a bit of gains built up, and some of these distributions we’re seeing are quite large across the board.
Jake Woodcock:
Some of these mutual funds we’re seeing low double digit returns on up to some are even 20% of the fund value, so it was really quite large and probably something that hasn’t got enough attention this year. The big gains get all the press, but those tax bills are maybe kind of behind the scenes there. Mike, do you want to maybe go through what that looks like on a tax return?
Mike Van Zuiden:
Absolutely. Sometime here in the fairly near future as the new year comes about, people with taxable accounts will start seeing these 1099s arriving. Your IRA accounts and your retirement accounts aren’t going to be impacted by this, but your taxable accounts are. I thought I would just touch a little bit on these forms that you’ll begin seeing that we’re going to use to prepare your tax return for the coming year, and just touch a little bit on what some of these numbers that you’ll see mean.
Mike Van Zuiden:
There’s a 1099-B that’s often used to report capital gains, and within that document, basically you’ll see the proceeds from the transactions that occurred on your behalf, and it will also report a basis. Obviously, the difference between what you made in the sale and the basis is the capital gain that Jake was talking about. Those gains will be broken down into short term and long term gain, and those numbers are something that will definitely have an impact on your tax return.
Mike Van Zuiden:
Your short term gains are going to be taxed at an ordinary income rate, and a short term gain would be something would be gained on something that was held for less than a year and sold. Then your long term gains, those are taxed at different rates depending on what your income range is.
Mike Van Zuiden:
If you are a joint filer, so married filing jointly, capital gains are taxed at 0% if your taxable income is $80,800 or less. We see a lot of people that come in and fall into that category. The next step up as far as long term capital gains rate, 15%. Any income that a married filing joint couple had from 80,801 up to 501,600, $501,600, that’s the 15% range.
Mike Van Zuiden:
So, capital gains, long term capital gains, for people that fall in that range, you pay pay 15%. Then anything above the 501,600 number, the capital gains are taxed at 20%. That is the impact of the capital gains to your tax returns. That’s the 1099-B. Those are the sorts of things you’ll see reported on that document that you’ll begin receiving here next month.
Mike Van Zuiden:
You’ll also see a 1099-INT. That is basically the tool for reporting interest. You’ll see interest income on there. If you have interest resulting from savings bonds, treasury obligations, things like that, those items are reported on that document as well. Those are really the big items that impact most people as far as the 1099 that you’ll receive for interest income.
Mike Van Zuiden:
Then there’s a 1099 for dividends and distributions. Just a couple of things to touch on there as far as what some of those numbers are and mean. You’ll see ordinary dividends reported on there, and an ordinary dividend basically is taxed at your ordinary income rate. Qualified dividends in Box 1b are reported there, and then as Jake was talking earlier about capital gains distributions, those will be reported in Box 2a on the 1099-DIV.
Mike Van Zuiden:
Those are really, I guess, the big three on that document. The last several years, Box 5 on that document, so those are 199A dividends, and those relate to investments held in real estate, investment trusts and things such as that. You’d also see some exempt interest dividends reported in Box 12 of that document. Basically, dividends that are received that are exempt from the interest there.
Mike Van Zuiden:
I want to stress to you again the things that we’re talking about now are not relevant to your IRAs or your retirement accounts, so these are in taxable accounts, so they’ll be coming soon, and the time will be upon us to reconcile the tax return with all of these documents and get to the bottom line.
Jake Woodcock:
There’s a lot going on on that form there from if you have a brokered account. How many people just drop that in your lap, Mike? “Hey, here it is.” How many people do you think actually comb through that and really know what’s going on there?
Mike Van Zuiden:
I would say most people just tell me, it’s kind of a “Tell me what I owe,” right? I got all these documents and I know my money made some money and I know it’s going to cost me. But no, I think it’s important to understand these things. We certainly relish the opportunity to sit down and talk with people about these things.
Mike Van Zuiden:
Some people come by, bring us their documents, “Hey, set me up with a tax return and call me when it’s ready.” But it’s a good basis for conversation and understanding what’s going on with your money. I think once that happens, then we can have some good conversations also about, “Well, what can we do about the tax implications we see here, right?”
Jake Woodcock:
Yeah, absolutely. Yeah, it seems like with the exceptional year we’re looking at with these big distributions, it could certainly come as a little bit of a surprise to some investors.
Mike Van Zuiden:
For sure.
Jake Woodcock:
Definitely interested to see how that goes. What’s interesting, I’d like to point out that there is an alternative path. We’ve been talking about the mutual fund capital gains distributions. In most of our managed portfolios maybe five years or so ago, we we’ve moved away from mutual funds. Pretty much all our portfolios consist of what are called exchange traded funds which, or ETS for short is how they’re generally referred to. But they’re built from the same regulation that governs mutual funds, but they operate fairly differently.
Jake Woodcock:
The mutual fund, I can either buy it directly from the mutual fund company. I can buy it in my brokerage account, but at the end of the day, what happens is I give the mutual fund company a dollar, they take it in, go out and buy the stocks they want to buy. But if someone wants to take a dollar out of that mutual fund, then they’ve got to sell some stuff and give the investor their money back.
Jake Woodcock:
That means other people’s activities can actually impact what your tax bill looks like. Because if there’s a lot of redemptions, the mutual fund has to sell a bunch of stocks and realize some gains that maybe they wouldn’t have otherwise.
Jake Woodcock:
The exchange traded funds, or the ETFs, they work different in the sense that they actually trade on the exchange like a stock. So, it’s not just giving a dollar to the mutual fund company. If I want to buy an ETF, I go out and I buy it on the open market on the stock exchange. The way those work is through authorized market participants who are the big institutional outfits that manage these type of operations.
Jake Woodcock:
There’s something magic going on behind the scenes there. If I want to buy a bunch of an ETF, what those participants do, they’re an intermediary between the ETF issuer and the investor. If I want to buy an ETF, they will actually go out. ETFs are very transparent, so those authorized participants know what all the ETF consists of. They’ll actually go out, buy all the stocks that the ETF consists of, go to the ETF company and say, “Hey, here’s all these stocks, give me some units of this ETF.”
Jake Woodcock:
Then the ETF issuer does that, and the opposite is true. If I want to sell my ETF, that authorized participant will buy the ETF from me and go redeem it through the ETF provider, and they’ll just say, “Hey, give me all the stocks that this ETF is made up of in exchange for this ETF unit.”
Jake Woodcock:
That’s the key to off loading some of these gains that the ETFs are just much more tax efficient, because when they give those shares to the authorized participant, unlike a mutual fund selling them, they can give the authorized participant all their lowest base of stock. So, effectively they can give all the tax bill to those authorized participants and the investors never have to see those tax bills, so just a huge tax advantage with ETFs.
Jake Woodcock:
There’s a number of other advantages that are outside the scope of our conversation today, but just worth pointing out that not every fund is created equal. There’s a big difference, especially tax wise, between the mutual funds and ETFs.
Jake Woodcock:
Anything else you think worth touching on, Mike?
Mike Van Zuiden:
I think we touched on everything I was hoping to speak to today. Look forward to visiting with a lot of you listening out there here very soon as we are rapidly approaching the filing season for income tax.
Jake Woodcock:
Yeah, getting a couple weeks out or are you guys gearing up?
Mike Van Zuiden:
The phone is ringing and appointments are being made, so it’s that time.
Jake Woodcock:
All right, well that should do it for time. Do want to mention that every Friday, NelsonCorp Wealth Management does Jeans for Charity. The charity we’re supporting this month is the Knights of Columbus Ladies Auxiliary.
Jake Woodcock:
Thanks again, Mike, for joining me up here. It’s been fun and we’ll see you in the new year.
Mike Van Zuiden:
All right. Thanks for having me.
Jake Woodcock:
Thanks.
Announcer:
Financial Focus is a production of NelsonCorp Wealth Management in Clinton and Davenport. The opinions voiced in the show are for general information only and are not intended to provide specific advice or recommendations for any individual. Any indices mentioned are unmanaged and cannot be invested into directly. Registered representatives securities offered through Cambridge Investment Research Incorporated, a broker dealer member of FINRA, SIPC, investment advisor representative, Cambridge Investment Research Advisors Incorporated, a registered investment advisor. Cambridge and NelsonCorp Wealth Management are not affiliated. Cambridge does not offer tax advice. For more information, visit our website at www.nelsoncorp.com.