Harry Sit's Blog, page 15

Mortgage Interest and Limit in TurboTax, H&R Block, FreeTaxUSA

Many homeowners refinanced to a sub-3% mortgage when interest rates were low a couple of years ago. The mortgage interest most people pay isn’t large enough to make them itemize their deductions. They just take the standard deduction. Those who can still deduct their mortgage interest tend to have a large mortgage.

Table of ContentsLimit on DeductionAverage Mortgage BalanceTurboTaxH&R BlockFreeTaxUSALimit on Deduction

The Tax Cuts and Jobs Act of 2017 reduced the limit on the mortgage balance on which you can deduct the mortgage interest from $1 million to $750,000. The lower limit applies to homes acquired after December 15, 2017. The large increase in home prices in recent years makes recently bought homes in high-price areas more likely to exceed the $750,000 limit.

However, lenders still report 100% of the mortgage interest paid on the 1098 form without adjusting for either the old $1 million limit or the new $750,000 limit. If your mortgage balance is over the limit, deducting the mortgage interest is more complicated than just using the number from the 1098 form.

It isn’t simply multiplying $750,000 by your interest rate either when your mortgage balance started above $750,000 and ended below $750,000 or when you took out the loan in the middle of the year.

Average Mortgage Balance

A key concept is your average mortgage balance during the year. When your average mortgage balance exceeds the limit, your deductible mortgage interest is:

Loan Limit / Average Mortgage Balance * Actual Mortage Interest Paid

If you paid $30,000 in mortgage interest on an average mortgage balance of $1,000,000 and you’re subject to the $750,000 limit, your deductible mortgage interest is pro-rated to:

$750,000 / $1,000,000 * $30,000 = $22,500

IRS Publication 936 gives several ways to calculate your average mortgage balance:

Average of first and last balance methodInterest paid divided by interest rate methodMortgage statements method

The first method is simpler and it gives you a slightly larger deduction but you can use it only if you didn’t prepay more than one month’s principal during the year.

Here’s how it works in TurboTax, H&R Block, and FreeTaxUSA tax software.

TurboTax

The screenshots below are taken from TurboTax Deluxe downloaded software. The TurboTax downloaded software is both less expensive and more powerful than TurboTax online software. If you haven’t paid for your TurboTax online filing yet, you can buy TurboTax download from Amazon, Costco, Walmart, and many other places and switch from TurboTax online to TurboTax download (see instructions for how to make the switch from TurboTax).

Find the mortgage interest topic in the Your Home section under Federal Taxes -> Deduction & Credits.

Form 1098

When it asks you to enter information from your 1098 form, enter the numbers as they appear on your form. If Box 2 is blank on your 1098, enter the mortgage balance at the beginning of the year (or your beginning loan balance if you took out the loan during the year).

You get to this summary after you answer a few more questions. Click on Done but you’re not done yet.

Purchase Date and Ending Balance

The purchase date of the home determines whether you have a $1 million limit or a $750,000 limit for the mortgage interest deduction. If this mortgage was from a refinance, you still enter the date when you originally bought the home.

TurboTax asks for the balance as of January 1 of the following year because it uses the “average of first and last balance method” to calculate your average mortgage balance for the year. This works when you didn’t make extra principal payments during the year.

TurboTax calculates a deduction using the “average of first and last balance method” but you can’t legally use that method if you prepaid more than one month’s principal during the year. You must calculate your average mortgage balance in a different way and give the pro-rated deductible mortgage interest to TurboTax.

If You Prepaid Principal

If you had the mortgage for all 12 months and your interest rate didn’t change during the year, which is the case for most people with a fixed-rate mortgage, you can use the “interest paid divided by interest rate method” to calculate your average mortgage balance. Suppose you paid $30,000 in mortgage interest and your rate is 2.875%, your average mortgage balance is:

$30,000 / 0.02875 = $1,043,478

Your deductible mortgage interest is:

$750,000 / $1,043,478 * $30,000 = $21,562

If your interest changed during the year, you’re better off using the “mortgage statements method.” Download the monthly statements from your lender. Add up your balance from January to December and divide by 12. That’s your average mortgage balance during the year. Use that number to calculate your pro-rated deductible mortgage interest and give it to TurboTax:

Loan Limit / Average Mortgage Balance * Actual Mortage Interest Paid

Verify on Schedule A

To confirm how much mortgage interest deduction you’re getting, click on Forms on the top right and find Schedule A in the list of forms in the left panel.

Scroll down to the middle and find Line 8. You’ll see the mortgage interest deduction.

H&R Block

Mortgage interest deduction works differently in the H&R Block software.

Find “Home Mortgage Interest (Form 1098)” under Federal -> Deductions.

1098 Entries

H&R Block offers a Home Mortgage Assistant. Click on that.

After saying we have a 1098 form and entering the name of the lender, we come to this form to enter the numbers on the 1098 form.

Wrong!

After answering some more questions about points and mortgage insurance premiums, which we don’t have, H&R Block says we can deduct 100% of the mortgage interest paid.

This can’t be right. We entered a beginning balance above $1 million on the 1098 form. H&R Block didn’t ask for the home purchase date to see whether the limit is $1 million or $750,000. It didn’t ask for the ending balance or the interest rate to calculate the average mortgage balance. H&R Block just uses the interest paid number from the 1098 form as if the loan limit doesn’t exist.

Calculate It Yourself

We go back to the 1098 entries to see if we missed anything. See there’s a Learn More link next to Box 2? What’s that?

There’s our answer. It says at the end:

If a limit applies to you, visit www.irs.gov and see Publication 936 Home Mortgage Interest Deduction. You’ll need to use the Worksheet To Figure Your Qualified Loan Limit and Deductible Home Mortgage Interest for the Current Year to calculate your deductible interest and limit your entry to that amount.

Translation: You’re on your own when your mortgage is over $750,000. Calculate it yourself and put the result here.

Granted that TurboTax doesn’t cover all situations but at least it makes an attempt to cover the most common scenario (only regular payments without extra principal payments). H&R Block just washes its hands and puts it all on you when your mortgage is above the limit. That’s lazy. Although only a small percentage of people deduct their mortgage interest now, among those who can still deduct, many have a mortgage above the limit.

It’s bad enough that the software doesn’t do the necessary work to help you calculate, but it’s inexcusable that it doesn’t warn you more conspicuously you’re on your own. Many people won’t notice the information hidden behind a subtle Learn More link.

So what do you do if you’re using the H&R Block software? Do what TurboTax does. First, calculate your average mortgage balance:

If you didn’t prepay more than one month’s principal, get the beginning balance and the ending balance. Take an average.If you made extra principal payments and your interest rate didn’t change, divide the interest paid by your interest rate.

Then, calculate your deductible mortgage interest:

Loan Limit / Average Mortgage Balance * Actual Mortage Interest Paid

FreeTaxUSA

I also checked how the online tax software FreeTaxUSA does it.

Similar to H&R Block, FreeTaxUSA puts a small question mark link next to the mortgage interest entry. Clicking on the question mark opens a pop-up window, which says toward the end:

If your debt is higher than the limits, use Publication 936 to figure out your deductible home mortgage interest amount and reduce the mortgage interest you enter accordingly.

You’re also on your own when you use FreeTaxUSA. It also doesn’t tell you clearly that you must do some extra work.

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H&R Block tax software is less expensive than TurboTax but this isn’t the only case where it punts and asks you to read the IRS instructions and come back with the answer yourself. See another example in How to Enter 2022 Foreign Tax Credit Form 1116 in H&R Block. You really have to know where it cuts corners when you use H&R Block software. It works well only when those cut corners don’t affect you. The same also applies to FreeTaxUSA.

Learn the Nuts and Bolts I put everything I use to manage my money in a book. My Financial Toolbox guides you to a clear course of action.Read Reviews

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No FDIC Insurance – Why a Brokerage Account Is Safe

News came last Friday that Silicon Valley Bank was taken over by the FDIC after it had a bank run. Silicon Valley Bank was the 16th largest bank in the country with over $200 billion in assets. Such a big bank failing so suddenly was a shock to the financial system.

Silicon Valley Bank primarily served business customers, not individual retail customers. The FDIC insurance limit of $250,000 isn’t very meaningful to a business. As a result, over 90% of the deposits at Silicon Valley Bank were over the FDIC insurance limit. The government rushed to make an exception and guaranteed all deposits at Silicon Valley Bank to reduce systemic risks.

Most of us don’t have over $250,000 lying around in cash. Even if we need to keep more than $250,000 in cash at times, it’s easy to spread the money over several banks to keep it fully insured. The money is safe as long as you stay under the FDIC insurance limit.

The news of Silicon Valley Bank’s failure also affected Charles Schwab. The stock price of Charles Schwab dropped over 20% at one point today. Charles Schwab has a banking arm — Schwab Bank. Schwab Bank also has uninsured deposits and unrealized losses in long-term bonds on its balance sheet. Many people do have more than $250,000 in Schwab brokerage accounts. Just the other day a reader asked whether it’s safe to buy Treasuries in a brokerage account.

Customer Assets at a Broker

There’s a big difference between having money at a bank and having money at a broker such as Charles Schwab, Vanguard, or Fidelity. Money at a broker isn’t insured by the FDIC but it isn’t like uninsured deposits at a bank.

When you have money at a bank, you have a lender-borrower relationship with the bank. The bank borrows money from you and lends money to others. As George Bailey explained in It’s a Wonderful Life, the bank doesn’t have your money in a safe. It’s in “Joe’s house, and Kennedy’s house, and a hundred others.” Or in Silicon Valley Bank’s case, it’s in long-term bonds that the bank intended to hold to maturity but lost value after interest rates went up sharply.

When you have money at a broker, the broker is only buying and keeping things for you. There is an exact mapping between what the broker says you have in your account and what the broker keeps for you. Your money is in stocks, bonds, mutual funds, ETFs, etc. The broker doesn’t invest your money in long-term bonds for itself.

Money Market Fund

When you have cash in a money market fund at a broker, the money market fund invests in very short-term bonds. When you’re getting a 4.5% yield in a money market fund, the yield is coming from the underlying holdings of the money market fund. It’s not coming from the broker.

The safety of a money market fund depends on the safety of its underlying holdings. The money market fund isn’t FDIC-insured but its underlying holdings may be issued by government entities. If the broker goes down, you still have shares in the money market fund and the money market fund still has its holdings.

The safest money market fund holds only Treasuries and other government bonds. Vanguard, Fidelity, and Charles Schwab all have a money market fund that invests only in Treasuries and government bonds. See my Guide to Money Market Funds.

Buy Treasuries

If you can commit to a set term (the equivalent of buying a CD at a bank), you can also buy Treasuries in a brokerage account. You don’t need FDIC insurance when you buy Treasuries because Treasuries are issued by the federal government.

The big-3 brokers Charles Schwab, Vanguard, and Fidelity all make it very easy to buy Treasuries with no fee. See How To Buy Treasury Bills & Notes Without Fee at Online Brokers and How to Buy Treasury Bills & Notes on the Secondary Market.

Madoff and MF Global

People lost money at brokers when the broker didn’t maintain the exact mapping between what it said customers had in their accounts and what the broker kept for the customers. Two recent examples are Bernie Madoff and MF Global.

Madoff falsified account records. He said he bought this and that for the customers but he really didn’t. It was a fraudulent scheme.

MF Global breached the legal separation between customer assets and broker assets. It “borrowed” from customer assets to cover failed speculations elsewhere. Customers were eventually made whole after MF Global went bankrupt but it took five years.

SIPC Insurance

Brokerage accounts are insured by SIPC up to $500,000 but the insurance doesn’t cover the payback from your investments. It only covers missing assets if the broker goes down.

If you don’t suspect that Charles Schwab, Vanguard, or Fidelity will act illegally as Madoff or MF Global did, the safety of your money at these brokers doesn’t depend on the financial health of Charles Schwab, Vanguard, or Fidelity.

Most of my money is in brokerage accounts. I don’t worry about whether the account is over the SIPC insurance limit. Money at a broker is safer than uninsured deposits at a bank.

Learn the Nuts and Bolts I put everything I use to manage my money in a book. My Financial Toolbox guides you to a clear course of action.Read Reviews

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Get Rid of Estimated Tax Payment Vouchers from TurboTax

The previous post Opt Out of Underpayment Penalty in TurboTax covered how TurboTax calculates an underpayment penalty that the IRS may not actually assess. You have to take an extra step to decline the penalty calculated by TurboTax. Here’s another example of TurboTax providing unwanted help that requires work to reverse.

Print or Save to PDF

When you’re done entering everything into TurboTax, it’s a good idea to print the tax forms or create a PDF file with all the forms as a draft. You should review the forms carefully and compare them with the previous year before you file. After you review everything and e-file, you should save the final filing to a PDF file for your records. TurboTax download software has a handy menu option for that: File -> Save to PDF.

Estimated Tax Payment Vouchers

TurboTax automatically includes 4 filled-out estimated tax payment vouchers (Form 1040-ES) when you print or save a PDF. This confuses many people. Most people pay their taxes during the year through withholding. Having the estimated tax payment vouchers printed out or included in the PDF doesn’t mean you must pay estimated taxes now.

The estimated tax payment vouchers are also a relic of the past. Even if you’re required to pay estimated taxes, sending a check with those vouchers by snail mail isn’t the best way to do it anyway. You’re better off paying electronically on the IRS website using either Direct Pay or EFTPS.

Direct Pay doesn’t require setting up an account but you have to verify your identity and enter your bank information every time. EFTPS requires setting up an account but subsequent payments are easier and faster. I use EFTPS.

When you use Direct Pay or ETFPS, you get a confirmation from the IRS of your payment immediately and you know that the payment will be credited to your account accurately. You have more chances of delay and errors if you send a check by mail with one of those estimated tax payment vouchers.

Exclude from Print or PDF

Having estimated tax payment vouchers printed out confuses you. Having them included in your tax filing PDF clutters up your file. If you’d like to avoid confusion, here’s how you can stop TurboTax download software from including them.

Click on Forms on the top right.

Scroll down and click on “Est Tax Options” near the bottom of the list of forms on the left.

Scroll down on the right to find the heading “Prepare Estimated Tax Payment Vouchers” in the middle of the form. Check the option “No, do not prepare estimated tax payment vouchers.”

Click on Step-by-Step on the top right to get back to where you were.

Now save to PDF or print your forms. It won’t have those useless estimated tax payment vouchers.

Learn the Nuts and Bolts I put everything I use to manage my money in a book. My Financial Toolbox guides you to a clear course of action.Read Reviews

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Opt Out of Underpayment Penalty in TurboTax and H&R Block

When you do your taxes in tax software, the software sometimes calculates an underpayment penalty. It thinks you owe the penalty when your tax withholding plus any estimated tax payments were below a certain threshold (the “safe harbor“):

Within $1,000 of your tax obligation; or90% of your current year’s tax obligation; or100% of your previous year’s tax obligation (110% if your AGI in the previous year was $150,000 or more)

If your income was uneven throughout the year, you can try to get out of paying the underpayment penalty through a complicated exercise using the “Annualized Income Installment Method.” It basically comes down to doing your taxes four times by separating your income and deductions into four sub-periods within the year and calculating your taxes for each sub-period.

I don’t know about you but I don’t have any appetite for doing my taxes four times.

There’s a much better way. The tax software is only trying to be helpful in calculating the underpayment penalty for you. You can decline its help and let the IRS calculate the penalty and bill you if they decide to assess a penalty.

The IRS actually often doesn’t assess a penalty when the tax software thinks you owe a penalty. You don’t have to volunteer the penalty now.

Here’s how to opt out of calculating the underpayment penalty in TurboTax and H&R Block software.

TurboTax

I’m using TurboTax downloaded software. TurboTax downloaded software is both more powerful and less expensive than TurboTax online software.

Find “Underpayment penalties” under Federal Taxes -> Other Tax Situations. Click on Start.

If TurboTax says you have a penalty for underpayment. Click on Continue.

TurboTax asks you about farming or fishing, which doesn’t apply to most people.

You can continue the confusing interview with more hoops to jump through but it’s much quicker if you switch to the Forms mode now by clicking on Forms on the top right.

TurboTax opens a form. Check the box next to item C to have the IRS calculate the penalty and send a bill if necessary. Chances are they won’t.

The underpayment penalty calculated by TurboTax is removed immediately after you check that box. Note in our example the tax owed meter dropped from $1,308 to $1,262 after we checked the box.

Click on Step-by-Step to return to the interview.

You’re back to the screen about farming and fishing. Click on “Other Tax Situations” in the sub-menu to exit this section.

H&R Block

It’s much more straightforward in the H&R Block downloaded software. H&R Block download is also both more powerful and less expensive than H&R Block online software.

Find “Underpayment Penalty” under Federal -> Taxes. Click on Go To.

H&R Block offers the option to let the IRS calculate the penalty right away. The option is selected by default.

H&R Block explains that it won’t cost you any more to have the IRS calculate the penalty. It actually will cost you less when the IRS doesn’t assess a penalty.

Learn the Nuts and Bolts I put everything I use to manage my money in a book. My Financial Toolbox guides you to a clear course of action.Read Reviews

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State Tax-Exempt Muni Bond Interest from Mutual Funds and ETFs

The previous post State Tax-Exempt Treasury Interest from Mutual Funds and ETFs covered how to get state income tax exemption on the portion of mutual fund and ETF dividends that are attributed to interest from Treasuries. This post covers how to do the same on the portion of fund dividends attributed to muni bond interest.

Muni Bond Funds and ETFs

Investors in higher tax brackets often invest in muni bonds in their taxable accounts. Although muni bonds typically have a lower yield than Treasuries and corporate bonds, they often still pay more after-tax when the investor is in a high tax bracket.

Most people invest in muni bonds through muni bond funds and ETFs. The broker reports fund dividends attributed to muni bond interest separately in Box 12 on a 1099-DIV form.

Your tax software knows about this special box. Whether you import your 1099 forms or enter them manually, the tax software will automatically mark the amount as tax-exempt for federal income tax.

Federal Tax-Exempt vs. State Tax-Exempt

It’s a different story for state income tax.

How a state taxes muni bond interest varies by state. Some jurisdictions such as Washington DC exempt interest from all muni bonds. Most states usually exempt interest only from muni bonds issued by entities within the state or in U.S. territories (Puerto Rico, Guam, Virgin Islands, and American Samoa). Some states have a reciprocal arrangement — “We don’t tax interest from your muni bonds if you don’t tax interest from our muni bonds.”

You need to know how much of the federally tax-exempt dividends on the 1099-DIV form is also state tax-exempt. Your tax software doesn’t know it only by the number on the form.

The broker supplies a breakdown of the tax-exempt dividends by source. It’s up to you to determine how much of the federal tax-exempt dividends from each source came from state tax-exempt muni bonds.

Suppose you own two funds in a taxable brokerage account that paid $2,500 in total tax-exempt dividends as reported in Box 12 of the 1099-DIV form. Your goal is to fill out a table like this with the percentage of state tax-exempt dividends for each fund and calculate your total state tax-exempt dividends:

FundTotal Tax-Exempt Dividend% State Tax-ExemptState Tax-Exempt DividendFund A$1,500100%$1,500Fund B$1,00025%$250Total$2,500$1,750

When you give the result to your tax software, it then knows to exempt that portion of the federal tax-exempt dividends from state income tax.

State % from Fund Managers

Although the 1099-DIV form and the dividend breakdown by funds are provided by the broker, you’ll have to get the number for the “% State Tax-Exempt” column from the managers of your mutual funds and ETFs.

If you own Vanguard mutual funds or ETFs in a Fidelity brokerage account, you get this information from Vanguard, not from Fidelity. Similarly, if you own iShares ETFs in a Charles Schwab brokerage account, you get the information from iShares, not from Charles Schwab.

Google “[name of fund management company] tax center” to find the information from the fund manager.

For instance, the Vanguard document shows that dividends from Vanguard New York Municipal Money Market Fund are 100% tax-exempt in New York in 2022, and 24.24% of the dividends from the Vanguard Tax-Exempt Bond Index Fund came from New York muni bonds.

Vanguard

Vanguard publishes the information in its Tax Season Calendar. Look for “Tax-exempt interest dividends by state.”

Fidelity

Fidelity publishes the information in Fidelity Mutual Fund Tax Information. Look for “Tax-Exempt Income From Fidelity Funds.”

Charles Schwab

Charles Schwab Asset Management publishes the information in its Distributions and Tax Center. Look for “[20xx] Supplementary Tax Information.”

iShares

iShares publishes the information in its Tax Library. Look for “[20xx] Tax Exempt Interest by State.”

State-Specific Requirements

Be sure to read the fine print. Just because a fund lists a percentage for your state doesn’t mean that percentage of dividends from the fund is state tax-exempt. Some states have additional requirements before you can claim the tax exemption.

For instance, the Vanguard tax-exempt income document includes these footnotes:

California and Minnesota require funds to meet in-state minimum threshold to be exempt from state tax. The funds in Table 2 do not meet this criteria [sic].

Illinois does not exempt the portion of dividends from state or local obligations held indirectly through a mutual fund.

This means even though the table shows that 15.23% of the dividends from Vanguard Tax-Exempt Bond Index Fund came from California muni bonds, California exempts none of it because the fund didn’t meet the state’s additional requirements. If you live in Illinois, you can’t claim any Illinois tax exemption on muni fund dividends, period.

Tax Software

You need to give the result to your tax software after you get the “% State Tax-Exempt” for each fund and calculate your State Tax-Exempt dividend with a table like this:

FundTotal Tax-Exempt Dividend% State Tax-ExemptState Tax-Exempt DividendFund A$1,500100%$1,500Fund B$1,00025%$250Total$2,500$1,750TurboTax

If you enter your 1099-DIV form manually, be sure the check the box for additional inputs to enter tax-exempt dividends in Box 12.

Unless your tax-exempt dividends came from a state-specific fund that’s 100% tax-exempt in your state, check the box “I earned tax exempt dividends in more than one state” and break it down between your state and “More Than One State.” TurboTax will claim the portion for your state as tax-exempt on your state income tax return.

H&R Block

After you enter the tax-exempt dividends in Box 12 of a 1099-DIV form, H&R Block asks you how much of it is also state tax-exempt.

FreeTaxUSA

After you enter the tax-exempt dividends in Box 12 of a 1099-DIV form, FreeTaxUSA asks you how much of it is also state tax-exempt.

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Most of the work in calculating the amount of fund dividends exempt from state taxes is in hunting down the percentage of state tax-exempt income for each fund and ETF in your taxable brokerage account. Tax software doesn’t know it only from the tax forms.

Learn the Nuts and Bolts I put everything I use to manage my money in a book. My Financial Toolbox guides you to a clear course of action.Read Reviews

The post State Tax-Exempt Muni Bond Interest from Mutual Funds and ETFs appeared first on The Finance Buff.

State Tax-Exempt Treasury Interest from Mutual Funds and ETFs

When you earn interest from U.S. Treasuries in a taxable account, the interest is exempt from state and local taxes. How the interest is reported on tax forms depends on whether you hold Treasuries directly or through mutual funds and ETFs.

Table of ContentsInterest from Treasury Bills and NotesTreasuries in Mutual Funds and ETFsGovernment % from Fund ManagersVanguardFidelityCharles SchwabiSharesCA, NY, and CT ResidentsTax SoftwareTurboTaxH&R BlockFreeTaxUSAInterest from Treasury Bills and Notes

When you buy Treasuries in a taxable brokerage account — see How To Buy Treasury Bills & Notes Without Fee at Online Brokers and How to Buy Treasury Bills & Notes On the Secondary Market — you’ll see the interest reported on a 1099-INT form and/or a 1099-OID form (for TIPS).

Interest from Treasuries is reported separately in Box 3 on a 1099-INT form.

Inflation adjustment for TIPS is reported separately in Box 8 on a 1099-OID form.

Your tax software knows about these special boxes in the tax forms. Whether you import the tax forms from your broker or enter them manually, the software will automatically mark the interest as exempt from your state income tax.

Treasuries in Mutual Funds and ETFs

Many money market funds, bond funds, and bond ETFs hold Treasuries. If you have these funds in a taxable brokerage account, a good part of the funds’ dividends may have come from Treasuries. The portion of fund dividends attributed to interest from Treasuries isn’t qualified dividends. It’s taxed at normal tax rates for federal income tax but it’s still exempt from state and local taxes.

When you have multiple mutual funds or ETFs in a taxable brokerage account, the broker reports dividends received from all sources on one 1099-DIV form. The 1099-DIV form doesn’t have a special box broken out for dividends attributed to Treasuries. Your tax software won’t know how much of the dividends were from Treasuries only by the numbers on the 1099-DIV form.

The broker supplies a breakdown of the dividends by source. It’s up to you to determine how much of the dividends from each source came from Treasuries. Suppose you own four funds in a taxable brokerage account that paid $6,500 in total dividends. Your goal is to fill out a table like this with the percentage of dividends from Treasuries for each fund and calculate your total dividends attributed to Treasuries:

FundTotal Ordinary Dividend% from TreasuriesDividend from TreasuriesFund A$5000%$0Fund B$1,00065%$650Fund C$2,00010%$200Fund D$3,00090%$2,700Total$6,500$3,550

When you give the result to your tax software, it then knows to exempt that portion of the dividends from state and local taxes.

Government % from Fund Managers

Although the 1099-DIV form and the dividend breakdown by funds are provided by the broker, you’ll have to get the number for the “% from Treasuries” column from the managers of your mutual funds and ETFs.

If you own Vanguard mutual funds or ETFs in a Fidelity brokerage account, you get this information from Vanguard, not from Fidelity. Similarly, if you own iShares ETFs in a Charles Schwab brokerage account, you get the information from iShares, not from Charles Schwab.

Google “[name of fund management company] tax center” to find the information from the fund manager.

Vanguard

Vanguard publishes the information in its Tax Season Calendar. Look for “U.S. government obligations information.”

Fidelity

Fidelity publishes the information in Fidelity Mutual Fund Tax Information. Look for “Percentage of Income From U.S. government securities.”

Charles Schwab

Charles Schwab Asset Management publishes the information in its Distributions and Tax Center. Look for “[20xx] Supplementary Tax Information.”

iShares

iShares publishes the information in its Tax Library. Look for “[20xx] U.S. Government Source Income Information.”

CA, NY, and CT Residents

California, New York, and Connecticut have additional requirements for exempting fund dividends earned from Treasuries. The fund management company will note in its published information whether a fund met the requirements of CA, NY, and CT. If a fund didn’t meet the requirements, the Treasuries percentage is treated as 0% for CA, NY, and CT residents.

For example, Vanguard Federal Money Market Fund earned 37.79% of its income from U.S. government obligations in 2022. Because it didn’t meet the requirements of CA, NY, and CT, investors in these three states must still pay state income tax on 100% of this fund’s dividends. People in other states pay state income tax on only 62.21% of this fund’s dividends.

Tax Software

You need to give the result to your tax software after you get the “% from Treasuries” for each fund and calculate your dividend from Treasuries with a table like this:

FundTotal Ordinary Dividend% from TreasuriesDividend from TreasuriesFund A$5000%$0Fund B$1,00065%$650Fund C$2,00010%$200Fund D$3,00090%$2,700Total$6,500$3,550

It’s easy to miss the entry point for this input unless you really look for it.

TurboTax

After you import or enter the 1099-DIV form, you need to check a box to say that a portion of the dividends is U.S. Government interest. It’s easy to miss because TurboTax says it’s uncommon, which isn’t true.

Now you enter the amount you calculated in your table.

H&R Block

H&R Block software shows a checkbox at the bottom of the 1099-DIV entries. This field doesn’t come in the import. It’s easy to miss because it’s at the bottom of a long form. You have to really look for it.

Instead of asking for a dollar amount, H&R Block goes by percentage. It forces you to do a bit of math. In our example, $3,550 from Treasuries divided by $6,500 total ordinary dividends is 54.62%. So we enter 54.62.

FreeTaxUSA

FreeTaxUSA has a radio button at the bottom of the 1099-DIV entries. It’s easy to miss because it’s at the bottom of a long form. You have to really look for it.

Now you give the dollar amount from your table.

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Most of the work in calculating the amount of fund dividends exempt from state and local taxes is in hunting down the percentage of income from Treasuries for each fund and ETF in your taxable brokerage account. You need to give the calculated amount to your tax software, which doesn’t make it obvious where the number should go.

A similar process also applies to muni bond funds and ETFs. A portion of the fund dividends is exempt from your state income tax (“double tax-free”). I’ll cover that topic in a separate post.

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One 1099-R Form for Two Rollovers in TurboTax and H&R Block

When you do a direct rollover from the pre-tax account in a workplace retirement plan to a Traditional IRA, you’ll get a 1099-R form after the end of the year that shows the rollover isn’t taxable. When you do a rollover from the pre-tax account to a Roth account, you’ll get a 1099-R form after the end of the year that shows a taxable amount.

Both of these 1099-R forms are straightforward. It’s either taxable or not taxable. You enter the 1099-R form in your tax software and tell it whether the rollover went to a Traditional account or a Roth account.

Combined 1099-R for Mixed Rollovers

When you do a mix of two or more rollovers in the same year — one to Traditional and one to Roth — your plan administrator may issue a combined 1099-R form for both rollovers. The combined 1099-R form shows that only a portion of your rollovers is taxable.

Example: Suppose you rolled over $30,000 to a Traditional IRA and $20,000 to a Roth account from the pre-tax account in your workplace retirement plan. You may get a 1099-R form that looks like this:

Box 1 Gross Distribution$50,000Box 2a Taxable Amount$20,000Box 2b Taxable amount not determinednot checkedBox 5 Employee contributions/Designated Roth
contributions or insurance premiums$0Box 7 Distribution code(s)GBox 7 IRA/SEP/SIMPLE checkboxnot checkedA combined 1099-R form

This 1099-R form is correct. It shows that a total of $50,000 came out of the plan. $20,000 is taxable because it went into a Roth account and the other $30,000 isn’t taxable because it was rolled over to a Traditional IRA.

Split 1099-R Form for Tax Software

Tax software such as TurboTax, H&R Block, or FreeTaxUSA sometimes has difficulty in dealing with a combined 1099-R form like this. The software asks you whether the money went to a Roth account. If you answer “Yes” it treats the entire $50,000 as taxable. If you answer “No” it treats the entire $50,000 as not taxable.

The software assumes that a rollover went into either a Traditional IRA or a Roth account but not both on the same 1099-R form. The trick to deal with this deficiency in the tax software is to split the combined 1099-R form into two — one for the rollover to the Traditional IRA and another for the rollover to the Roth account.

If you imported the combined 1099-R form, delete it and enter two 1099-R forms manually. Use the same payer name, address, and tax ID for both 1099-R forms.

You enter this 1099-R form for the rollover to a Traditional IRA:

Box 1 Gross Distribution$30,000Box 2a Taxable Amount$0Box 2b Taxable amount not determinednot checkedBox 5 Employee contributions/Designated Roth
contributions or insurance premiums$0Box 7 Distribution code(s)GBox 7 IRA/SEP/SIMPLE checkboxnot checkedA 1099-R Form for Rollover to Traditional IRA

You tell the software that this rollover went to a Traditional IRA. The software will make it not taxable.

Then you enter another 1099-R form for the rollover to a Roth account:

Box 1 Gross Distribution$20,000Box 2a Taxable Amount$20,000Box 2b Taxable amount not determinednot checkedBox 5 Employee contributions/Designated Roth
contributions or insurance premiums$0Box 7 Distribution code(s)GBox 7 IRA/SEP/SIMPLE checkboxnot checkedA 1099-R Form for Rollover to Roth Account

You tell the software that this rollover went to a Roth account. The software will make it taxable.

If your combined 1099-R form has a positive number in Box 5 because you made non-Roth after-tax contributions (“mega backdoor Roth“), include it on the applicable 1099-R form depending on whether the non-Roth after-tax contributions were rolled over to a Traditional IRA or a Roth account.

The two manually split 1099-R forms added together have the same numbers as the original combined 1099-R form. You’re splitting it only because the tax software isn’t smart enough to handle the combined 1099-R. The numbers are combined again on your 1040 tax form. It will show that you’re paying tax on only the portion that you rolled over from a pre-tax account to a Roth account.

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One 1099-R for Two Rollovers in TurboTax and H&R Block

When you do a direct rollover from the pre-tax account in a workplace retirement plan to a Traditional IRA, you’ll get a 1099-R form after the end of the year that shows the rollover isn’t taxable. When you do a rollover from the pre-tax account to a Roth account, you’ll get a 1099-R form after the end of the year that shows a taxable amount.

Both of these 1099-R forms are straightforward. It’s either taxable or not taxable. You enter the 1099-R form in your tax software and tell it whether the rollover went to a Traditional account or a Roth account.

Combined 1099-R for Mixed Rollovers

When you do a mix of two or more rollovers in the same year — one to Traditional and one to Roth — your plan administrator may issue a combined 1099-R form for both rollovers. The combined 1099-R form shows that only a portion of your rollovers is taxable.

Example: Suppose you rolled over $30,000 to a Traditional IRA and $20,000 to a Roth account from the pre-tax account in your workplace retirement plan. You may get a 1099-R form that looks like this:

Box 1 Gross Distribution$50,000Box 2a Taxable Amount$20,000Box 2b Taxable amount not determinednot checkedBox 7 Distribution code(s)GA combined 1099-R form

This 1099-R form is correct. It shows that a total of $50,000 came out of the plan. $20,000 is taxable because it went into a Roth account and the other $30,000 isn’t taxable because it was rolled over to a Traditional IRA.

Split 1099-R Form for Tax Software

Tax software such as TurboTax, H&R Block, or FreeTaxUSA has difficulty in dealing with a combined 1099-R form like this. The software assumes that a rollover went into either a Traditional IRA or a Roth account but not both on the same 1099-R form.

The trick to deal with this deficiency in the tax software is to split the combined 1099-R form into two — one for the rollover to the Traditional IRA and another for the rollover to the Roth account. Use the same payer name, address, and tax ID for both 1099-R forms.

You enter this 1099-R form for the rollover to a Traditional IRA:

Box 1 Gross Distribution$30,000Box 2a Taxable Amount$0Box 2b Taxable amount not determinednot checkedBox 7 Distribution code(s)GA 1099-R Form for Rollover to Traditional IRA

You tell the software that this rollover went to a Traditional IRA. The software will make it not taxable.

Then you enter another 1099-R form for the rollover to a Roth account:

Box 1 Gross Distribution$20,000Box 2a Taxable Amount$20,000Box 2b Taxable amount not determinednot checkedBox 7 Distribution code(s)GA 1099-R Form for Rollover to Roth Account

You tell the software that this rollover went to a Roth account. The software will make it taxable.

If your combined 1099-R form has a number in Box 5 because you made non-Roth after-tax contributions (“mega backdoor Roth“), include it on the applicable 1099-R form depending on whether the non-Roth after-tax contributions were rolled over to a Traditional IRA or a Roth account.

The two split 1099-R forms added together have the same numbers as the original combined 1099-R form. You’re splitting it only because the tax software isn’t smart enough to handle the combined 1099-R. The numbers are combined again on your 1040 tax form. It will show that you’re paying tax on only the portion that you rolled over from a pre-tax account to a Roth account.

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Deliver I Bonds Bought as a Gift in TreasuryDirect

Many people bought I Bonds as a gift and kept them for the future when I Bonds had a good interest rate last year. These bonds started earning the good rate while they were held in a “gift box.” They are eligible for delivery to the registered recipient now.

No Change in Terms

Delivering a gift bond moves the bond from one account to another. It doesn’t change the terms of the bond — how much interest the bond earns, when the bond can be cashed out, or when the early withdrawal penalty will stop. Those terms were set on the bond itself at the time it was originally purchased. The bond carries the same terms as it moves from one account to another. It doesn’t matter which account the bond resides in.

Limit Resets by Calendar Year

Receiving a gift counts against the recipient’s annual limit in the calendar year of the receipt. Because the annual limit resets on January 1 each year, you can deliver a gift early in the year even though you bought it last October. You don’t have to wait 12 months.

Reason to Postpone

If the gift recipient wants to preserve the annual limit for their own purchase, they may want you to postpone the gift delivery but it doesn’t matter between spouses because you can always buy a new gift and hold it in the gift box again.

When you deliver the current gift and buy a new gift to replace it, the gift recipient has a bond and you have a bond in the gift box. If the gift recipient were to buy directly, the new bond has to wait 12 months before it can be cashed out, whereas the 12-month clock on your gift bond already started last year.

Postponing delivery to preserve the annual limit makes sense only when you’re unwilling to buy a new gift.

Delivering the gift now clears the gift out of your gift box. It closes the loop. You will have one less thing hanging in the air. Unless you have a good reason to postpone, just deliver the gift and move on.

Full Delivery

The principal value of the received gift counts against the recipient’s annual limit. The interest earned doesn’t count against the limit. You can deliver a $10,000 bond in full to the recipient even though the bond is worth more than $10,000 at the time of delivery because it earned some interest.

To deliver the gift, log in to your TreasuryDirect account and click on Gift Box on the right in the menu at the top.

Go into the bond in the list and click on Deliver. Choose the option “Deliver full amount.”

You need the recipient’s TreasuryDirect account number. The name on their TreasuryDirect account and the name on your gift must match exactly including the use of the middle initial versus the full middle name.

Edit Registration

The gift bond moves into the recipient’s account as soon as you click on Submit to deliver the gift.

The rightful owner of the gift takes full control of it now. If you made yourself the beneficiary when you bought the gift, the owner can edit the registration to make you the second owner and grant you the transact rights now. Or they can put a different second owner or beneficiary on the bond. See How to Add a Joint Owner or Change Beneficiary on I Bonds and How To Grant Transact or View Right on Your I Bonds.

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How to Enter 2022 ESPP Sold in FreeTaxUSA: Adjust Cost Basis

If your employer offers an Employee Stock Purchase Program (ESPP), you should max it out. You come out ahead even if you sell the shares as soon as you can. See Employee Stock Purchase Plan (ESPP) Is A Fantastic Deal.

After you sell the shares from the ESPP, part of the income will be included on your W-2. However, the 1099-B form you receive from the broker still reflects your discounted purchase price. This post shows you how to make the necessary adjustment on your tax return using FreeTaxUSA.

Don’t pay tax twice!

If you use other tax software, please read:

How To Report ESPP Sales In TurboTaxHow to Report ESPP Sales in H&R Block SoftwareTable of ContentsWhen to Report1099-B From BrokerFreeTaxUSAAdjust Cost BasisVerify on Form 8949When to Report

Before you begin, be sure to understand when you need to report. You report when you sell the shares you bought under your ESPP. If you only bought shares but you didn’t sell during the tax year, there’s nothing to report yet.

Wait until you sell, but write down the full per-share price (before the discount) when you bought. If you purchased multiple times, write down for each purchase:

The purchase dateThe closing price on the grant dateThe closing price on the purchase dateThe number of shares you bought

This information is very important when you sell.

Let’s use this example:

You bought 1,000 shares under your ESPP on 9/30/20xx. The closing price on the purchase date was $12 per share. The closing price on the grant date six months before was $10 per share. You bought at $8.50 per share with the discount.

You would write down:

Grant Date4/1/20xxMarket Price on the Grant Date$10 per sharePurchase Date9/30/20xxMarket Price on the Purchase Date$12 per shareShares Purchased1,000Discounted Price$8.50 per share

Keep this information until you sell.

1099-B From Broker

When you sell, you will receive a 1099-B form from the broker in the following year. You will report your gain or loss using this 1099-B form and the information you accumulated for each purchase. Some brokers will supply supplemental information for your purchases.

Let’s continue our example:

You sold 1,000 shares from your purchase above on 10/5/20xx at $11.95 per share. After commission and fees, you netted $11,925. You received a 1099-B form from your broker showing a sales proceed of $11,925 in the following year. The 1099-B form shows the cost basis as $8,500, which reflects your discounted purchase price.

Because you didn’t hold it for two years after the grant date and one year after the purchase date, your sale was a “disqualifying disposition.” The discount is added as income to your W-2. This raises your cost basis. If you just accept the 1099-B as-is, you will be double-taxed!

FreeTaxUSA

Now let’s do it in FreeTaxUSA.

Find “Stocks or Investments Sold (1099-B)” in the “Common Income” section under “Income” in the menu. Click on “Add an Investment Sale.”

Choose “One at a time.”

Enter the numbers on your 1099-B as they appear. The cost basis on your 1099-B was reported to the IRS but it was too low. 

Don’t make any changes here. Your broker sent this information to the IRS. It has to match.

Adjust Cost Basis

You have this opportunity to make an adjustment. Check the “Yes” radio button and the box for “The basis shown in Box 1e is incorrect.”

Enter your purchase cost plus the amount added to your W-2. When you did a “disqualifying disposition” your cost basis was the full value of the shares on the date of the purchase. The market price was $12 per share when you purchased those 1,000 shares at $8.50 per share. Your employer added the $3,500 discount as income to your W-2. Therefore your true basis is $8,500 + $3,500 = $12,000.

If you didn’t sell all the shares purchased in that batch, multiply the number of shares you sold by the discount price on the date of purchase and add the discount included on your W-2. For example, if you sold only 500 shares and your employer added $1,750 to your W-2, your corrected cost basis is:

$8.50 * 500 + $1,750 = $6,000

If you had a wash sale, your 1099-B form would indicate it as such. We didn’t have a wash sale in our example.

We’re done with one ESPP sale. Repeat if you sold more than once during the year.

Verify on Form 8949

We can verify that the adjustment makes it all the way to the tax form.

Click on “View Form 1040” on the right.

Scroll down to find Form 8949 in the popup. You see the negative adjustment in column (g).

If you didn’t make the adjustment and you just accepted the 1099-B as-is, you will pay capital gains tax again on the $3,500 discount you are already paying taxes through your W-2. Remember to make the adjustment!

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