Taxable brokerage account income questions

On various occasions, a client may receive income in an Edward Jones account that may need to be reported to another taxpayer. This usually occurs when:

• Non-married joint tenants contributed to an account.
• Securities belonging to someone else were sold in an account for convenience.
• Assets were transferred to heirs after income was received in a deceased person’s account.

To report the income to the other parties, the primary account holder may need to issue a Form 1099 to the owner of the income, usually the other joint tenant. This is called nominee reporting. Consult your tax professional for assistance with nominee reporting.

The alternative minimum tax (AMT) rules attempt to ensure at least a minimum amount of federal income tax is paid by taxpayers who have substantial income, but through exclusions, deductions or credits, would pay little regular income tax. Under the AMT rules, when the alternative minimum tax calculated for the year exceeds the regular income tax, that excess amount generally must be paid in addition to the regular income tax.

The AMT is generally calculated by first determining the taxpayer’s alternative minimum taxable income (AMTI). This requires that many items of income and expense be recalculated under separate AMT rules. Once the AMTI is calculated, taxpayers may be entitled to subtract from AMTI an exemption amount based on filing status before determining the amount of any AMT liability. IRS Form 6251 may be used by taxpayers to determine AMT liability, if any. Consult your tax professional for assistance with AMT.

Social Security benefits received can be taxable at any age. The amount of Social Security benefits subject to taxation is determined by calculating “provisional income,” which generally includes adjusted gross income, tax-exempt interest income and one-half of Social Security benefits. For more information, see:

• Income taxes and your Social Security benefit on the Social Security Administration website.
• Topic number 423 - Social Security and equivalent railroad retirement benefits on the IRS website.

Since tax-exempt interest income is included in provisional income, it can affect the amount of tax an individual pays on his or her Social Security benefits. However, tax-exempt interest typically will have less impact than other types of interest income because yields on tax-exempt bonds are usually lower than yields on taxable bonds. Tax-exempt interest income also can minimize federal income taxes because it is not included in taxable income. The taxation of Social Security benefits is only part of an individual’s tax situation. Consult your tax professional.

Generally, income such as interest, dividends and capital gain distributions paid to your account is reportable even if you reinvested the income payments.

While tax-exempt income generally is not taxable at the federal level, it may be reportable, since it may affect the amount of Social Security benefits subject to taxation, and/or may affect whether you are subject to Alternative Minimum Tax (AMT). Consult with your tax professional on how to report this income.

You may be able to claim a credit or take a deduction for the amounts of foreign tax paid to a foreign country. For amounts withheld in excess of the foreign tax withholding treaty rate, you may need to contact the foreign taxing authority to request a refund. Each country has different filing requirements. Consult a qualified tax professional for more information.

Certain dividend income may qualify for the reduced qualified dividend and long-term capital gains tax rate:

• Dividends from equities, traditional preferred stocks and foreign stocks that trade on a U.S. exchange typically pay qualified dividends.
• Dividends from mutual funds and exchange traded funds (ETFs) are based on the underlying assets within the fund portfolio. Generally, dividends from stock funds are qualified, a portion of the dividends from balanced funds is qualified and a portion is non-qualified, and bond fund dividends are non-qualified.

Qualified dividends are taxed at the same rates as long-term capital gains, while non-qualified dividends are taxed at ordinary income tax rates.

Capital gain distributions generally are made when a mutual fund manager sells securities within the fund portfolio and realizes an annual net gain. Long-term capital gain distributions are reported on Form 1099-DIV in Box 2a, Total Capital Gain Distributions, and qualify for a reduced tax rate, while short-term gain capital gain distributions are included as part of the total in Box 1a, Total Ordinary Dividends. Whether a gain is long-term or short-term is determined by the amount of time the fund portfolio held the securities sold, not by how long the individual held shares of the mutual fund.

The cost basis of an investment is usually the amount you paid for it, including any commissions, fees, reinvestments and original issue discount (OID). It also may include adjustments for sales, principal returns, mergers, splits and spin-offs.

For equities and fixed-income securities, Edward Jones uses a cost basis method of original lot cost. The lot relief method (sell order) used in Select accounts is first-in, first-out (FIFO), and our Advisory account types use tax-advantaged lot relief methods intended to minimize the income tax impact of trades. Exceptions include:

• You have made an election out of the default cost basis and/or lot relief method(s).
• You direct us, at the time of the sale, to sell specific shares.
• Shares are missing cost basis at the time of the sale and you do not direct us to sell specific shares. In this case, the shares without cost basis are sold first.

For domestic open-end mutual funds, Edward Jones uses:

• Select accounts: The average cost basis method and FIFO lot relief method. Separate averages are calculated for covered and non-covered shares.
• Advisory account types: The original lot cost method and tax-advantaged lot relief methods.

If the security was purchased and held at Edward Jones and is tracked by our cost system, we will provide the cost basis of the sold security on your Form 1099-B, but we only report to the IRS cost basis for covered shares. For details about covered and non-covered shares, see cost basis reporting requirements.

Commissions generally are not tax deductible as an itemized deduction. Instead, commissions are generally added to the purchase price and subtracted from the sale price to determine the gain or loss on disposition of the security. The Edward Jones confirmation reflects the total purchase cost, including commissions. Form 1099-B reflects the net proceeds received after the commission has been subtracted. For additional information, see IRS Publication 551 and refer to the Basis of Assets under the Stocks and Bonds subsection under Cost Basis.

One reason the IRS may send a taxpayer a letter requesting additional tax payments is because the taxpayer failed to correctly complete and/or file an income tax return for that tax year. Taxpayers with income below the standard deduction amount may not need to file a return, but sale/redemption proceeds from Form 1099-B must be included in the calculation to determine if a return is necessary. Therefore, individuals receiving Form 1099-B generally must file a tax return, even if solely for informational purposes and no tax is due.

Consult your tax professional about how to report the information on Form 1099-B and/or how to respond to the IRS letter.