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Investing Specialists

Don't Overlook the Valuable Intelligence in Your Tax Forms

Christine Benz

Has your mailbox (or email box) been a little more crowded than usual?

That could be because tax forms are starting to roll in and will continue to do so for the next few months. If you're an employee you'll be receiving a W-2 form; if you have investments or income from other sources, such as Social Security or contract work, you'll receive 1099s. You'll probably receive a grab-bag of these forms before tax season is over.

Many people tuck these papers into a folder and hand it all over to their accountants without taking a closer look. And even investors who fill out their own tax returns using tax-preparation software often plug the relevant information into the program without taking the time to process it.

Yet these forms can yield valuable intelligence--about your income trends, your investing habits, and whether you're taking sufficient advantage of tax-sheltered investment vehicles, among other issues. As you review your W-2 and 1099s, here are some of the key data points to pay attention to.

W-2 Forms
Only employees will receive a W-2; if you're among the growing ranks of people working in the "gig economy," you'll receive a statement of your income via a 1099-MISC form. As you review your W-2, take stock of the following.

W-2 Box 1: Wages, Tips, Other Compensation
Start with the big picture: Compare 2017's wages to the prior year's. If you see an increasing trend, that's all for the good. But if your wages have been flat or declining, maybe it's time to ask for a raise or potentially look for a job where your skills would be appreciated through greater monetary reward. Remember that phantom income has the potential to inflate the number you see in this box--if you've received restricted stock units from your employer that have vested, for example, the amount that vested in 2017 will show up in Box 1, even if you haven't sold the stock and pocketed the money.

You may also notice that the amount in Box 1 is lower than what you know to be your gross income. That's because Box 1 shows your gross income less any of your pretax deductions, such as health insurance premiums, your contributions to health savings account or flexible spending arrangement, or contributions to a traditional 401(k) or other defined-contribution plan. (If you're making Roth 401(k) contributions, however, they will not reduce the amount that's in Box 1.)

W-2 Box 12
Here, you'll find your contributions to your employer's retirement plan for the preceding tax year. Take note of the dollar amount--if you didn't contribute the maximum amounts of $18,000 (for those under age 50) or $24,000 (over age 50) for 2017, see if you can swing a higher contribution rate in 2018. Contributions are going up a bit for this year: to $18,500 for savers under age 50 and $24,500 for savers who are 50-plus.

Alongside Box 12b you'll see a letter denoting your contribution type. The notation "D," "E," or "G" indicates that you've made pretax (traditional) contributions to a 401(k), 403(b), or 457 plan, respectively, whereas the letters "AA," "BB," and "EE" denote Roth contributions. Whether you expect your tax rate to be higher or lower in retirement is the main determinant of whether to go with Roth or traditional contributions. If you're not sure, most plans that allow Roth contributions will allow you to split your contributions between the two account types.

W-2 Box 14: Other
This box depicts a grab-bag of additional information that the employer wishes to impart to the employee; it allows for information that doesn't have its own box on the W-2, such as union dues and educational assistance payments. Employees receiving restricted stock units may see a notation about them here.

The first thing to know about 1099s is that there are lots of different subtypes--1099-DIV, 1099-INT, 1099-MISC, and so on. The unifying theme among them is that they document that you received some type of income during the preceding year, whether from your investments or from working or other sources; that income may or may not be taxable. (You won't receive a 1099 from your tax-sheltered retirement accounts unless you've taken a withdrawal or some other action.)

Most investors are familiar with the basic 1099-DIV and 1099-INT forms: The former reports dividends and capital gains from taxable investments during the prior year, and the latter depicts interest income received. Form 1099-B, meanwhile, depicts any capital gains or losses realized in taxable accounts. Some investment firms amalgamate all of this information into a single consolidated 1099.

As you look over your 1099s, here are some of the key line items to focus on.

1099-DIV Boxes 1a and 1b: Total Ordinary Dividends, Qualified Dividends
The first two boxes (or columns, depending on how your form is laid out) of 1099-DIV forms deal with dividends: Box 1a shows you the total ordinary dividends you received, and Box 1b shows you which of those were qualified. Ideally, all of your dividends will count as qualified, because they're eligible for a lower tax rate than nonqualified ones. Dividends from most U.S. companies, as well as qualified foreign corporations, count as qualified.

For the 2017 tax year, investors in the 10% and 15% income tax brackets pay 0% on qualified dividends, those in the 25%-35% brackets pay 15% on dividends, and investors in the 39.6% bracket pay 20% on qualified dividends. (Note that there are holding-period requirements to obtained qualified dividend tax treatment.) By contrast, nonqualified dividends, from REITs and some foreign stocks, for example, are subject to your ordinary income tax rate. Those basic dividend tax rates are staying the same in 2018, though the income levels that map to them will be a bit different. (This article details the changes.)

If the figure in Box 1a is much bigger than 1b, that's a cue to assess asset location: If you're holding securities kicking off nonqualified dividends in your taxable account, could you make room that type of holding within your tax-sheltered accounts, while prioritizing qualified dividend payers for your taxable? And if you have dividend-rich holdings--even if their dividends are qualified--it's also worth considering whether such holdings might make more sense in your tax-sheltered accounts, as discussed here.

1099-DIV Box 2a: Total Capital Gain Distribution
This box depicts whether your mutual fund holdings made a capital gains distributions last year. (If you yourself made a sale, you'll see that reflected on form 1099-B, not 1099-DIV.) Such distributions are getting harder and harder to avoid in this long-running bull market: Funds have gains on their books, and those gains must be distributed to shareholders when those appreciated securities are sold. Yet some funds, especially broad market equity ETFs and index funds and tax-managed funds, do a better job minimizing those capital gains payouts than others. Some investors have put off ditching their serial capital gains distributors because of fear of triggering their own taxable capital gain on the sale, but that might not be as big a deal as they suspect, for reasons discussed here.

1099-DIV Box 6: Foreign Tax Paid
If you hold foreign stock funds in your account--or even U.S.-focused funds that dabble in foreign securities--Box 6 of 1099-DIV depicts any foreign taxes paid on those holdings for the year prior. Investors in foreign stocks have to pay taxes on their earnings in the company's country of domicile, as well as to the U.S. The key to not getting taxed twice is to claim a deduction or credit for foreign taxes already paid; this post discusses whether to take a credit or deduction.

In addition, the ability to deduct foreign taxes paid may make a taxable account a more attractive receptacle for foreign stocks than an IRA or 401(k). Investors should take care to not put the tax cart before the horse, however, as discussed in this article. Moreover, some dividends from foreign stocks aren't qualified, so placing them within a taxable account may offset, at least in part, the value of the foreign tax credit.

1099-DIV Box 10: Exempt-Interest Dividends
This box depicts the amount of tax-exempt interest dividends that you received. If you're in the 25% tax bracket or above, the income you receive from a municipal bond (or bond fund) will likely be higher than what the after-tax income you receive from a taxable account. The tax-equivalent yield function of Morningstar's Bond Calculator can help you compare the yields on two investments, one taxable and the other tax-exempt, factoring in the tax effects.

1099 DIV Box 11
This box displays any interest you have received from so-called private-activity bonds. While such bonds often pay higher interest rates than other types of munis, the downside is that they're subject to the alternative minimum tax. (Such bonds tend to be especially prevalent in municipal money market mutual funds.) The good news is that the new tax laws going into effect in 2018 significantly increase the AMT exemption amounts, as discussed here. In addition, those full exemptions are available to taxpayers with significantly higher incomes--$500,000 for individuals and $1 million for married couples filing jointly--than was previously the case. That means that the AMT will affect many fewer taxpayers going forward than is the case for the 2017 tax year.

No 1099 DIV
What if you didn't receive a 1099-DIV from a taxable account that you know you hold? First, be aware that you won't receive a 1099 from your tax-sheltered retirement accounts if you've just been making contributions; you'll only get a 1099 if you've taken a distribution or some other action with the account. Nor will you receive a 1099 of any kind if your earnings were less than $10 in 2017, though you're still required to report those earnings to the IRS on your tax return. Unfortunately, the persistently low-yield environment means that many savers haven't received 1099s from their small accounts for several years running. That's a wake-up call to, first, not hold more in low-yielding safe securities than you really need, and second, seek out higher-yielding cash options. Higher yields have been coming available recently. Online savings accounts have been cash investors' best source of yield and liquidity in recent years; cash investors can now finds yields of 1.5% or more via FDIC-insured online savings accounts, in line with the yields on money market mutual funds, which aren't FDIC-insured.

Too Many 1099 DIVs
On the flip side, if you received many 1099s from different providers, that could be a signal that portfolio is "busier" than it needs to be. Is there a way to consolidate your accounts with a single provider or two, rather than maintaining a lot of "onesie" accounts? This article provides some tips for streamlining.