• How do taxes work with Betterment?

    Last Updated: December 13, 2016 4:27PM EST

    Individual ("Personal") or Joint Taxable Accounts
    With taxable investment accounts, you generally owe taxes each year on the dividends and other distributions paid to you that year.  You may also owe taxes when you sell shares, depending on whether or not you’ve realized capital gains on the investment.  
     
    Taxation of Dividends
    Most ETFs pay dividends, reported on Form 1099-DIV. These are generally taxable, typically at your ordinary marginal tax rate (0-39.6%, Federal). For high earners, an additional 3.8% “net investment income tax” applies. Certain ETFs that hold stocks may distribute “qualified” dividends, which are potentially subject to lower tax rates (Box 1b). Some ETFs hold municipal bonds, which pay dividends that are partially or wholly exempt from federal and/or state tax (Box 10 of 1099-DIV). 

    Other Distributions
    Some ETFs make distributions parts of which are not taxed as dividends, but rather as capital gains, or return of capital. Capital gains distributed are reported on Form 1099-DIV as well (Box 2a).  These are usually minimal for index-based ETFs used by Betterment (indeed, this is one reason why ETFs are more tax-efficient than mutual funds).  Return of capital is rare, but could apply, for example, to real estate ETFs that sell some of their holdings, and is reported in Box 3, 8 or 9 (See IRS Pub 17 for details).


    Foreign Tax Paid
    For ETFs with non-US holdings, the 1099-DIV can indicate foreign tax paid. This could happen when such ETFs have already paid foreign taxes on distributions made by companies in foreign jurisdictions, before passing them on to U.S. shareholders. To mitigate double taxation on the same income, the U.S. rules potentially allow for a deduction or tax credit for these amounts (Box 6).  
     
    Taxation of Capital Gains 
    At Betterment, we sell shares on your behalf whenever you withdraw funds, change your allocation, or we rebalance, harvest losses, or assess our fee. When you sell shares that have appreciated, you realize capital gains tax. If the investment has depreciated in value, you realize a capital loss, which is used to offset other gains that you realized that year, and any excess loss may be deductible from your earned income, up to a threshold set by the IRS.  Losses not used that year may be carried forward to future years.  The amount of capital gains tax you owe depends on your net gains (including losses carried over from prior years) and how long you held your investments before selling.  Short-term capital gains tax applies if you sell shares you held for one year or less. The federal short-term capital gains tax rate is the same rate as your income tax rate (0-39.6%). Long-term capital gains tax applies if you sold shares you held longer than a year, and ranges from 0-20%. For high earners, an additional 3.8% “net investment income tax” is added for both. For each ETF across your portfolio, Betterment's TaxMin algorithm automatically sells losses first (starting with shares which have the highest cost) and if realizing gains is unavoidable, it prefers long-term over short-term, which is likely to reduce your tax burden. Learn more about TaxMin.  All sales, including sale price, cost basis, and holding period, are reported on Form 1099-B.
     
    Traditional IRA or SEP IRA
    Traditional and SEP IRAs may afford a deduction against your ordinary income in the tax year during which you contribute funds, if you qualify based on your income.  Any dividends you receive are automatically reinvested by Betterment, and grow tax-free until withdrawal.  When you withdraw from the account, taxes are generally due at your ordinary income tax rate applicable at that time, both on earnings and on all contribution amounts that were previously deducted.  Penalties may also be due if you don’t meet the withdrawal qualifications (e.g., you withdraw before age 59.5).  Read more from the IRS on IRAs and SEP IRAs.

    Roth IRA
    Roth IRA contributions are made with dollars you’ve already been taxed on -- you don't get a deduction.  However, at retirement, as long as you've held the account for at least five years and met the other qualified withdrawal criteria, none of the amount withdrawn is taxed.  Any dividends you receive are automatically reinvested by Betterment, grow tax-free, and are also withdrawn tax-free.  Read more from the IRS on Roth IRAs.
     
    Betterment is not a tax advisor, nor should any information in this article be considered tax advice. Please consult a tax professional.
     
  • When will my tax forms be available?

    Last Updated: January 27, 2017 5:04PM EST
    Tax forms will not be made available prior to February 15 due to the 30-day window related to certain TLH+ requirements, which carry through to the end of January. We also need final confirmations on distributions from fund providers regarding their dividend payout classifications. This helps prevent costly corrections and amended returns.

    When possible, Betterment strives to provide tax forms well in advance of the IRS 1099 tax forms issuance deadline, which is February 15.

    Please note that 1099 tax forms are automatically imported to your Betterment account by February 15, in both CSV and PDF formats. We will notify you via email when these are ready. We will also integrate with Turbo Tax, H&R Block, and TaxACT. Unlike other online advisors, we make our forms in-house, with clear summaries provided.

    To see tax forms from previous years, please review your Activity page, and then click the "Tax Forms" tab. You can also simply log in here.
  • Where do I find my tax forms if I have multiple accounts, e.g. a personal account and a trust account?

    Last Updated: January 29, 2016 4:39PM EST
    Your tax forms will be available on the Activity page for each account, starting in mid-February. You can visit the Activity page and select "Tax Forms" to download the statements.
  • My tax preparation software has a limit on the number of transactions it supports. How can I use it to report all of Betterment’s transactions?

    Last Updated: February 14, 2017 4:32PM EST
    Please note that Betterment is not a tax advisor and the information provided should not be construed as tax advice, but should be used for informational purposes only. Please consult a qualified tax professional or the IRS to determine the rules that apply to your individual tax situation.


    Certain versions of tax preparation software have a limit on the number of transaction lines they support for automatic upload. This varies from provider to provider. If you are unable to automatically import your tax forms into your tax software, the IRS allows you to report the summary information on your electronic tax return and send a paper copy of your statement with Form 8453 to the IRS after your tax return has been accepted.

    For the purposes of reporting your Betterment transactions by filing Form 8453, you should check "Form 8949, Sales and Other Dispositions of Capital Assets (or a statement with the same information), if you elect not to report your transactions electronically on Form 8949" when completing Form 8453.

    For more information about Form 8453, please see www.irs.gov/uac/About-Form-8453.
  • If I have multiple accounts, e.g. a personal account and a trust account, how do I automatically import my tax forms into my tax preparation software?

    Last Updated: January 29, 2016 4:40PM EST
    If you have multiple accounts with Betterment, your tax forms will import differently, depending on which software provider you use. Please review the important points below to ensure that you accurately report your tax information.

    TurboTax
    When you import your tax information into TurboTax, you will see a screen listing each of the documents available for import, with the name of the corresponding Betterment account next to each. Make sure to check or uncheck the documents applicable to the tax return you are working on.

    Please see the screenshot below for an example:


    H&R Block
    Online: During the import process, H&R Block’s import summary window will provide you with a view of the tax documents imported from Betterment. You will be able to see the corresponding account name for your 1099-DIV and 1099-R tax forms, if you have any, but unfortunately H&R Block does not allow import of this information for 1099-B forms, so transactions for multiple accounts will be shown together (as shown in the screenshot below). Please review the applicable PDF tax statement provided on the Activity page of each Betterment account to ensure you import the correct information.


    Desktop: H&R Block’s desktop software does not allow import of account names. When you log in to Betterment from the H&R Block desktop software, you will see all of the tax information for all of your accounts, but unfortunately H&R Block will not display the account names for each piece of information. If you decide to use H&R Block’s desktop software, you are responsible for verifying that you are importing information for the correct account.

    TaxACT
    TaxACT does not support import for Betterment customers with multiple accounts. If you have multiple accounts and would like to use TaxACT, please download the CSV of your tax information from your account’s Activity tab and use TaxACT’s CSV import tool.
     
  • What do I need to know about importing my tax forms in TurboTax?

    Last Updated: February 15, 2017 9:36AM EST
    • Please note that while Betterment has provided the tax information in the format specified by the tax preparation software providers, we do not manage the software itself. If you are experiencing issues with your tax import, we encourage you to contact the software providers directly. To connect with a TurboTax Expert who is specially trained, please contact TurboTax directly.
    • If you have two-factor authentication enabled at Betterment, please use an App password generated within your Betterment account instead of your standard Betterment password. You can generate an App Password at Betterment by visiting the Security tab and clicking "Generate a new App Password."

    Betterment integrates with TurboTax tax preparation software to allow automatic import of your tax information.

    In some cases, TurboTax software may round the data imported from Betterment. This is not something Betterment can control, so please take care to verify the data import with the information provided on your Betterment tax forms. For more information on rounding, please see the IRS instructions for Form 8949.

    Please note that software providers may have different versions of their tax preparation software and not all versions will support automatic import of brokerage data. Betterment cannot control which versions have automatic import enabled, so please ensure you review your options prior to software purchase if you would like to use the automatic import feature.

    Online Version: From the Import Summary screen, select “Add Other Documents”. On the following screen, type “Betterment” into the “Import from my bank or brokerage” field. Select “Betterment” from the list below and click “Continue” to import.

    Desktop Version: In addition to the online import method detailed above, you can also select “Import” from the File menu and click “From Financial Institution” - please see the screenshot below for reference.



    On the following screen, type “Betterment” into the “Enter financial institution name here” field. Select “Betterment” from the list below and click “Continue” to import.

    For Exempt Interest Dividends:

    Betterment invests in a variety of state municipal bonds. If you are importing a 1099-DIV and Box 10 (Exempt Interest Dividends) is not $0, TurboTax will show you a screen which asks: “Choose the state where your tax-exempt dividends came from:”

    From the dropdown, select “More Than One State":



    You may also consult the tax form detail and the fund company website to determine the state(s) associated with your tax-exempt dividends. The fund company resources may be found here in our FAQ.

  • What do I need to know about importing my tax forms in TaxAct?

    Last Updated: January 26, 2017 11:09AM EST
    Please note that while Betterment has provided the tax information in the format specified by the tax preparation software providers, we do not manage the software itself. If you are experiencing issues with your tax import, we encourage you to contact the providers directly.

    For more information, please see the TaxAct support site.


    Betterment integrates with TaxAct tax preparation software to allow automatic import of your tax information. Please note that TaxAct only allows automatic import for 1099-B forms.

    In some cases, TaxAct software may round the data imported from Betterment. This is not something Betterment can control, so please take care to verify the data import with the information provided on your Betterment tax forms. For more information on rounding, please see the IRS instructions for Form 8949.

    IMPORTANT: Rounding done by TaxAct may cause some wash sales to be reported incorrectly. If a transaction has a wash sale that is less than $0.50, TaxAct’s software will round the amount Betterment provides to $0 and will override the wash sale amount provided by Betterment with an amount equal to the difference between sale proceeds and cost basis. This may result in an incorrect amount of wash sale for the transaction. Betterment cannot control this process, so please ensure you check all of your individual transactions against the 1099-B provided by Betterment to verify that your tax return is correct.

    Please note that software providers may have different versions of their tax preparation software and not all versions will support automatic import of brokerage data. Betterment cannot control which versions have automatic import enabled, so please ensure you review your options prior to software purchase if you would like to use the automatic import feature.

    Online Version: Select “Stock data import” from the “Investment Income” section of the Federal Q&A tab - please see the screenshot below for reference:



    On the following screen, click “Electronic import” and select “Betterment” from the “Select Brokerage or Software Vendor” dropdown.  After the import is complete, you can use the “Stock Assistant” tool to review your data.

    Desktop Version: In addition to the online import method detailed above, you can also select “Import” from the File menu and click “Stock Data” - please see the screenshot below for reference.



    On the following screen, click “Electronic import” and select “Betterment” from the “Select Brokerage or Software Vendor” dropdown. After the import is complete, you can use the “Stock Assistant” tool to review your data.
  • What do I need to know about importing my tax forms in HR Block?

    Last Updated: January 26, 2017 11:04AM EST
    Please note that while Betterment has provided the tax information in the format specified by the tax preparation software providers, we do not manage the software itself. If you are experiencing issues with your tax import, we encourage you to contact the providers directly.

    For direct support from H&R Block, please see the H&R Block support site
    .

    Betterment integrates with H&R Block tax preparation software to allow automatic import of your tax information. 

    In some cases, H&R Block software may round the data imported from Betterment. This is not something Betterment can control, so please ensure you verify the data import with the information provided on your Betterment tax forms. For more information on rounding, please see the IRS instructions for Form 8949.

    Here are some important tips for filing with H&R Block:

    H&R Block’s rounding may cause some values to import as $0; please select all transactions for import into your return to ensure your tax return has all the complete and accurate information provided by Betterment.

    If you are using the desktop version, wash sales which are rounded to $0 by H&R Block may not automatically import the adjustment code “W”. Please review your transactions against the PDF provided by Betterment to verify the proper code is selected.

    H&R Block imports 1099-DIV information for exempt-interest securities (e.g. MUB, CMF, NYF, and TFI) in two separate transactions, one for taxable dividends and one for tax-exempt dividend amounts. Please select both transactions to ensure you import your complete tax information from Betterment.


    Please note that software providers may have different versions of their tax preparation software and not all versions will support automatic import of brokerage data. Betterment cannot control which versions have automatic import enabled, so please ensure you review your options prior to software purchase if you would like to use the automatic import feature.

    Online Version: Select the Federal tab of the tax preparation questionnaire and click the “Income” icon in the top toolbar. Select the checkboxes for the tax forms you’ve received (1099-B and 1099-DIV in the “Interest and Investment Income” section and 1099-R in the “Retirement and Social Security Income, Including Retirement Plans” section). Click “Next”, and on the following page, click “Add New 1099” (the exact text will differ for 1099-R, 1099-B, and 1099-DIV). Please see the screenshot below for reference:



    On the following screen, type “Betterment” in the “Financial Institution” field and click “Next” to import your data.

    Desktop Version: Select the Federal tab of the tax preparation questionnaire and click the “Income” icon in the top toolbar. From the “Where Do You Want To Go?” screen, click on the appropriate form (1099-R, 1099-B, or 1099-DIV). On the next screen, click “Import” (the exact text will differ for 1099-R, 1099-B, and 1099-DIV). Please see the screenshot below for reference:



    On the following screen, type “Betterment” in the “Bank, broker, or financial Institution” field, select Betterment, and click “Import” to import your data.
  • Why are there so many transactions on my 1099-B? How can I reconcile the transactions on my Activity tab with my 1099-B?

    Last Updated: February 15, 2017 10:39AM EST
    Your 1099-B could be long, particularly if you have frequent allocation changes or withdrawals. In particular, if you have enabled TLH+, you may see many transactions. What shows up as a single transaction in your activity tab (Withdrawal, Tax Loss Harvesting) can actually be multiple ETF sales for tax purposes, which is what the 1099-B shows. Sales are grouped by date of sale. You can also reference your quarterly statements for a chronological list of transactions, each with a breakdown by ETF sold. The CSV download of your 1099-B can also be useful to sort the information in different ways, or to import into other software.
  • Why are the dates shown for dividends on my Activity page different than the pay dates on my 1099-DIV?

    Last Updated: December 04, 2015 10:54AM EST
    When dividends are paid, it may take two or three days for the reinvestment in your account to complete. Dividend reinvestment trades are displayed on your Activity page on the date the transaction completes. However, dividends are reported on your tax forms on the date they were paid, which will be several days prior to the date of reinvestment.
  • How should I interpret the information on my 1099-DIV?

    Last Updated: February 15, 2017 1:33PM EST
    Your 1099-DIV is a record of all dividends and distributions earned in your Betterment account during 2016. It includes taxable dividends and distributions as well as exempt-interest dividends paid by municipal bond ETFs. There are multiple boxes on your 1099-DIV, each of which reports a different piece of information which must be included in your tax return:

    Box 1a Total Ordinary Dividends: The total amount of dividends and short-term capital gain distributions paid in 2016. 

    Foreign tax paid (reported separately in Box 6) is added to the dividends and distributions reported in Box 1a as well. If you had foreign tax paid in 2016, the total amount reported in Box 1a will be higher than the amount actually received. For more information on foreign tax, please refer to IRS Publication 514.

    Tax-exempt dividends (reported separately in Box 10) are not included in Box 1a. If you received tax-exempt dividends in 2016, the total amount reported in Box 1a will be lower than the amount actually received.

    Box 1b Qualified Dividends: The amount of dividends included in Box 1a that are subject to applicable long-term capital gains rates.

    Box 2a Total Capital Gain Distributions: The total long-term capital gain distributions paid to you in 2016. These differ from long-term sales reported on your 1099-B, and instead come from the distributions paid by some ETFs.

    Box 6 Foreign Tax Paid: The total foreign income taxes paid in 2016 on income from the ETFs’ investments in foreign securities. Federal tax law can permit U.S. taxpayers to take either a deduction or credit for these taxes; for more information please refer to IRS Publication 514 or consult with a tax professional.

    Box 10 Exempt-Interest Dividends: The total amount of tax-exempt dividends paid by municipal bond ETFs in 2016. 

    Please note that Betterment is not a tax advisor and the information provided should not be construed as tax advice, but should be used for informational purposes only. Please consult a qualified tax professional or the IRS to determine the rules that apply to your individual tax situation.
  • Why did I not receive a 1099-DIV, despite having received dividends?

    Last Updated: December 15, 2016 1:37PM EST
    You may only receive a 1099-DIV if your taxable dividends totaled $10 or more. However, you must report all taxable dividends to the IRS, even if you don’t receive a Form 1099-DIV.

    To find your total dividends, click here and filter by “Dividends” for the 2016 calendar year. You can then download a CSV statement to total your 2016 dividend activity.

    Please note that Betterment is not a tax advisor and the information provided should not be construed as tax advice, but should be used for informational purposes only. Please consult a qualified tax professional or the IRS to determine the rules that apply to your individual tax situation.
  • What is foreign tax paid? How do I calculate the foreign percentage of my dividends?

    Last Updated: March 29, 2017 12:38PM EDT
    As part of your Betterment account, you may own ETFs that invest in foreign ​holdings and throughout 2016, the ETFs may have included foreign-source dividends in their distributions and may have paid foreign tax on those dividends. If applicable, the foreign tax paid has​ been​ reported on your 1099-DIV in Box 6.​

    Foreign source income is related to but different from foreign tax paid. Securities that do not report foreign tax paid may still have foreign source income. For the securities that have it, the foreign source income amount is included in the total dividends and distributions reported to you as part of Box 1a and Box 1b in the 1099-DIV Detail section​ of your Consolidated Tax Statement​.

    The percentage of foreign source income varies by ETF, so please consult materials from the fund provider. For example, here are some resources below:

    Vanguard Foreign Tax Credit Worksheets
    iShares Distributions - Year End Tax Supplement Report
    Schwab Tax Information - see Foreign Tax Income

    Federal tax law attempts to prevent double taxation on ​your foreign source income amounts and therefore you may be eligible to claim either a deduction or credit for foreign tax paid.​

    Betterment is not a tax advisor and the information provided should not be construed as tax advice, but should be used for informational purposes only. Please consult a qualified tax professional and refer to IRS Publication 514, IRS Form 1116, and IRS Publication 17 to determine the rules that apply to your individual tax situation.
  • How can I calculate my state-specific municipal bond ETF interest?

    Last Updated: February 14, 2017 12:47PM EST
    Please note that Betterment is not a tax advisor and the information provided should not be construed as tax advice, but should be used for informational purposes only. Please consult a qualified tax professional or the IRS to determine the rules that apply to your individual tax situation.

    A portion of the dividend income from your municipal bond ETF holdings may be exempt from state income tax, depending on your state’s tax laws. To calculate the state-specific percentages of your municipal bond ETF holdings, please consult materials from the fund provider. To help, here are some resources below to find more specific information about the holdings of various Municipal Bond funds which may be used in your portfolio:

    National: 
    MUBiShares Tax-Exempt Interest by State
    TFISPDRS Prospectus information (download the TFI "Fact Sheet")

    California State specific: 
    CMFiShares Tax-Exempt Interest by State

    New York State specific: 
    NYFiShares Tax-Exempt Interest by State

    For TurboTax users:

    If you are importing a 1099-DIV and Box 10 (Exempt Interest Dividends) is not $0, TurboTax will show you a screen which asks: “Choose the state where your tax-exempt dividends came from:”

    From the dropdown, select “More Than One State":



    You may also consult the tax form detail and the fund company website (links above) to determine the state(s) associated with your tax-exempt dividends.
  • Will I receive a 1099-R if I received an IRA Tax Statement?

    Last Updated: February 03, 2017 10:22AM EST
    Not necessarily. 1099-Rs are only provided to you and the IRS if you had a distribution from your IRA in 2016. Distributions include, but are not limited to, early withdrawals, removals of excess contributions, recharacterizations, or rollovers.

    If you have more than one type of retirement account (e.g. a Traditional IRA and a Roth IRA) or more than one type of distribution, you will receive multiple 1099-Rs. If you did not have a distribution in 2016, you will not receive a 1099-R. 1099-Rs are also not required for direct transfers between IRA trustees. Please consult IRS Publication 590 for details on IRA distributions and transfers.

    Please note that Betterment is not a tax advisor and the information provided should not be construed as tax advice, but should be used for informational purposes only. Please consult a qualified tax professional to determine the rules that apply to your individual tax situation.
  • How does Betterment keep track of dividends, capital gains, and capital appreciation for tax purposes with shares being bought in fractional amounts?

    Last Updated: January 29, 2016 4:44PM EST
    Betterment's infrastructure keeps track of all relevant information about the shares you own. At tax time, you'll receive all the tax forms you need, produced by us, detailing all the activity in a simple-to-read format. 

    That infrastructure is also engineered to make the right decisions. So it attempts to rebalance optimally, minimize your tax burden, and keep you on track all at once. 

    Here is what happens when you withdraw from a goal: 

    - Betterment’s Tax Impact Preview informs you of the estimated taxes you will pay on this withdrawal before you confirm the withdrawal.

    - Betterment first looks at the current asset allocation, and will consider selling the investments you are overweight, to bring you back into balance. 

    - Once we know how much of each investment to sell, we choose the tax lots in the following order to attempt to reduce the tax you pay: Losses first (short-term, then long-term), gains second (long-term, then short-term).  Losses offset other gains and potentially ordinary income, so they may reduce your tax and are sold first.  Because short-term gains are typically taxed at a higher rate, we sell them absolutely last.

    - We execute the trades, at no cost to you, and send the funds back to your linked account. Note that your actual tax impact depends on how much you withdraw, when you bought, and how the investments performed.
  • How does Tax Impact Preview work?

    Last Updated: December 29, 2015 2:02PM EST

    Selling shares is a taxable event—those sales could be triggered by a withdrawal or an allocation change. Tax Impact Preview shows the estimated gains and losses the sale is expected to realize, as well as an estimate of the taxes that may result, in real-time, before the transaction is carried out.

    When initiating a withdrawal amount on the Transfer tab or adjusting the allocation slider on the Advice tab, the estimated tax impact will appear, giving you access to a summary of the short- and long-term gains and losses expected to result from the sales.

    Tax Impact Preview generates this estimate by “pre-playing” the transaction to simulate the trades that will take place across all of the ETFs that you hold.  

    To determine those trades, our algorithms first check whether each asset class is over or underweight by comparing your current allocation to your target allocation. The amount of bonds and stocks to sell is determined in a way that brings each asset class back to the portfolio’s target allocation.  

    Once the specific ETFs and amounts to sell have been determined, Betterment’s algorithms use the TaxMin accounting method to select the specific lots that will be sold. For each ETF, TaxMin selects losses first and short-term capital gains last in order to minimize the tax impacts.

    Tax Impact Preview sums up all the losses and gains that are expected to be realized across the different ETFs and tax lots. If your losses outweigh your gains, Tax Impact Preview will estimate your realized losses. If your gains outweigh your losses, estimated taxes owed will be displayed.

    The estimated tax is an upper bound, meaning it assumes the highest applicable tax rates of 39.6% federal, 13.3% state, 3.8% medicare surtax and deductibility of state taxes. Actual taxes are likely to be different depending on specific circumstances, including, but not limited to, the marginal tax rate applicable to you, any subsequent trading activity, the presence of other capital gains or losses for the year, and securities prices at the moment your execute the trades.

    Tax Impact Preview is just an estimate, since it depends on the current prices of each ETF, which won’t necessarily be the price at the time you trade.  However, it will give you a good idea of the impact of the transaction. Tax Impact Preview is not tax advice.

    Learn More

     
  • Where can I find my 5498? When will it be available?

    Last Updated: May 15, 2017 4:13PM EDT
    You will receive a 5498 form if you had made annual or rollover contributions into your Betterment IRA. Direct transfers into your IRA will not be reported, per IRS requirements. The information on your 5498 form will also be reported to the IRS. 

    Your 5498 tax form can be found on your Activity page. Generally this form will be made available each May for the prior year, after the April 18 tax filing deadline. 
  • How tax efficient is Betterment?

    Last Updated: May 03, 2017 10:08AM EDT
    Betterment portfolios and the systems that manage them are constructed from the ground up to be maximally tax efficient. This begins with security selection, where we use index tracking ETFs instead of mutual funds. Unlike actively managed funds, index tracking funds have significantly lower turnover resulting in materially lower incidences of capital gains being passed on to investors. In addition, the legal and administrative structure of most ETFs differs from mutual funds in the way that investors are insulated from each other rather than pooled together. As a result, ETF investors are only responsible for their own tax consequences rather than sharing in the collective tax burden through distributions. The end result of just holding ETFs is a portfolio with lower capital gains burden which is also entirely immune to mutual fund style administrator-driven distribution.

    In addition, Betterment portfolios extract further efficiencies from asset class selection that varies by account tax status. For taxable accounts, Betterment portfolios employ municipal bonds as a major US bond component to lower investor tax burden. Municipal bonds are federally tax-exempt, and may be tax-exempt at the state level. Tax-deferred accounts do not benefit from the tax-exempt status of municipal bonds, so we use a diverse set of high-quality US bonds instead.

    The tax impact of Betterment portfolios is also made more efficient through a number of automated day-to-day management features:
    • All cash-flows are used to reduce the portfolio drift, which reduces future taxable rebalances. For example, a deposit from a dividend or automatic transfer will always buy the most underweight asset classes first. Similarly, a withdrawal will sell the most overweight assets first.
    • Tax lot selection is optimized to reduce taxes. Lots with losses are always sold before lots with gains. Short term losses are preferred over long term losses, and long term gains are preferred over short term gains. Additionally, lots with the highest cost basis, and therefore the lowest embedded potential tax burden, are sold first.
    • Rebalancing transactions and portfolio updates are tax aware, and always avoid short-term gains which are typically taxed at the highest rates.
    • Tax-loss harvesting is employed to actively take advantage of portfolio losses to offset other gains and ordinary income on your tax return.
  • Why are the sales proceeds and/or cost basis so high on my 1099-B?

    Last Updated: December 15, 2016 9:29AM EST
    Your sales proceeds and cost basis on your 1099-B may be much higher than your balance ever was at any given time in your Betterment account. That’s because these numbers represent the total amount of cash proceeds from the sale of securities, even if the proceeds were then used to buy securities again. This can happen many times over the course of the year. 

    The cost basis is amount of money you paid to purchase the shares that are being sold, with possible adjustments for wash sales and nondividend distributions. The sales proceeds figure, as defined in your tax forms, is simply “the amount of money you received in exchange for selling your shares this year.”

    Let me give you an example to illustrate. Let’s say you made a $100 deposit and then withdrew it after you gained $10. For this transaction, your cost basis is $100, and your proceeds are $110. 

    Now imagine you reinvested the same $110 and sold it for $120. For this transaction, your cost basis is $110, and your proceeds are $120. 

    However, your total cost basis for the year is $210 and your total proceeds are $230, even though your balance never exceeded $120.

    Rebalances, allocation changes and tax loss harvesting can all increase your aggregate proceeds and cost basis to many times what your balance was during the year, but it’s really the same funds being used, and the important number, for tax purposes, is the difference between your overall cost basis and proceeds, not either of those numbers on their own.
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