Lessons from Tax Season

"Tax season" ended last week for 2014 income tax returns.  This season seemed particularly painful given the delay in receiving Forms 1099 from financial institutions, new health insurance reporting, and IRS tangible property regulations that were modified in the middle of February!  These factors served to make the time frame for completing tax returns even more compressed than in the past.  Here are a few observations that can make the next tax season smoother for you and for us.

Certain investments can greatly complicate your income tax return.  Although income taxes should not be the primary factor in choosing suitable investments, you should be aware of the tax reporting implications of those choices, which can add to the costs of preparation and delay the timing of when the tax return can be completed.

For example, with the sharp decline in interest rates over the past several years, purchasing bonds, notes, and certificates of deposit on the market rather than at original issue will result in the payment of premiums and accrued interest.  The financial institution's Form 1099 will report to the IRS the amount interest income earned according to the stated coupon rate, which greatly overstates the actual economic interest earned.  Tax elections and complicated calculations for premium amortizations and accrued interest adjustments are necessary to avoid overpaying tax.

Another example relates to investments that are bought and sold by investment advisors as if the investment were shares of stock, but the investment is actually a tax partnership.  As an owner of a partnership you will receive a Schedule K-1 rather than a Form 1099 for the investment income or loss.  Tax partnerships are complicated!  Many times the K-1s are not even provided until September, requiring a six-month extension of your tax return.  Some of the partnerships invest in foreign entities that require expanded disclosures in your tax return.  Others hold property in a variety of other states that may require you to file tax returns in those states.  All of these consequences bring delays and added costs.

Asset location can simplify the complexities of these investments.  Placing complicated fixed income or tax partnership investments in individual retirement accounts (IRAs) avoids the associated tax reporting requirements.  Your investment advisor should be able to view your IRA and regular investment accounts on an overall portfolio basis.  Each type of account does not need to be perfectly allocated among asset classes if on an overall basis proper asset allocation is achieved.  Those with small IRAs may have sizeable company 401(k) accounts that can be separately managed under the terms of the company plan.

Get an early start with the information that is available.  Much of your tax information should be available at the first of February.  Organizing that information will help to identify what is missing.  Preparing that portion of your tax return and adding the information that arrives later will help avoid last minute surprises, allow better service and reduce the likelihood of mistakes.

There isn’t a lot we can directly do to cause the government to simplify the burden of tax compliance, but we can each take some steps in our personal circumstances to deal with the reality of what we face.  We appreciate each and every one of our clients and look forward to continuing to serve you in the future.