Special Report

15 Investment Pitfalls and Surprises to Avoid During Tax Season

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6. Unexpected tax bills from mutual funds

Those who own in mutual funds in non-retirement accounts, especially equity mutual funds, need to be aware of a tax trap related to these funds or they may get an unexpected tax bill come tax season. Just like an individual would, mutual funds realize profits or losses when they sell certain stock holdings. These gains are distributed to fund share owners, who then have to pay taxes on these distributions, whether they reinvested the proceeds or used the funds for other purposes.

Further, buyers who invest in a mutual fund late in a year before distributions were made and after large gains may end up owing taxes on gains that were made before they even owned the fund.

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7. Not assuming the right tax bracket for dividends

Investors love dividends, and over the course of a lifetime of investing, those dividends can end up making up a substantial portion of investors’ total returns. If investors own dividend stocks in a taxable account, they have to pay taxes on those dividends whether they reinvest the funds or use the money for other purposes.

One common mistake investors make, particularly around the years when there are changes to the tax code, is to assume that tax rates for dividends are static. In 2003, President George W. Bush lowered the tax rate on dividends from being taxed at the individual income tax brackets to 15%. These have changed under President Barack Obama and again under President Donald Trump. It is always best to check what they are. Know your tax bracket for dividends or you will get a tax bill for money you may have already spent or reinvested.

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8. Distributions from public partnerships, LLCs, and LPs

Many investors invest in public partnerships, master limited partnerships, trusts, and LLCs. First time investors in these security products may consider the units’ payouts as dividends, when they are actually considered income and a return of capital. Rather than receiving a 1099-DIV tax form, unit owners will likely be receiving a K-1 form to be filed with their tax returns. Some K-1 filings, however, are not available by the April 15 tax filing deadline, which leaves investors guessing as to the amount of taxes due without the full documentation. This generally requires an amended tax filing, and it can easily create late pay penalties and/or interest due.

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9. International investing tax surprises

As more and more people travel abroad, or even as they live or retire internationally, they are sometimes tempted to invest internationally as well. This may be investing in a home, buying stocks, or even investing in mutual funds of sorts in those countries. Most nations have tax treaties with the United States, but some do not.

When you invest directly in a foreign country, not only will local tax jurisdiction likely take effect, but you also may get taxed by the United States. U.S. citizens are required to pay taxes on income and gains regardless of where they are generated. And owning investments in a foreign country is likely to create a tax filing obligation in that country as well, which means more tax-prep fees and perhaps different tax rates.

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10. Bitcoin and cryptocurrency owners beware

The IRS treats bitcoin and other cryptocurrencies as real property, not currency. Because of their nature as a virtual currency, some investors might think the IRS cannot track their investments, but it can. Many people who traded in cryptocurrencies during the media frenzy of a few years back got caught off guard when they had to pay taxes on the gains. The IRS issued guidance regarding virtual currencies. When it comes time to pay taxes on virtual currencies, the IRS would mainly consider the length of ownership and your filing status, but professional advice here might come in handy.