Tony Molina, CPA•February 16, 2024
Welcome to our Ask Wealthfront series, where we tackle your questions about personal finance and investing. Want to see your question answered here? Reach out to us on social media and we’ll try to address it in a future column.
How do taxes work for the interest I earned in my Cash Account? What about earnings in my taxable investing account?
As you gear up for tax season, it’s normal to wonder how your earnings from various accounts will be taxed. While everyone’s tax situation is different and it’s impossible for a blog post to tell you exactly what you specifically will owe, it is possible to share some general principles to help you understand the basics. That’s what we’ll do in this post, focusing on our Cash Account and taxable investing accounts like our Automated Investing Account, Automated Bond Portfolio, and Stock Investing Account.
Before we dive into the details, here’s a high-level overview of what you can expect from Wealthfront for your Cash Account and taxable investing accounts this tax season:
- If you earned more than $10 in interest or $600 in awards in a Wealthfront Cash Account, we’ll send you a 1099. Use this form to file your 2023 tax return.
- If you have a taxable investment account with dividends or realized capital gains, we’ll send you a Consolidated 1099. Use this form to file your 2023 tax return.
- If you use our Tax-Loss Harvesting service, you can use your harvested losses to lower what you owe—we automatically include this information in your Consolidated 1099.
Remember: If your tax situation is complicated or you just feel like you need more guidance, it’s smart to speak with a tax professional. With this in mind, here’s a more detailed explanation of how taxes work for the Wealthfront Cash Account and our taxable investing accounts.
Taxes on high-interest accounts like the Wealthfront Cash Account
We’re very proud of the high 5.00% APY we offer on the Wealthfront Cash Account through our partner banks—because the APY is so high, it’s possible to earn a significant amount of interest on your cash. It’s important to remember that this interest, just like the interest from any high-yield account, is taxed as ordinary income (just like your paychecks are if you earn a salary).
At the federal level, ordinary income is taxed progressively, with marginal rates that currently range from 10% all the way up to 37%. The rate you’ll pay depends on the total amount of taxable income you have that year and your filing status (single, married filing jointly, etc).
If you live in a state with income tax, you could also owe state income tax on the interest you earn in a high-yield account. State tax treatment of interest varies widely from state to state—for example, in California, marginal tax rates currently range from 1% all the way up to 12.3%, while other states (like Florida, Alaska, and Texas for example) have no state income tax at all.
If you’re a Wealthfront client and you earned more than $10 of interest (or $600 in awards) during the previous year, we’ll send you a Form 1099 at the start of tax season (usually late January). Use that form when you file your tax return.
Taxes on investing accounts like a Wealthfront Automated Investing Account, Automated Bond Portfolio, or Stock Investing Account
To understand how your investments are taxed, it’s important to know the difference between the two types of investing gains: short-term capital gains and long-term capital gains. When you sell an investment for more than you paid for it, that is known as “realizing a gain.” Whether that gain is a short-term capital gain or a long-term capital gain depends on how long you held that investment before selling it.
Gains realized for investments held for a year or less are short-term gains, and they are taxed just like ordinary income (which, as we described above, means it is taxed progressively at federal marginal rates of up to 37% and potentially taxed at the state level depending on where you live).
You realize a long-term capital gain when you sell an investment for more than you paid for it but you held it for longer than one year. Long-term capital gains rates are generally lower than ordinary income tax rates, and range from 0% to 20% at the federal level. As is the case with ordinary income rates, long-term capital gains are different depending on which state you live in.
Dividends are another source of income for investors. If you earn dividends, those are generally taxable even if you don’t sell the investment. Dividends can be taxed at long-term capital gains rates if they are “qualified,” or as ordinary income if they are not. This article does a deeper dive on the details of how dividends are taxed.
It’s also worth noting that some dividends from bond ETFs are taxed-advantaged —and this applies to you if you have an Automated Bond Portfolio at Wealthfront. Dividends from US Treasury ETFs are typically exempt from state tax, which can be especially valuable if you live in a higher tax state like California.
The information above might seem complicated, but at Wealthfront, we want to keep your tax season as simple as possible. Each tax season, Wealthfront will send you a Consolidated 1099 containing information about all of your long- and short-term capital gains, along with any dividends. Just plug this information into your tax preparation software or share it with your tax professional.
Don’t forget about your harvested losses
Tax-loss harvesting is a tax-minimization strategy that takes advantage of daily market volatility to improve your after-tax returns. When an investment in your portfolio declines below its purchase price, you can sell that investment, “harvest” the loss, and buy a similar investment to retain the overall risk and return characteristics of your portfolio. At Wealthfront, we automate this strategy at no additional cost. When tax time rolls around, you can then use those harvested losses to offset your taxable gains.
Harvested losses first offset any capital gains realized at Wealthfront. Losses beyond that can offset capital gains realized outside of Wealthfront. Losses left over after that can be used to reduce your taxable ordinary income up to $3,000. Any remaining losses after that can be used in a future tax year.
If you’re a Wealthfront client with Tax-Loss Harvesting enabled in your taxable investing account, we’ll automatically include information about your harvested losses on your Consolidated 1099. If you use TurboTax to file your taxes, your Tax-Loss Harvesting information will be automatically imported when you upload your Consolidated 1099—there are no extra steps to take.
Tax season doesn’t need to be taxing
Taxes can get complicated, and we encourage you to head over to our Help Center if you have more questions, or to speak with a tax professional about your unique situation. We hope this information helps!
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Disclosure
The information contained in this communication is provided for general informational purposes only, and should not be construed as investment or tax advice. Nothing in this communication should be construed as a solicitation, offer or recommendation to buy or sell any security. Any links provided to other server sites are offered as a matter of convenience and are not intended to imply that Wealthfront Advisers, Wealthfront Brokerage or any affiliate endorses, sponsors, promotes and/or is affiliated with the owners of or participants in those sites, or endorses any information contained on those sites, unless expressly stated otherwise.
Wealthfront Advisers and its affiliates do not provide legal or tax advice and do not assume any liability for the tax consequences of any client transaction. Clients should consult with their personal tax advisors regarding the tax consequences of investing with Wealthfront Advisers and engaging in these tax strategies, based on their particular circ*mstances. Clients and their personal tax advisors are responsible for how the transactions conducted in an account are reported to the IRS or any other taxing authority on the investor’s personal tax returns. Wealthfront Advisers assumes no responsibility for the tax consequences to any investor of any transaction.
The effectiveness of the tax-loss harvesting strategy to reduce the tax liability of the client will depend on the client’s entire tax and investment profile, including purchases and dispositions in a client’s (or client’s spouse’s) accounts outside of Wealthfront Advisers and type of investments (e.g., taxable or nontaxable) or holding period (e.g., short- term or long-term).
Wealthfront Advisers’ investment strategies, including portfolio rebalancing and tax loss harvesting, can lead to high levels of trading. High levels of trading could result in (a) bid-ask spread expense; (b) trade executions that may occur at prices beyond the bid ask spread (if quantity demanded exceeds quantity available at the bid or ask); (c) trading that may adversely move prices, such that subsequent transactions occur at worse prices; (d) trading that may disqualify some dividends from qualified dividend treatment; (e) unfulfilled orders or portfolio drift, in the event that markets are disorderly or trading halts altogether; and (f) unforeseen trading errors. The performance of the new securities purchased through the tax-loss harvesting service may be better or worse than the performance of the securities that are sold for tax-loss harvesting purposes.
Tax loss harvesting may generate a higher number of trades due to attempts to capture losses. There is a chance that trading attributed to tax loss harvesting may create capital gains and wash sales and could be subject to higher transaction costs and market impacts. In addition, tax loss harvesting strategies may produce losses, which may not be offset by sufficient gains in the account and may be limited to a $3,000 deduction against income. The utilization of losses harvested through the strategy will depend upon the recognition of capital gains in the same or a future tax period, and in addition may be subject to limitations under applicable tax laws, e.g., if there are insufficient realized gains in the tax period, the use of harvested losses may be limited to a $3,000 deduction against income and distributions. Losses harvested through the strategy that are not utilized in the tax period when recognized (e.g., because of insufficient capital gains and/or significant capital loss carryforwards), generally may be carried forward to offset future capital gains, if any.
All investing involves risk, including the possible loss of money you invest, and past performance does not guarantee future performance. Historical returns, expected returns, and probability projections are provided for informational and illustrative purposes, and may not reflect actual future performance. Please see our Full Disclosure for important details.
The Annual Percentage Yield (APY) for the Cash Account is as of November 3, 2023 and may change at any time, before or after the Cash Account is opened. The APY for the Wealthfront Cash Account represents the weighted average of the APY on the aggregate deposit balances of all clients at the program banks. Deposit balances are not allocated equally among the participating program banks.
Investment management and advisory services are provided by Wealthfront Advisers LLC (“Wealthfront Advisers”), an SEC-registered investment adviser, and brokerage related products, including the Cash Account, are provided by Wealthfront Brokerage LLC, a Member of FINRA/SIPC.
Wealthfront, Wealthfront Advisers and Wealthfront Brokerage are wholly owned subsidiaries of Wealthfront Corporation.
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About the author(s)
Tony Molina is a Product Evangelist at Wealthfront. He is a Certified Public Accountant (CPA) and holds Series 66 and Series 7 licenses from FINRA. View all posts by Tony Molina, CPA
