Read The Transcript Below:

Steven (00:51):

Hello everyone and welcome to the next episode of the Retirement Tech Services podcast, financial Professionals Edition. I’m your host, Steven Jarvis, CPA, and this week on the show I’m very excited for our conversation because I talk often about the challenges that can come with tax reporting. As a long-time listener, you’ll know that one of my favorite sayings is the tax planning isn’t done until it’s been reported correctly. And we end up with this almost sticky area, a little bit of how tax planning gets reported. And a couple of years ago now, custodian called Betterment, which happens to be one of the largest independent digital investment advisors in the United States and has an RIA-facing platform. More and more advisors are getting on. Betterment came across my radar because I liked their tax reporting. They didn’t do it for me. I wish they would’ve, but they didn’t do it just for me. But it really stood out because it provided more information than I typically saw from other custodians. And so I reached out and found the good people at Betterment who are doing this great work and invited Eric Bronnenkant to come join me, who’s the head of tax at Betterment to talk about this world of tax reporting. So Eric, welcome to the show.

Eric (01:57):

Thanks, Steven. It’s a pleasure to be here.

Steven (02:00):

Well, I really appreciate you taking the time to come on and share. We want you to talk a little bit about Betterment. I’m seeing Betterment tax forms more and more often, but for our listeners who might not be familiar, give us a little bit of background on Betterment and then your role at Betterment and then we’ll dive into some of this tax reporting stuff.

Eric (02:16):

Sure. Well, I mean Betterment has been around since 2010, so we’re not a startup anymore, but I wouldn’t say we’re an incumbent either. And I’ve been working at Betterment since 2017. Before that, I was working at Ern Steering for about 15 years, and I had a lot of experience working with investment advisors, individual clients. So when I found an opportunity to work at Betterment, I applied for it and I really saw it as a way to leverage my experience in the investment and tax planning area and scale that as much as possible. 

Steven (02:51):

Eric, you’re one of those rare people who’s both a CPA and CFP. So of course I have to ask which exam was harder, but more importantly, I that out, Ben, I’m a self-proclaimed tax nerd. This isn’t a couple of tax nerd who got together and dissected the tax code. You have the experience and focus both on the technical tax side, which is important, but how we relate this to a client.

Eric (03:13):

That’s true. And when I first started at Betterment, I was trying to think to myself, what are the areas of friction for our customers right now? And how can I solve those as quickly as I can? Also factoring in other prioritization and goals, but being in charge of taxes, I wanted to help our customers be as tax efficient as possible. I mean, you’ve also heard of the word tax alpha, right? Where people trying to figure out how do they get extra return from their investments by using different tax strategies. So that’s one area that we focus on, but also another area I would call tax compliance Alpha, which is where we give our customers, try to give our customers the best tax preparation experience. And when you came to me about the supplemental tax form, which I’m obviously a huge fan of because of the fact that I knew that getting that information for a lot of people was difficult and for many clients and their accountants, they would historically have to find that information on different fund providers websites and then use that and then try to do they call it self calculation and calculate that on their own.

(04:25):

And from my experience that for many people, that was a point of friction that made tax preparation more difficult, and I saw it as a way for Betterment to differentiate itself by designing a supplemental tax form that really made our customer lives easier.

Steven (04:43):

So let’s talk about the supplemental tax form for a minute because that is really the piece that stood out to me the most. The first time one of those came across my desk, it kind of caught me by surprise. I was like, wait a second, why doesn’t everyone have this? And I’ll let you talk about that in just a second. But for context, for listeners who don’t have the tax preparation experience, which is most of my listeners, there’s a couple of things that constantly cause challenges for tax preparers when it comes to investment reporting. And most custodians, more or less feels like they just kind of take this approach of here’s what we’re minimally required to report all the best of luck. And especially there’s a foreign tax piece to this that’s on the supplemental form that Betterment puts out. There’s also a state piece of this, which you were talking about, Eric, that there’s some states in particular that are worse for this, and it also depends on the type of investment portfolio you have.

(05:33):

But yeah, I know CPAs who will have to create their own spreadsheet that’s state-specific to go pull this information of what percentage of this investment versus that investment is tax-free at the state level or taxable at this other state level. And it’s this huge mess that creates a lot of opportunities for error and issues and confusion. And it’s not even all happening within the tax software, even though I think we use certainly one of the more expensive tax prep softwares. Hopefully, that makes it better. I don’t know that’s always the case, but they’re pouring millions if not hundreds of millions of dollars into the development of this software that still can’t handle this very common investment aspect because the tax code is so broad that we’re going to come across these things that are a little bit unique. So Eric, talk about why all custodians don’t just give us this information because clearly you have it, and specifically how Betterment developed this better tool for helping this reporting get done correctly.

Eric (06:28):

When I first started at Betterment, we actually didn’t have any supplemental tax form. So I guess the great opportunity was that I was effectively starting with a blank slate. I wasn’t trying to convince something to change what they were doing. I knew that we needed a supplemental tax form. And so given the opportunity to design it in a way to make customer lives easier and make accountant lives easier, thinking about both of those people, whether it’s a DIY or someone who has an accountant, I knew that there was an opportunity to make this a smoother process. And also thinking about feedback that we get from advisors and from customers historically has been this is not a good experience. So I tried to look at it as, all right, well, I am at this blank slate. If I had my ideal outcome, what would it be?

(07:20):

So looking at that starting from ground zero, and then as you mentioned, there are basically three components that there’s the foreign-sourced income. I knew that helping customers figure out their foreign tax credit for investing in international funds has always been a struggle. And the number one issue is, well, what is your foreign-sourced income? And for many people, they just guess because they don’t want to spend the time and energy to go to all the different investment providers and do all these self-calculations. Putting all those numbers into one box for them really made their lives easier. Ultimately getting through the Form 1116, which is what you use to calculate your foreign tax credits, definitely streamlines that process. And then there’s the US government interest. So in general, US government interest is exempt from state and local taxes. So knowing how much US government interest that you pay can have a pretty significant impact on your state and local taxes and being able to easily identify that number and basically just summing that up for an entire portfolio definitely made everyone’s life easier.

(08:23):

Also, thinking about the municipal interest. So in general, out-of-state, municipal interest is taxable in your resident state if you have state income tax, so like I live in New Jersey and if I invest in non-New Jersey bonds, then I have to pay not New Jersey taxes on that interest, a significant portion of confusion comes from people trying to figure that out on their own and being able to personalize that, which is something I’m pretty sure I haven’t seen anywhere else, where we pull the customer’s address on December 31st and know what state that they’re in. And then we do a calculation of how much of that interest is in-state versus out-of-state. And candidly, after we released our supplemental tax forms for the first time, which was super exciting, I got some feedback from customers, advisors, different social media platforms. It was really nice to hear from people how this made their lives easier. And I have to admit that I didn’t expect as much feedback as I got, and it was very heartwarming and I really was able to feel the customer’s appreciation.

Steven (09:29):

Which obviously I reached out with my own positive feedback on it. I’ve certainly heard that from other people. So that is always exciting to see that it’s having an impact on the end user because sometimes it can be challenging to be removed from that end user experience and say, okay, what is going to make a difference? But yeah, I mean you guys just hit it right on the head with this one. So Eric, give me some perspective on why don’t we see this from everyone else. I mean, you’re talking about this, you had the idea on Friday and on Monday you could release the format. I can’t imagine that was the case otherwise everyone else would flip the switch and do it tomorrow as well. So talk about the effort that goes into this. How do you make this a reality? 

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Eric (10:47):

Our dividend data provider is Broadridge, and they provide us a daily file with all of their tax information. So all the foreign-sourced income per ticker, US government interest in state versus out of state breakdown of all the state. So we get all this information, but the issue is that most custodians provide the information in aggregate to customers and then ultimately they let them calculate it on their own or share it with their CPA. I would say that the reason that they don’t personalize as much, that definitely requires more effort. Also, that doesn’t always work perfectly. There are some people who move of course, so then sometimes we have to let’s say regenerate a supplemental form or something like that because of someone who’s moved. So I would say that even though I love the personalization, there is a trade-off for it, but there are people who do ask for revisions, things like that. I would also argue that some custodians may just not want to dip their toes into it. They may see it as going into an area that they may not that they have enough expertise in. So just a few ideas, but I definitely see it as a differentiator for sure. And just kind of hearing some of the feedback on how this has made preparing their taxes easier or their client’s taxes easier has always been very positive. 

Steven (12:08):

I definitely love that emphasis on taking the feedback series so that you’re receiving from the users of your platform. And I know I have advisors who listen on all sorts of different platforms. So two things to keep in mind here. One, your feedback is important and if you work with a custodian that you don’t feel like is taking that seriously, but you have to ask yourself, when was the last time I provided the feedback and how often am I providing the feedback? And this also just helps give you an idea of what is possible so that as you’re giving feedback, it doesn’t just feel like I’m waving a magic wand here. These things can happen. You need to make sure that you’re part of encouraging those improvements that happen across the industry. So clearly Betterment is very serious about taking feedback and doing something with it. Anything you can share about things you’re working on currently or things you hope to be able to improve in the future on tax reporting?

Eric (12:53):

You also mentioned appreciation for some of the other things on our tax forms, and I’ve also been listening to some of your previous podcasts. So I got attuned to common topics. One of them seemed to come up a number of times was qualified charitable distributions. QCDs, there’s always confusion in this area. Partly I’ll blame the IRS, the fact that it’s reported on a 1099R, but there’s no special coding on the 1099R. One of the things that we do is that we have a, I don’t want to use the word supplemental, we’ll call it on the next page down on the extra information or an activity page where we’ll say, oh, qualified charitable distribution paid on 12/15 for $20,000. And this helps bridge the gap between what clients do and what their CPAs know about, which is not always perfect because it’s pretty common that someone will do the charitable distribution but then not tell their accountant about it. And having this on the form, even in the activity is a way to close that gap and reduce the risk that this gets reported as a taxable distribution.

Steven (14:01):

Yeah, because the supplemental tax form we’ve been talking about is really for taxable investment accounts. Definitely also noticed and very much appreciated that additional activity that’s reported with the 1099R from Betterment because like you said, I’m happy to blame the IRS, but there isn’t a great way just in the codes they’re provided for custodian to say, Hey, this was a QCD, but it can be as simple as here’s the other activity. And so again, for advisors listening who are yet to the point where that’s going to be automatically reported, this is the kind of information you need to be paying attention to that. If you’re not on a platform like Betterment that’s going to do the reporting for you, you need to bridge that gap because otherwise it’s just going to get lost in translation. And especially for something like a QCD, that’s a fantastic planning opportunity that turns into basically a nightmare of getting taxed twice if we don’t report it correctly.

Eric (14:50):

Great summary, Steven. Another thing I was thinking about is we’ve recently come out with something called Smart Transitions where if let’s say you have an appreciated asset held elsewhere and you want to transfer it over, but you don’t want to sell it, let’s say immediately you want to sell it over time. We’ve created a strategy where you can have what’s called a gains allowance. So let’s say you were comfortable recognizing $20,000 in gains per year. We can set it up so that your asset can be sold over time. The sale can be reflected with $20,000 in gains every year till you run through all of your investment that you acquired through the transition. So that’s something that’s exciting for me to help advisors who are trying to transition customer assets. Some of them are hesitant about that transition and this is something that makes the transition easier.

Steven (15:45):

Yeah, absolutely. I could definitely see the value of that. Eric, I’m going to put you on the spot just a little bit here. I don’t think we talked about this before, but I know another point of frustration at times point of challenge with especially tax reporting around investments is around cost basis especially, you mentioned transitioning assets. I mean that’s certainly one of the places that can come up if advisors are helping clients change platforms and then an asset gets sold years later, and so tax form comes through, the 1099 comes through, we’ve got $50,000 of proceeds and sure the custodian marks that the basis wasn’t reported to the IRS, but we still see proceeds of 50,000 in a basis of $0. So anything Betterment’s doing around that to help advisors on their platform or at least can you share some insight into why these kinds of things go on?

Eric (16:30):

Arguably the number one reason for that is for assets that were acquired before, cost basis reporting, what we’ll call those non-covered lots transitioning, those assets typically have no cost basis reported to the IRS when they’re ultimately sold. Also, there are some times where the confer or the other custodian doesn’t provide that information. So things that we try to do reaching out to the other custodian to get that information so that we can properly report the cost basis when it is appropriate. But you’ve definitely highlighted an important point where people have had issues for sure on assets that they’ve transitioned from one firm to another, or even they haven’t transitioned them if they’re just been held for a long time. But I guess one of the good things though is that since they’re being reported with no cost basis, ultimately the customer can put their correct cost basis in when they file. Also, that assumes that they’re aware of that issue and not just importing everything into their tax software and assuming that it’s all correct. So I would say our reporting for non-covered lots. One good thing is that they’re typically on a separate 1099B, so that’s a way that they’re identified. They’re not typically mixed in with all the other investment sales. So I feel like that’s arguably the best that we can do, especially if we don’t have any cost-based information.

Steven (18:00):

That might sound like a simple thing for those listening, but that’s actually huge to be able to at least identify it separately because I mean, you alluded to it in there, a lot of these 1099Bs will come out and it all just kind of gets smooshed together. I’m sure that’s the technical word for it just all gets smooshed in there. And if you got a 40-page 1099B, you might not even realize that you’ve got three securities in there that had a $0 cost basis. As you’re flipping through this really quick, or as a tax preparer in March when they’re doing 400 tax returns, is just looking at the summary page. They got to get through all of these tax returns. So they’re looking at the summary page at the gross level. They’re saying, oh yeah, there’s cost basis, let’s move on. But if they were to dig down a little bit and start identifying, wait, there’s some individual securities that have a $0 cost basis, it makes me think that get ahead of myself just a little bit for advisors.

(18:48):

As we think about action items coming out of this conversation, advisors should absolutely have a checklist that they go through, whether they’re transitioning themselves to a new custodian or just even as they bring on clients onto their platform, whether they’re working for another advisor or they haven’t been working an advisor at all. As you transition assets between custodians, you should absolutely have some kind of checklist you’re going through to make sure you’re double-checking all these things. Because Eric, to your point, some of this on the custodian side is, Hey, it’s the best we can do with the information we’re given. Betterment can’t make up cost basis if it’s not provided to ’em.

Eric (19:23):

Now, another thing I was thinking about in the unknown cost basis category is a stock that was wired through a non-qualified stock option where frequently the cost basis is shown as zero. And even if those assets are transferred over to a new firm, they’re likely stuck at the zero cost basis, and it’s not until that tax return is ultimately being prepared. Are any adjustments being made to properly reflect the true cost basis of the stock options?

Steven (19:53):

Yeah, another great example where the reporting on its own might not get you to where you need to be. We need to be on the lookout for these things. Eric, I really appreciate you coming on and sharing all the great things that Betterment is doing. Before we dive into action items or more action items, I’ve already gotten ahead of myself, talk about where advisors can go to learn more about Betterment and maybe talk just a little bit about who’s a great fit for the Betterment platform.

Eric (20:15):

I mean, our website is definitely the first place, so that’s betterment.com to find out more information. And now, are you talking about specifically about advisors or are you just talking about customers, or?

Steven (20:26):

Yeah, let’s talk about advisors. So if our advisors who are listening to this podcast that definitely run into it at times where advisors are like, you know what? If I came across a solution that provided added more value to my clients, I don’t know that everyone’s out there eager to hop around between custodians. There’s a lot of administrative work that goes with it, but I know those changes happen and if there’s value to the client, I know advisors are open to it. So from the advisor perspective, who are you seeing as a great fit for the Betterment platform?

Eric (20:53):

I would say small to medium-sized RIAs. I would call it Tech Forward, that many of them are planning focused and they want to minimize the work that they need to do to deal with a lot of the back office type of things. The asset transitions, the tax reporting, all of these types of things, the portfolio management, those are all areas that they can effectively shift on to Betterment to better focus on doing personal financial planning and adding value where they know how to do it the best.

Steven (21:27):

Perfect. Well, thank you for sharing that. As I think about action items from our conversation today, I mean, having that transition checklist I think would be a great step for advisors to take as you’re onboarding new clients or if you end up in a situation where you’re transitioning between custodians. Another thing that comes to mind, I mean, we’ve been talking obviously a lot about what Betterment specifically is doing, and I would imagine that just with how, like you said, not a startup anymore, but still relatively new and in the space compared to how long some of these other custodians have been around. We probably have a lot of people listening who aren’t on the Betterment platform. So as you think about the conversation Eric and I have had today, if you’re not on a platform that’s doing that additional tax reporting, these are areas that you should be keenly aware of and doing something to help your clients address.

(22:12):

Because if the custodian’s not doing it for you, I mean your options are kind of throw up your hands and hope for the best, which I can tell you from firsthand experience is not going to always pan out well. Or you can proactively take steps, whether it’s through reviewing tax returns or proactively communicating with CPAs, following a lot of the advice that we talk about on this show or using the resources that our retirement tech services community members get access to. There are things that you’re able to do to proactively help your clients have a different outcome. Even though I joke about it, this isn’t about making CPA’s lives easier, it’s about having better outcomes for your clients.

Eric (22:48):

I think those are all great points, Steve, and trying to figure out how tax optimization, now, whether that’s on the portfolio side or on the tax reporting side, are definitely key contributors out to that for sure.

Steven (23:01):

Yeah, absolutely. Well, Eric, thank you so much again for being here and for everyone listening. Until next time, good luck out there, and remember to tip your server, not the IRS.