There’s nothing like watching an investment spike. However, a potentially lucrative investment may not be as it seems when the tax implications are taken into account.
Capital gains taxes in the U.S. are separated into short and long-term capital gains rates. With the latter, your income will influence what you pay. A low earner may pay 0%, whereas a top earner could max out at a 20% tax on investment gains.
So, how do taxes work when you invest with M1 Finance?
Does M1 Finance Offer Tax-Loss Harvesting?
As we mention in our M1 Finance review, tax-loss harvesting is something that’s missing from this low-cost, no-commission robo-advisor.
For professional investors and day traders, the lack of tax-loss harvesting may turn them away from the platform.
The concept of tax-loss harvesting is quite simple. Traditional brokerages will often employ this feature to automatically sell certain securities at a loss to offset a capital gain elsewhere. Regular investors can save thousands of dollars on their taxes when taking advantage of this feature.
While M1 investing doesn’t offer tax-loss harvesting as a feature, there are actions you can take to reduce your capital gains taxes at M1.
Short-Term Capital Gains vs. Long-Term Capital Gains
Before we explore how you can save on taxes with M1, it’s important to understand the difference between short-term capital gains and long-term capital gains.
All assets held for less than one year and sold at a profit will be classified as a short-term capital gain. These profits are taxed in the same way as income from salaried employment. If you’re a high net worth individual, you could be paying up 30-40% on these types of gains.
Long-term capital gains, on the other hand, are levied on assets that have been held for a minimum of one year. Your tax rate is based on your income, with three possible tax brackets:
- 0%
- 15%
- 20%
In most cases, you won’t need to concern yourself with short-term capital gains tax because M1 investing is a platform aimed at people who are planning for the future. As we detail in our M1 Finance review, this is not the platform for day traders.
How Do Taxes Work with M1 Finance?
Taxes can be complicated which is why M1 Finance requires you to put some thought into how your taxes work. Firstly, dividends and interest earned through M1 will be subject to income taxes, unless your portfolio is within a tax-deferred retirement account, such as a 401(k).
Let’s assume you invest in one of M1’s expert pies and that pie pays a dividend. You will pay taxes on any dividends paid. Dividends will be taxed at your usual income tax rate. If they are qualified dividends, which most are, you will be taxed at a lower rate of tax.
If you invest in a pie that doesn’t pay dividends, you only pay taxes on that pie when you sell the assets within. Even if you happen to be up on an investment, you only pay taxes when you realize those gains.
M1 Finance Tax Minimization
A cool feature offered by M1 investing is the tax minimization feature. While the platform doesn’t offer classic tax-loss harvesting, M1 will automatically attempt to move money into and out of your account in a way that reduces the taxes you pay.
Whenever you withdraw from M1, they will sell your assets in order of priority, which are:
- Losses that offset future gains
- Assets that result in long-term gains.
- Assets that result in short-term gains.
As long as you withdraw sparingly, M1 will automatically protect you from short-term capital gains tax liability.
Another great way to minimize your taxes with M1 is to create an M1 Finance Roth IRA account. This is a tax-sheltered account that can protect you from tax liabilities going forward.
M1 Finance Retirement Account Taxes
If you have a retirement account with M1, taxes work a little differently. As we already mentioned, you don’t incur normal taxes when you sell assets within your retirement accounts.
Taxes on retirement accounts are not incurred when you buy and sell, nor are dividend payments and interest gains. In the eyes of the IRS, the only time a taxable event occurs is when money is removed from the retirement account.
Once funds are withdrawn from the retirement account, the owner of the account must then pay tax on any distributions as ordinary income. These distributions will be reported on IRS Form 1099-R.
Naturally, there are ways and means to move money in and out of a retirement account in a tax-efficient manner.
The Bottom Line
M1 Finance doesn’t offer the same type of formal tax-loss harvesting as traditional brokerages. The platform’s tax minimization feature does help you to reduce your tax burden, however.
To buy, sell, and profit in the most tax-efficient way, we recommend avoiding any form of short-term trading with M1. As long as you’re willing to hold your assets for at least a year, you will pay minimal taxes on your investment gains.
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