As an investor, you are responsible for paying capital gains taxes owed on any returns earned from your portfolio each year. Come tax season, brokerages issue the documentation you need to complete your taxes for the prior year.
Occasionally, security issuers need to update dividend or interest payments after they’ve been reported — that’s income reclassification. We’ll help you understand what it means when one of your securities goes through income reclassification.
Read more: 4 steps to plan ahead for your taxes
What is income reclassification?
Income reclassification refers to changes made by security issuers to previously reported dividends or interest payments. As a brokerage, Ally Invest provides you with the most current information available ahead of the IRS deadline, but sometimes a security issuer might find it’s necessary to update that information. This results in new documentation, which your brokerage will prioritize updating for you as soon as possible. While these updates can happen any time, they most likely occur prior to March 15th.
Certain investments are more prone to reclassifying their interest or dividends. If you hold multiple securities subject to these revisions, you could receive multiple corrected documents. It may be beneficial to wait until later in the tax season to file your return to avoid the need for amendments. You can speak to a tax professional for further guidance.
While this list is not exhaustive, these types of securities are more likely to undergo income reclassification:
Individual stocks
Mutual funds and ETFs
Real Estate Investment Trusts (REITs)
Real Estate Mortgage Investment Conduit Securities (REMICs)
Widely Held Fixed Income Trusts (WHFITs)
Unit Investment Trusts (UITs)
Types of income reclassifications
Non-dividend distribution: If a portion of a dividend exceeds the company’s earnings and profits, it is generally considered a non-taxable return of capital. Up to 100% of the dividend may be reclassified from a taxable dividend to a return of capital, resulting in a decrease in the original value of the security held.
Other common reclassifications: Investments may experience other changes in taxes due on dividends. These dividends may include other types of income such as capital gains, foreign tax or tax-exempt interest. They may also consist of qualified, non-qualified or section 199A dividends. This is most common with mutual funds and similar securities.
What to expect with updated documents
Forms to expect: Income reclassifications are typically reported on tax Form 1099-DIV. Reclassifications that affect cost basis information, such as return of capital, may result in an updated 1099-B.
Identifying corrections: The "CORRECTED" box at the top right corner of the first page will be checked, along with the correction date. Corrected transactions will have a 'C' in the 'Additional Notes' column.
Updating tax software: If you have previously imported your tax data into software, such as TurboTax, additional imports or manual adjustments may be necessary.
If you need help determining whether any further actions are required for your tax filing, consult a tax professional for guidance on next steps.
