Tax Guide 2013 for LendingClub and Prosper 1099 Forms

lendingclub1099

Updated 2014. I’ve gotten a few tax-filing questions regarding P2P lenders Prosper Lending and Lending Club. For tax year 2013, LendingClub provided individual investors extra guidance with their Tax Guide for Retail Investors [pdf]. Using this information, I have updated this post.

Don’t file too early. My first recommendation is to not print out or download any of your 1099s until mid-March. Both Prosper and LendingClub seem to regularly issue corrected and/or amended 1099 forms with new numbers late in February. If you already printed them out earlier, go back and make sure they haven’t been changed. After having to file an amended return a few years ago, I always wait until after mid-March to gather all my tax documents.

Where to find your tax documents. I don’t think either Prosper or Lendingclub sends you 1099 forms in the mail. The easiest way for me to direct you to these documents is for you to cut-and-paste the following URLs into your web browser and then log into your accounts. Here are screenshots of what the pages should look like for Prosper and LendingClub.

https://www.prosper.com/secure/account/common/statements.aspx

https://www.lendingclub.com/account/taxDocuments.action

Tax disclaimer. I am not a tax professional. The following is based on my best attempt at understanding the fuzzy world of P2P lending taxes. I am simply sharing how I’m going to do my personal tax return, but you should consult a tax professional for an expert opinion. You may not get all or most of these forms.

LendingClub

LendingClub 1099-OID. OID stands for original issue discount. The total of Box 1 is basically what LendingClub is reporting as the interest earned on your loans, net of fees. This interest should be reported on Schedule B and taxed as ordinary interest income (similar to interest from bank accounts).

LendingClub 1099-B (Recoveries for Charge-offs). If you had any loans charged-off*, but they still recovered some money later on, that will be reported here. It should be broken down into either short-term or long-term capital gains. Because it already tells me short-term or long-term, I will simply report the totals with acquisition and sell date(s) as “various”.

LendingClub 1099-B (Folio secondary market). If you sold any loans on the secondary Folio market, then the sales should be reported here. It should also be broken down into either short-term or long-term gains or losses. I will simply report the totals on Schedule D, using my acquisition and sell date(s) as “various”.

LendingClub 1099-MISC. I would just type this form into TurboTax box-by-box or submit directly to your accountant, usually under “Other Income”. Box 7 amounts will be subject to self-employment taxes, Box 3 amounts will not.

Prosper Lending

Prosper 1099-OID. Similar story to the LendingClub 1099-OID above, except they just give you the total from all your loans. Again, I have all zeros except for Box 1, which I will report as ordinary interest income on Schedule B.

Prosper 1099-B (Recoveries for Charge-offs). Again, anything listed here should be broken down into either short-term or long-term capital gains/losses and recorded on Schedule D. Prosper includes loan charge-offs on this form.

Prosper 1099-B (Folio secondary market). Again, anything listed here should also be broken down into either short-term or long-term gains or losses.

Prosper 1099-MISC. I would just type this form into TurboTax box-by-box or submit directly to your accountant, and it should be pretty straightforward. Box 7 amounts will be subject to self-employment taxes, Box 3 amounts will not.

*Reporting Charge-offs

If you have loans that were charged-off in 2013 (loan is very late and attempts to collect have failed, so they give up), you can write them off as a non-business bad debt. You can find these in either your year-end statements (LendingClub) or your 1099-B form (Prosper). These are all treated as short-term capital losses, which you can use to offset short-term capital gains from other investments or you can deduct against up to $3,000 in ordinary income per year (with the balance carrying forward to the next year).

More resources: Let me also recommend Peter Renton’s post at LendAcademy, the follow-up comments on that post, and this forum post by AmCap as good references for an intelligent discussion on the topic. Also see the LendingClub and Prosper tax pages, even though they aren’t especially helpful.

Prosper vs. LendingClub Investor Experiment: 15.5 Month Update

1402_prosper700

After posting the 1-year update (Part 1, Part 2) of my Beat-The-Market experiment back on November, I got bored. I had started with $10,000 split evenly between Prosper Lending and Lending Club, but although this alternative asset class had potential, I just didn’t find it reliable enough for me to invest significant funds in it.

I didn’t sell off my existing loans, but I stopped reinvesting in new ones. I hadn’t logged into either account for months, but this week I wanted to download my tax documents. So, I figured another update was in order, 3.5 months later.

$5,000 LendingClub Portfolio. As of February 19th, 2014, the LendingClub portfolio had 199 current and active loans, 36 loans that were paid off early, and none in funding. 6 loans are between 1-30 days late. 8 loans are between 31-120 days late, which I will assume to be unrecoverable. 7 loans have been charged off ($152 in principal). $1,814 in uninvested cash. Total adjusted balance is $5,305. This is only $1 higher than 3.5 months ago.

1402_lc700

$5,000 Prosper Portfolio. My Prosper portfolio now has 185 current and active loans, 56 loans that were paid off early or payoff in progress, and none in funding. 4 loans are between 1-30 days late. 10 are over 30 days late, which to be conservative I am also going to write off completely (~$183 in remaining principal). 14 have been charged-off ($302 in principal). $1,619 in uninvested cash. Total adjusted balance is $5,255. This is $45 less than 3.5 months ago.

1402_prosper700

What has happened since my last check-in on November 1st?

  1. My total adjusted balance is $10,560, which is a $44 drop over the last 3.5 months. Even with the increase in idle cash, my total balances should still be inching up, not down. It appears that an increasing number of late and defaulting loans are starting to catch up to me.
  2. My idle cash balance across both accounts has increased by $1,527 in just 3.5 months, indicating an increasing number of early loan payoffs and thus fewer people paying me 10% interest rates.
  3. Prosper is currently doing worse relatively than LendingClub. This could change again in the future. Here’s an updated chart tracking the LendingClub and Prosper adjusted balances over these past 15.5 months:
    1402_pr_lc

I suppose that I’ll hang onto these loans and see how the rest unfolds. I know that other people report 10%+ annual returns on Prosper and Lending Club and may be better loan pickers than me, but I still be wary setting such high expectations for the average P2P investor. I’m still in the black and doing okay, but I wouldn’t count your chickens until the loans get a bit more mature.

Can I Really Withdraw My Roth IRA Contributions At Any Time Without Tax Or Penalty?

Revised for 2014. This post about how to withdraw past Roth IRA contributions has been popular over the years amongst search visitors, and I have completely updated it using the most recent IRS documentation. Besides emergencies, this information may also be useful for early retirees under age 59.5 that wish to access some of their tax-deferred funds without incurring taxes or penalties.

This is a follow-up to my post Roth IRA Contribution vs. Emergency Fund Savings, where I suggested that people should just fund their Roth IRAs first over an Emergency Fund. The simple reasoning was that anyone can withdraw their Roth IRA contributions at any time, without penalty. (Not earnings, just contributions.) Put in $5,000, and you can take out $5,000 later – be it one day later, one week later, or one decade later. But some concerns were raised about the validity of that assumption, so I wanted to iron that out here using IRS Publication 590.

First, we head to the Roth IRA section, specifically the subsection called Are Distributions Taxable?. Here, the first sentence states:

You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s)

Sounds pretty clear, but let’s keep looking. The next section talks about qualified distributions, like those made after you turn 59½, which are definitely not taxable. We are given this decision flowchart (Figure 2-1), and… whoops, we may not even pass the first box. Taking out your contribution within the first 5 years is not a qualified withdrawal. 

But wait. Not all unqualified withdrawals are taxable. Going to How Do You Figure the Taxable Part?, we are directed as follows:

To figure the taxable part of a distribution that is not a qualified distribution, complete Form 8606, Part III.

Here is a link to Form 8606 [pdf] and the Form 8606 instructions [pdf].

Here’s how you would fill out the form for the simple situation of taking out former Roth IRA contributions. On Part III, Line 19, you would include the money you took out as a distribution – “Enter your total nonqualified distributions from Roth IRAs in 2013″. This would carry over to line 21. But then on Line 22 you would “Enter your basis in Roth IRA contributions”. Line 23 tells you to subtract the difference (21 minus 22). If you are taking out less than you formerly contributed over the years, your net taxable amount would be zero.

What about a possible 10% penalty? In the section on the penalties Additional Tax on Early Distributions, we see this:

Unless one of the exceptions listed below applies, you must pay the 10% additional tax on the taxable part of any distributions that are not qualified distributions.

Since this unqualified distribution of a former contribution is not taxable, there is no “taxable part” and thus no penalty to worry about.

In conclusion, although taking out a former Roth IRA contribution as a distribution may be (1) an unqualified distribution, it is also (2) not taxable and (3) not subject to any additional penalties. When subsequently filing your taxes, remember to fill out IRS Form 8606 as indicated above so show the IRS that you are only taking out your original basis.

How Do I Make A Withdrawal?
If you are under 59½, you usually need to make a specific request to your broker. Here is the info from my Vanguard account:

You can request a withdrawal from your IRA online, over the phone, or by mail. You can have a check sent to you, have the proceeds deposited directly to your bank account, or transferred to a nonretirement Vanguard account.

World Stock Market Cap Breakdown by Country: 1900 vs. 2013

worldcap1900

When learning about investing, it is good to remember that nearly all the “commonly accepted advice” out there is based on at most 100 years of historical returns. Meanwhile, many of us still have 50 or more years ahead of us. Is that enough data? I’m pretty comfortable with broad patterns such as stocks outperforming bonds over long periods across nearly every developed country. However, as the conclusions get finer I get more and more skeptical.

For example, I wouldn’t bet all my chips on any one country. The world will look very different in 50 years, and I doubt we’ll be able to predict much of it. (Though I’m sure it will seem “obvious” in retrospect.) Take a look at these two charts comparing the relative market capitalizations of world equity markets as of the end of 1899 and 2013.

worldcap1900

I’ll check back in around 2050…

Source: Credit Suisse Global Investment Returns Yearbook (via Abnormal Returns)

The Importance of Calculating After-Tax Returns

Gus Sauter, former CIO at Vanguard, talks about the need to focus on after-tax investment returns in an interview with the WSJ (found via Abnormal Returns). He answers the question What’s your most important tax advice for mutual-fund investors?:

For equity investors with a long time horizon, it is important to search for funds that have low annual distributions of capital gains. Grinding through the math, it turns out that a fund that realizes and distributes most of its capital gains annually would have to outperform a fund that distributes minimal capital gains by as much as 2% per year in order to provide the same long-term, after-tax return. Funds that have lower turnover are a pretty good place to start looking for low capital-gain distributions. Index funds are an obvious candidate.

For fixed-income investors in higher tax brackets, municipal-bond funds can be an attractive alternative to taxable bond funds.

In 2013, many successful active funds that trade frequently (high turnover) distributed sizable capital gains. Resources like Morningstar.com can provide information about turnover ratio and after-tax returns for specific funds.

Here are the 2013 capital gains distributions for all Vanguard funds. Both Vanguard’s Total US Stock and Total International Stock funds distributed zero capital gains for 2013. For your own holdings, you can check your tax statements to compare the relative size of the capital gains with the share price (NAV).

Index Fund vs. Hedge Funds: Buffett $1,000,000 Bet Update

Carol Loomis of Fortune has just posted the 6-year update in Fortune of the $1,000,000 index fund vs. hedge fund bet between Warren Buffett and a successful hedge fund manager. The hedge funds were in the lead early on, but started lagging behind last year. Over 2013, the index fund lead widened further. 60% of the way through the 10-year bet (1/1/08 to 12/31/17), the Vanguard S&P 500 index fund backed by Buffett is up by 43.8%. The group of hedge funds hand-picked by Protégé Partners are up by 12.5%, a gap of over 30%.

Will this collection of hand-picked hedge funds be able to outperform a simple, low-cost index fund over the long run? Hedge funds employ the smartest minds but also charge hefty fees of roughly 2% of assets annually + 20% of any gains. At the start of the bet, the past performance of the hedge funds were excellent – from inception in July 2002 through the end of 2007, the Protégé fund gained 95% (after all fees), soundly beating the Vanguard S&P 500 index fund’s 64%. But lots of funds have good performance when looking backwards. It is much harder to pick out winning managers ahead of time (and harder on those managers when everyone is looking).

Read the story of how the bet came to be in the original 2008 Fortune article “Buffett’s Big Bet”. Read the terms of the bet and each side’s opening arguments at LongBets.org. This carefully-tracked bet was part of the inspiration for my transparent Beat the Market experiment. Too often, people are not honestly and accurately tracking the performance of their portfolios… again, starting ahead of time. It is natural to point out your winners and conveniently forget the losers.

You can read my original 2008 blog post and halfway 5-year update here.

New myRA Retirement Accounts Quick Summary

Now that the dust has settled a bit, here’s a quick breakdown of the newly-announced myRA based on the description “simple, safe and affordable starter retirement savings account”.

  • Simple = Direct payroll deduction. myRA will be funded directly through paycheck withholding, likely using the same infrastructure used to buy savings bonds via TreasuryDirect. No employee match. No bank account required. One investment option.
  • Safe = Government-backed principal protection. The only thing you can buy in the myRA is a security identical to the G Fund of the Thrift Savings Plan available to federal employees. First, it has a principal guarantee so that your balance will never go down. Second, it pays interest based on the weighted average of all treasuries with maturities 4 years or more (2.5% as of January 2014). So it has the higher interest you’d get from owning longer-term bonds without the risk of loss.
  • Affordable = Low contribution requirements. Minimums of $25 needed to start, and $5 per paycheck for future contributions.
  • Starter = Temporary and small. Must be rolled over to a “regular” Roth IRA held at a private custodian when the account value reaches $15,000 or after 30 years.
  • Retirement account = Structured as a Roth IRA. The myRA is a Roth IRA with the US government as the custodian, as opposed to a private company like TD Ameritrade. Account grows tax-deferred, and qualified withdrawals at retirement are tax-free. Same contribution limits ($5,500 for 2014) and same income limits ($129k MAGI for single, $191k MAGI for couples in 2014).

I would also add that it is not available yet, and will only be coming to select employers in “late 2014″. The goal is to be available to all W-2 employees via payroll deduction eventually, but that is unlikely to be earlier than 2015. For a more in-depth discussion, I liked this article by Michael Kitces at Nerd’s Eye View.

Much like modern car manufacturing, this is an attempt at fashioning a “new” retirement vehicle using existing parts from other models. Why? The President had to piece this thing together using executive order instead of pushing new legislation through Congress.

Will myRA entice people who currently aren’t saving for retirement? I like the ease of paycheck deductions and the idea that you’ll never lose money. But the overall package just isn’t exciting enough. There is no buzz. People are not clamoring to sign up right away. Instead of just 4+ year Treasuries, it should offer both a principal guarantee and the highest interest rate of any US bond (30-year Treasuries?). Make it as attractive as possible.

Financial Advisors Can Improve Portfolio Performance by 3% a Year?

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alphaAt a major ETF industry conference, Vanguard CIO Tim Buckley shared a preview of an upcoming report from by Vanguard Research. The general idea is that a good financial advisor should be able to affect the performance of client’s portfolio by three full percentage points. That’s a really big number, and I’m sure it has many advisors excited. Here’s how that 3% breaks down:

  • 1.5% – Controlling client behavior. Avoid market timing. Don’t chase performance. Stick with asset allocation. Stay the course and keep investing during market downturns.
  • 0.60% – Efficient tax management. Maintain optimal asset location (not allocation) to minimize tax costs. When money is needed, determine which assets and when to sell.
  • 0.50% – Keeping costs low. You have the ability to choose investments with low expenses.
  • 0.40% – Rebalancing. Rebalance regularly back to target asset allocation.

Buckley used the terms “controlling alpha”. Alpha is defined as excess risk-adjusted return above a benchmark, usually involving things like timing asset class movements and careful stock selection to make the difference. In contrast, the four factors listed above are less about being smarter than everyone else and more about avoiding simple mistakes.

This is still helpful advice, as these are the areas in which you should realistically expect assistance when looking for a financial advisor. It’s quite unlikely that the friendly person in the office building downtown is the next Warren Buffett. However, he or she may be the calming voice that you need to stay the course. I don’t know about 3%, but I do think a good advisor can invest better than many people on their own. As long as the advisor costs less than their “advisor alpha” benefit, you’ll come out ahead. The hard part, as always, is to find one of these “good” advisors.

Of course, being a DIY investor I feel I can do all these things myself. I also can’t help but notice again that many of these aspects are already rolled up into a nice balanced fund like the Vanguard Target Retirement 20XX Funds. By being all-in-one, the fund discourages trading and encourages doing nothing. The funds rebalance back to their target asset allocations automatically. The costs are extremely low. The only area where they come up short is tax-efficiency. However, for many individual investors the vast majority of their retirement assets are located in tax-advantaged accounts like IRAs and 401ks. In those cases, the benefits of tax-management are minimal.

It will be interesting to read the methodology behind the full report when it is published.

Sources: InvestmentNews (registration req’d), ETF.com

Prosper P2P Loans Class Action Settlement

P2P lender Prosper.com was sued because the defendants “allegedly violated securities laws due to Prosper’s selling securities without qualifying or registering them and acting as an unlicensed broker-dealer” (they later registered with the SEC). I was just notified that the case was settled without admission of wrongdoing for $10 million (1/3rd will go to lawyers of course). Details at ProsperClassAction.com.

You are eligible for a portion of this settlement if you purchased notes from Prosper between January 1, 2006 and October 14, 2008. This period is sometimes referred to as “Prosper 1.0″. You used to be able to bid on loans, and many early investors lost money while this new model was being tested out (their loan collection methods back then were horrendous). Accordingly, settlement payouts will be made “in proportion to the aggregate amount of losses”.

It appears that you don’t have to file a claim to get your share of the settlement. However, if you have changed e-mails since buying since investing in a Prosper loan, you may not have gotten this notice. Also, if you moved you should update your address on record to make sure you get that check.

1994-2013 Callan Periodic Table of Investment Returns

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Reader Ben shared this in the comments, and I think it deserves a separate mention. Every year, investment consultant firm Callan Associates updates a neat visual representation of the relative performance of 8 major asset classes over the last 20 years. You can find the most recent one below (click to view PDF), which covers 1994 to 2013. Each year, the best performing asset class is listed at the top, and it sorts downward until you have the worst performing asset. You can find previous versions here.

You can try to find some patterns, but I doubt you’ll find anything significant. Sometimes an asset class has a hot streak that last a few years, and other times an asset class is on top one year and bottom the next. Most recently, Emerging markets equities were on top in 2012, and bottom in 2013.

Also, while the table compares relative performance, you can also note that absolute performance changes all the time as well. In 2013 the best asset class returned +43% while the worst asset class returned -2%. Contrast this with 2008, when the best asset class returned +5% while the worst asset class returned -53%. Sometimes you just can’t lose, and other times you just can’t win.

So I won’t bother predicting what will happen in 2014, and will instead continue owning multiple, less-correlating asset classes using low-cost passive investments. Oh, and I make sure to rebalance them regularly.

Estimate Your Portfolio Personal Rate of Return – Calculator

Updated and revised for 2014. Some of you may be wondering how well your specific portfolio performed last year (or over any specific period of time). Let’s say you started the year with $10,000 and put in another $5,000 through 10 different deposits spaced throughout the year, and ended up with $16,000. What was your rate of return? Your main goal is simply to separate the effect of new deposits (or withdrawals) and your actual return from investments.

Figuring out your exact personal rate of return requires you to know the exact dates of all your deposits and withdrawals, along with a financial calculator or spreadsheet program with an IRR function (example here). However, for a quick and simple estimate of your returns, try this calculator instead:

Initial Balance: $
Total Deposits: $
Total Withdrawals: $
Final Balance: $
Time period:   year(s)
Your estimated annualized rate of return:   %

Instructions

  1. Get your initial balance. This is probably from your brokerage statements. Try January of last year.
  2. Tally up any deposits or withdrawals. For example, let’s say you know you put $3,000 in your Roth IRA and also 5% of your $40,000 salary into a 401(k). That would be $3,000 + $2,000 = $5,000. That’s it, you don’t need to worry about looking up the specific dates and amounts.
  3. Get your final balance. Your December statement is probably available already.
  4. Find the time elapsed (in years) between your initial and final balances.
  5. Hit Calculate. An estimate of your annualized return is instantly given.

How Accurate Is This Estimate?
The calculator assumes that the inflows and outflows are spread evenly around the middle of the year. I originally saw this method in the book The Four Pillars of Investing (review). However, unless the deposits and withdrawals are very large as compared to the initial balance, the estimates are actually pretty good.

For example, let’s say that you start with $100,000 on 1/1/13, and end up with $120,000 on 1/1/14. If you had net deposits of $10,000 during the year, the calculator above would estimate your return at 9.52%. If the $10,000 was actually deposited all at once on one of these specific days, you would get the following exact returns:

Deposit Date Exact Return
1/1/13 (very first day) 9.1%
6/04/13 (middle of the year) 9.5%
1/1/14 (very last day) 10%
Estimate 9.5%

 

Also check out the rest of my Tools and Calculators.

Another Reason Why Vanguard Target Retirement Funds Are Underrated

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Index funds are growing increasingly popular. Yet Carl Richards tweets that over the last 15 years, the actual investor return for the popular Vanguard S&P 500 index fund (VFINX) lags nearly 2% a year behind the fund’s official return. That works out to a final balance that is 24% less. This means that if you account for the timing of actual dollar inflows and outflows, the average investor in the fund actually earned a lot less than they might think. (More explanation on investor returns vs. advertised returns here.)

Here’s the data taken straight from Morningstar. The longer the time period, the worse the relative performance:

As Abnormal Returns put it, “indexing is no panacea“. I think part of the problem is that people use the S&P 500 as a proxy for the overall stock market and thus trade it much more frequently… and poorly. If you were really afraid during the 2008 financial crisis, it was really tempting to sell your stock shares and keep it in something “safe” instead like bonds or cash. You may still be in cash today after missing out on the rebound.

But what about the Vanguard Target Retirement 20XX Funds, which are basically just a mix of different index funds? Specifically, let’s take the Vanguard Target Retirement 2045 Fund (VTIVX). It’s mostly stocks, and mostly US stocks at that, so it should behave similarly to VFINX. Check out the 10-year growth chart comparison with the S&P 500 fund:

However, the average investor returns for the Vanguard Target Retirement 2045 Fund are much closer to the fund returns. The investor return over the 10-year period is actually better than the fund return, although some of that may have to do with the small asset base in 2004.

Why is this? My opinion is that people who own the Vanguard Target Retirement fund trade a lot less frequently. Part of this is self-selection. If you buy this fund, you desire simplicity. Also, if you own an all-in-one fund that holds both stocks and bonds together, you don’t have the problem of seeing one investment drop while the other rises. This is the benefit of buying a “balanced” fund.

You won’t see Vanguard Target Retirement funds being touted very much in the financial media. Their returns are rarely at the top since they are index-based, so magazines and newsletters won’t write about them. Most advisors are supposedly charging you for their “expert” advice, so they will of course recommend something more complicated. Even index fund enthusiasts like myself often don’t invest in them because we like to fine-tune and tinker (sometimes to our detriment).

Despite their boring nature and lack of publicity, I have long recommended Vanguard Target Retirement funds to members of my family. They are simple yet diversified, have very low expenses, and designed to be left alone. You don’t even have to rebalance your holdings; it is done for you automatically. Could you do better? Maybe. Could you do worse? Definitely.