Handling Tax-Exempt Investment Income with H&R Block

It’s tax return filing season in the United States, and the anticompetitive tax preparation companies are being less than helpful as usual. If you trade stocks and bonds in the markets (or more wisely just use a roboadvisor like Wealthfront or Betterment), you may be scratching your head when it comes to reporting tax-exempt income from U.S. Treasury obligations, municipal bonds, or foreign-sourced dividends.

Here’s a quick guide on how to enter in these significant tax-saving figures within H&R Block desktop software, made especially for those who receive supposedly helpful “supplemental” tax forms from their broker that unfortunately don’t walk you through the steps within the software interface.

Caveat: I am not a tax professional, so please feel free to comment with any additions or corrections!

U.S. Government Interest

Your broker must provide a 1099-DIV if you’ve received taxable dividends from your holdings during the tax year, and Box 1a is what’s generally taxable by the federal government. However, some portion of those dividends might have come from U.S. Treasury bonds or similar, and that portion is usually not taxable by your state or local government. Your broker’s supplemental form might include an “amount of U.S. Government interest included in Box 1a of your 1099-DIV” – take that number and divide it by the value in Box 1a to get a percentage.

Now within H&R Block, scroll to the bottom of the page while verifying your 1099-DIV details to find a checkbox to signal you have some U.S. Government interest.

On the next page, enter in the percentage you calculated. This will be used in your State return later, if applicable.

Foreign Sourced Income

If you have an internationally diversified portfolio (as any wise investor should), some dividends may come from foreign sources and could result in a foreign tax credit for you. Your broker hopefully sent you a supplemental that states the “amount of foreign sourced income included in Box 1a and Box 1b of your 1099-DIV“. Add these together and keep the sum handy for when you get to the Foreign Tax Credit (Form 1116) part of the interview.

Once you’re there, add a new record for “Passive” income and use the sum to fill in the value of gross U.S. taxable income from a “country” called RIC (Registered Investment Company).

Later on, use the total values of Box 7 across all your 1099-DIVs to fill in the value of taxes paid on this screen. Use the last day of the year as the “date paid”.

More details can be found on this excellent post specifically about how to claim the Foreign Tax Credit.

Municipal Interest

This category of investment income is perhaps the most confusing and easiest to miss or screw up. You may be holding funds that invest in municipal bonds – these are financial instruments that local governments often use to raise funds for major infrastructure projects. They’re great for cities because their interest rates are usually lower than other lending mechanisms, yet they are also good for investors because they have favorable tax treatment. A win-win for urban planners and finance bros alike!

Your broker hopefully provided a supplemental that specifies the “amount of in-state and out-of-state income included in Box 12 of your 1099-DIV” – based on your current state of residence. If not, you may have to look up each of your funds and calculate the percentage of returns from your state manually…

Once you have these figures, go to your State tax return (assuming California here) and enter the amount of out-of-state income when you get to this screen:

For the next set of screens, just copy the values that H&R Block pulled from the Federal return. You don’t need to make any adjustments unless your foreign funds somehow invested in your state’s municipal bonds or you were only a part-time resident of your state for the year.

Hope this helps demystify these common tax-exempt income sources. If you see any errors or potential optimizations, please let me know – ideally before the tax return deadline!

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.