1099-Misc from the broker list payment in lieu of Dividend (long term capital gain)

[nagalkad]

Is there a way to reclaim the 'long term capital gain' if it is noted on 1099-Misc from the broker listed payment in lieu of Dividend? if yes, how do I enter it?

[JohnB5677]

If you have a Box 8, Substitute payments in lieu of dividends or interest, this means that your broker lent out your shares to a short seller. The 'substitute payments in lieu of dividend or interest" is the short seller making you whole for the dividend collected while he held the stock. Unfortunately, they don't qualify for favorable tax rates on qualified dividends.

You could run through the entry questions for the 1099-MISC again.

 When you run through the questions, you will come to a question about whether you intended to make money. If you did intend to make money, then it will tax your money as a business and apply the Self-Employment Tax. You can then deduct your expenses if you have any. If you did not intend to make money, then the program will just add the income as ordinary income with no Self Employment Tax

See Original Posting

[nj7210]

I'm faced with a similar situation where I have received payments in lieu of dividends and have margin interest expense.  While trying to offset Payments in lieu of dividends against the interest expense by going through the 1099Misc form,  I didn't come across any questions other than the boxes to enter the amounts listed on the 1099Misc. 

Could you please advise again where to specify the information? I'm using the TurboTax delux version. 

[Beezer371]

Good question.  I wonder if you need to file a Schedule C to do this.  

[DianeW777]

Yes, if you answer the question about whether you intended to make money essentially it is asking about a business as noted by our Tax Expert @JohnB5677.

This would file a Schedule C and allow business expenses against the income. 

@Beezer371 

@nj7210

[Ionnowhy]

I own a business and am using Turbotax Home + Business.

On my investments from my personal brokerage account, I have substitute payments (PIL/Payment in Lieu) reported on box 8 of 1099- MISC.

On the personal section of the desktop software, I enter the amount in 1099-MISC box 8 but it doesn't ask me if I intended to make money. I did incur a significant margin expense, but I can't figure out how to deduct the margin expense against the PIL. It does not ask me if I intended to make money so I can initiate a schedule C and report my expenses.

Also, must I pay self-employment taxes to take advantage of the deduction? How much is the self employment tax I'd owe?

Thank you!

[DaveF1006]

Yes, if you intend to use Schedule C, you will need to pay self-employment tax. Your self employment tax is determined from what your net income is after you enter your income - expenses.  For an example, if your net earnings are $10,000, your self -employment is calculated by the following example.

1. $10,000 X .9235 = $9235 
2. $9235 X .153 = $1413 (This is the self-employment tax on $10,000 worth of net income. 

With this said, a Schedule C is only generated from earned income. Substitute payments are not earned  income but are payments of dividends or interest on securities that you own. If your securities are held in "street name" by your brokerage firm, the brokerage may "lend" them to someone who sells short. This is why the program never asked you if you intended to make money. it would have prompted you if you reported the substitute payments in Box 3, which would have been incorrect.

If these are on loan when the dividend or interest is paid out (goes ex-dividend), you would be paid an amount to substitute for the dividends or interest you're entitled to as the real owner. This is not earned income but something that is generated from a passive activity. I would use caution and not use a Schedule C even though this may be a normal business activity that you engage in. This could raise a red flag with the IRS. 

As far as deducting the business investment expense, business investment expenses use to be reported as an itemized expense on Schedule A but are no longer allowed but may be allowed in the state where you live. 

@Ionnowhy 

[Ionnowhy]

@DaveF1006 

Thank you for clarifying the issue. Appreciate your thorough and prompt response.

A few follow up questions:

1. In that case, would a conservative approach then to avoid any unwarranted IRS attention be to use 1099 Misc to report any PIL I have?

2. I would owe neither SE tax (assuming I max Social Security on W2 wages, this would be 2.9% and not 15.3% in your message, correct?)  nor NIIT (3.8%). Since these are not considered wages, I assume I wouldn't owe medicare taxes either? So I "only" pay the applicable federal and state taxes and no SE/ NIIT/ Medicare taxes?

3. Lastly, I can't deduct the margin expense against PILs? If I have a surplus margin expense after offsetting all my investment income, it is best to carry it forward to a future year?

4. Does the carry forward of margin expense work only if I itemize deductions? If I use SD since the margin expense isn't high enough, I forfeit the margin expense from this as well as all prior years and can't carry it to next year?

Thank you so much.

[DaveF1006]

In answer to your questions:

1. The 1099 MiSC is the correct and only form to use to report substitute payments. This is reported as other income on your 1040.
2. You would pay the applicable federal and state taxes on other income and no SE/ NIIT/ Medicare taxes since this is not earned income.
3. Since investment expenses are no longer deductible for federal income tax purposes, it cannot be carried forward to be used in future years to offset income.
4. Regardless, whether you itemize or claim the standard deduction, you cannot carry forward any unused investment expenses.

@Ionnowhy

[Ionnowhy]

@DaveF1006 

Thank you again.

Margin expenses would be considered interest expenses, correct? My understanding for the 4 statements you made is as follows- Could you confirm/ refute (Bolded my responses just to draw your attention)?

1. The 1099 MiSC is the correct and only form to use to report substitute payments. This is reported as other income on your 1040. Agreed
2. You would pay the applicable federal and state taxes on other income and no SE/ NIIT/ Medicare taxes since this is not earned income. Thank you for clarifying this.
3. Since investment expenses are no longer deductible for federal income tax purposes, it cannot be carried forward to be used in future years to offset income. Is this true for interest expenses such as margin interest: Turbotax allows me to carry forward unused interest expense if I use itemized deduction I thought? or is margin expense not considered interest expense?
4. Regardless, whether you itemize or claim the standard deduction, you cannot carry forward any unused investment expenses. Is this true for interest expenses such as margin interest: Turbotax allows me to carry forward unused interest expense if I use itemized deduction I thought? or is margin expense not considered interest expense?

Hopefully, this would help me (and other users with similar questions) best use turbotax. Thank you!

[AbrahamT]

You can deduct margin interest from your taxes by itemizing your deductions and subtracting margin interest costs from your net investment income You can never deduct more than your investments earned in any given year. So in answer to your two questions is as follows; 1- Only if you itemize, then you would be allowed to take margin interest as an expense and 2- Only the margin expense upto the amount from the Substitute payment in lieu of dividend would be allowed. Any excess amount will "NOT" be allowed to be carried forward.

[Ionnowhy]

@AbrahamT @DaveF1006 

Thank you for your response.

I am not sure I fully comprehend, "Only the margin expense upto the amount from the Substitute payment in lieu of dividend would be allowed. Any excess amount will "NOT" be allowed to be carried forward."

The article https://turbotax.intuit.com/tax-tips/investments-and-taxes/what-is-form-4952-investment-interest-exp... states, " The IRS does allow you to carry forward the disallowed deduction into future years, however. In this example, you can use the $2,000 in disallowed expenses for this year in a future year, but the same restrictions continue to apply. You must have net investment income to deduct qualifying investment interest."

Could we use the following example?

Margin Interest: $125,000

1. STCG and Non- Qualified Dividends of $50,000- The margin interest will offset this. So interest left= 75,000

2. LTCG and QD: I can elect to treat them as #1. If I do, interest left to carryover is 25k, and if I don't, interest carried forward is $75k?

3. Let us assume PIL was 10k in this scenario- This is not offset by margin interest and won't affect the amount of margin that can be carried forward in scenario 2 (either 25k or 75k based on the elections made for #2.) I will need to pay federal and state income taxes only on this amount.

Is that inaccurate?

Thank you.

[AbrahamT]

Based on this, see HERE  see Section 8 through 13 of what goes into the category of net investment income, all capital gains both short term and long term go into the category of net investment income as well as all dividends both qualifying and nonqualifying. So in your case, yes all this income falls into this category. And yes, the margin interest expense can be carried over to the following year for any excess over the net investment income. So in your example, whatever the combination is for LTGC and STCG, QD and Non-Qualifying Dividends, whatever your margin interest expense is in excess of that, it may be carried over ONLY if you itemize.  Can you clarify what you mean by NIL?  

[Ionnowhy]

@AbrahamT 

Thank you.

To your question, "Can you clarify what you mean by NIL? "- I am assuming you meant PIL? PIL= Profits in Lieu of Dividends. Thank you!

[AbrahamT]

In that case, then it's part of your dividend subcategory and goes into that net investment income category as previously discussed.

Substitute payments in lieu of dividends result from your broker lending out the stock you own to short-sellers. Those short-sellers borrow your shares and then sell them on the open market, betting that they'll go down in value before they have to repurchase them and return the shares to you.

If the stock pays a dividend during the period that they've borrowed shares, then the short-sellers have to reimburse you for the lost dividend income. This reimbursement is the substitute payment made in lieu of the dividends you would otherwise have received directly from the company issuing the stock.