Investor Brain

Monday, February 13, 2006

Computing Your Taxes

Note:  This is a portion of the column that ran in Barron’s on February 13, 2006.  The original was co-authored by my Electronic Investor partner in crime, Kathy Yakal, but only my contribution is shown here.  Please reference the original to see Kathy’s thoughts on online tax prep sites.  She’s an insightful writer who also reviews financial software for PC Magazine. 

TAX-PREPARATION SEASON OUGHT TO BEGIN with a basic question: Should you do it yourself or hire the job out? If you feel that you’re educated enough on the ins and outs of filing your own return, with all the complications your life presents tax-wise, then pick up a copy of a tax-preparation program to help you out.

Filing a full 1040 long form by hand by yourself could qualify as proof of insanity, especially if you’ve done any substantial trading last year. Entering data on transactions—including dates, cost bases, sales prices—plus dividends and interest and then making the appropriate calculations by hand isn’t complicated, but it is extraordinarily and unnecessarily tedious. Plus, it all but invites errors on your returns.

If you have a relatively straightforward tax situation—salary, the typical deductions for mortgage interest and state and local taxes, plus simple investment returns—tax-software Websites should be able to handle your return without much complication. The program will ask you relevant questions; you fill in the answers as you go along. The interview process should cover most of the usual tax questions, and make suggestions along the way.

It’s not a substitute for a living, breathing professional if your tax situation isn’t pretty cut and dried. But if it is, it may be possible to download your relevant data—such as W-2s from your employer, 1099s from financial institutions, mortgage and property-tax-payment data from your bank—and let you computer do most of the work. If you prepared last year’s tax return on a computer, you can transfer basic data—name, address, Social Security number, dependents—into your new return, which also reduces the tedium. And if you’re organized and use personal-finance software, such as Intuit’s Quicken or Microsoft’s Money, the process can be further automated.

Tax software also can mitigate several other hassles of filing. If you are subject to the dreaded alternative minimum tax, the software will at least inform you of the bad news. Doing your taxes by hand may require a second set of calculations. If you’re subject to the AMT, it’s probably because you’re unlucky enough to live in a state with a hefty income tax, such as New York or California. The popular tax programs also have state versions, which take your federal data and prepare your state return with relatively little extra effort. Finally, tax programs can alert you to errors and omissions, and to situations that might invite an audit.

We took a look at the tax programs and online services available with an eye for how they’ll work for a relatively active investor. This year, we also looked at how the programs adapted to changes in the tax laws, as well as how they work for dealing with the home-office deduction.

The major names in tax-preparation software continue to be TurboTax, by Intuit, and TaxCut, by H&R Block. Both overhauled their interviews for the 2005 season; TurboTax’s was somewhat more successful; the program’s ease of use improved considerably.

TurboTax’s interview, which we reviewed using its Premier edition (list price $69.95, though many retailers throw in gift cards and other freebies), allows you to import data from financial institutions that use Intuit’s .OFX file. Importing data into TurboTax is an extremely smooth process, especially if you’ve got broadband Internet access. If your bank, broker or mutual fund is part of the network, as most major ones are, pulling in tax-related data is very easy. Many employers also are tapped into the network, either directly or via a processor such as ADP, allowing employees to import their W-2 data quickly and accurately.

We imported data from several brokerage accounts that have been supplied to us for our annual review of online brokers into TurboTax. One of our accounts has quite a few transactions in it, and TurboTax brought them all in flawlessly this time. We haven’t been as lucky in past years; this facilitated import is a huge improvement.

TaxCut doesn’t have the same import capability, however. You’ll manually enter all that data from those 1099 forms that your brokers have sent. We reviewed TaxCut Premium ($49.99 list, also with various goodies from major retailers), which includes H&R Block’s DeductionPro.

If you’re manually entering your stock transactions, be sure to use trade dates rather than settlement dates. If you sold a stock on Dec. 29, 2005, for instance, even though it didn’t settle until Jan. 2, 2006, it counts as a 2005 transaction. Most brokers send out a summary 1099, informing you of the proceeds from all of your transactions over the past year. You’ll need the detailed records of each transaction to be sure the dates and amounts are correct.

Both TurboTax and TaxCut did a good job of dealing with changes to individual-retirement-account contributions, and they examine whether you’re eligible for a Roth IRA rather than a traditional one. TaxCut’s extensive audio help points out that your traditional IRAs are exempt from bankruptcy filing, and encourages users to maximize their contributions, whether they’re deductible or not.

This year, TurboTax added quite a few ways to spend your refund, in the event you’ve given Uncle Sam an interest-free loan last year. You’ll be given the chance to purchase gift cards from a wide variety of retailers, at a discount, with your refund. We think a better use of your refund is to roll it into your IRA or other investment accounts.

If you’re new to tax software, TurboTax is the way to go. TaxCut users will be well-served by picking up the 2005 version unless you want to shift the data entry load over to your computer. (Either program lets you import data from the other’s preceding year’s return.) Check the TurboTax Website (http://www.turbotax.com) to see if your financial institutions are in its system.

FOR THE PERIPATETIC TRADER, neither TurboTax nor TaxCut will make the job of preparing your Schedule D easy, though. That’s where TradeLog and GTT TradeLog come in handy (http://www.armencomp.com). These programs, published by Armen Computing, help those who actively trade to generate portfolio-performance reports as well as prepare a Schedule D.

GTT TradeLog, which is supported by Green Trader Tax (http://www.greentradertax.com), is aimed at traders who need to track mark-to-market transactions. TradeLog is for all the other active traders. Prices range from $49 for a version that is restricted to 100 transactions, to $349 for the mark-to-market version.

The programs produce a file in TXF format that can be imported into TurboTax or TaxCut for preparing your entire return. We found that TurboTax handled the larger number of transactions more elegantly and with fewer errors.

Monday, February 06, 2006

Conversion Trouble Part 2

WHEN WE QUERY READERS each year about what they want in a broker, we typically get 100 or so thoughtful e-mails on the subject over the course of a few weeks. This year, we’ve already heard from several hundred of you on a combination of subjects: problems with the Harrisdirect conversion; the fears of BrownCo customers as they face their upcoming conversion; and wish lists of what Barron’s readers want from their online brokers.

Following our report two weeks ago about the problems E*Trade has had assimilating the Harrisdirect customers, our mailbox filled with new complaints, revealing new issues. Sitting on hold while waiting to talk to someone in customer service remains a major complaint, but another repeated by numerous correspondents involves the rates E*Trade pays for cash balances.

One reader reported that the rate he was getting for cash was one-quarter of what Harris had been paying, and was well below 1% annually. An official at E*Trade told us that Harrisdirect customers were mapped into various FDIC-insured or SIPC-covered products based on the cash balances held in their accounts. Customers were notified of the products they were mapped in December, and were also told they could change their sweep options at any time after they had been converted. With a sweep account, the brokerage makes short-term investments with idle balances.

Harrisdirect customers were also informed in their transition letters that they had additional options, and could change their default-account options after the conversion. For legal reasons, however, E*Trade could not automatically do this for them.

There’s a tool on the E*Trade brokerage site that advises customers where to put their cash, depending on the yield they’d like to achieve. But the customers have to take some action themselves and make the change. It’s not automatic.

Perhaps much of this communication got lost amid the holiday cards in December, as the cash-account conversion appears to have come as a surprise to quite a few Harris customers. One reader reported receiving two or three letters from E*Trade every week, and ignoring many of them since the first several missives were soliciting mortgage business. He now suspects some of the letters he tossed as junk probably contained important account-conversion information—but all the envelopes, even the ads for additional services, had the same printing on the outside.

Given the number of Barron’s readers who were taken by surprise by certain aspects of the Harris to E*Trade conversion, it appears that quite a few important messages got tossed in the rubbish because they looked like ads. BrownCo customers, don’t make the same mistake. And, everybody, keep those e-mails coming about your experiences and preferences regarding online brokers.

SPEAKING OF BROKERAGE integrations, Ameritrade (http://www.ameritrade.com) and TD Waterhouse (http://www.tdwaterhouse.com) closed their consolidation deal Jan. 25. The company is now called TD Ameritrade Holding and its shares trade under Ameritrade’s ticker symbol, AMTD.

Online-brokerage customers won’t notice any changes for several months. Although the takeover is complete from a financial standpoint, the two brokerages will continue to operate as separate entities through 2006. Katrina Becker, TD Ameritrade’s director of communications, says that the integration will take about 12 months. In the meantime, TD Waterhouse continues to solicit new customers. We will review the offerings separately in our online-broker review, even though the TD Waterhouse site will no longer exist in the 2007 review.

“Ameritrade will be the platform you’ll see once the consolidation is completed. We will begin integrating key tools from the TD Waterhouse platform later this year, and plan to complete the back-end conversion in 12 months,” Becker says. This process mirrors the Datek conversion, which significantly improved Ameritrade’s offerings for active traders.

TAX TIME IS COMING. From time to time, we are asked complicated questions about how to calculate the tax basis of a particular holding when there are takeovers, spinoffs, stock splits and reinvested dividends. Some of these actions can be very difficult to track down.

GainsKeeper, which a number of online brokers have adopted to help their customers track the tax consequences of their trades, just introduced BasisPro Cost Basis Analyzer, which can be used to generate the correct cost basis quickly. BasisPro uses a database of historical information for thousands of different securities to generate the correct cost basis.

BasisPro can be accessed directly through BasisPro’s Web interface (http://www.gkis.net/basispro), or via the Web portal of a retail broker-dealer that offers BasisPro to its clients. If a cost-basis inquiry is made that the BasisPro database can’t answer, GainsKeeper’s product-support staff will provide the requested cost-basis information for that specific security within 48 hours and update the BasisPro database accordingly.

More brokers are jumping on the GainsKeeper bandwagon. We expect several announcements shortly.

Monday, January 23, 2006

Lost in Translation

THE HORROR, THE HORROR.

The conversion of accounts from Harrisdirect to E*Trade, which took place between Jan. 10 and 13, turned into a disaster. As noted here last year ("Lowering the Velvet Rope,” Aug. 15.), E*Trade Group benefited in this deal by getting the affluent clients of Harrisdirect. Those folks apparently have made out less well.

Our Electronic Investor e-mail account swelled with reports from unhappy former Harrisdirect clients, telling us of problems logging in, disappearing cash, positions reported incorrectly and hours on the phone waiting on hold after the changeover.

Jarrett Lilien, president and chief operating officer of E*Trade Group (ticker: ET), told us customers with multiple accounts linked to a single log-in had been sent materials telling them how to update their passwords. That system hit what Lilien called “a roadblock” and ran very slowly, which made customers think that their accounts were no longer available or had been lost. These customers called the E*Trade support lines for help.

The conversion also involved changing clearing firms, from Pershing to E*Trade’s own system. This required E*Trade to run both systems concurrently for three days while the data were moved over.

E*Trade had hired several third-party firms to manage some of the data conversions, and although tests prior to the conversion worked fine, on the actual date they failed. The affected customers, who thought that positions had gone missing, also called the support lines for help.

Another problem arose when the cash held in Harris accounts was moved to E*Trade. Owing to the difference in database technology, the cash was logged as transactions, which could trigger backup withholding for tax purposes. The third-party vendor hired by E*Trade had turned off tax withholding for those transactions, but apparently turned it back on prematurely.

As a result, numerous customers got a shock when they looked at their balances, thinking that a chunk of cash had disappeared. This error was fixed within a few hours, but in the meantime, affected customers flooded the E*Trade support lines to find out what had happened.

E*Trade had doubled its support staff for the week, but the series of problems generated seven times the usual number of calls. That created a huge backlog and a lot of unhappy new customers. Says Lilien: “We’re secure, the money is still there, but we didn’t handle the conversion right.”

On Jan. 15, the customers transferred from Harris received an e-mail from E*Trade that said: “Although the majority of Harrisdirect customers have migrated to E*Trade smoothly, there were customers who experienced significant frustration. To those customers, we apologize sincerely.” The e-mail said the problems that erupted during the conversion have been addressed and corrected, with the exception of the long hold times on the phone.

To make up for the inconveniences, former Harrisdirect customers will be given credit for up to five stock or option transactions that they execute between Jan. 17 and Feb. 16. We shall see whether a $65 discount in commission costs will keep these customers on board.

E*Trade’s intention in acquiring Harrisdirect, as well as BrownCo, is to be viewed as a financial partner for those with high-account balances. The firm has added Credit Suisse First Boston research for those with over $100,000 in assets, and is building out an advanced aggregator for research for those customers.

On Jan. 17, E*Trade announced that customers would be protected from online fraud via the firm’s Complete Protection Guarantee, which provides fraud coverage, bill-payment protection and privacy protection. Surveys show that customers believe that their home PCs are safe, when in fact they may be lacking some key protection.

E*Trade has enabled two-factor authentication for those who want it, which means requesting a key fob that generates a random number that the user types in to log into an account—an approach that’s used with many corporate networks. The Complete Protection Guarantee is an extension of banking protections, already in place, to the brokerage side of the business.

If you have a Brown account, should you worry about the conversion? E*Trade’s Lilien says that the Brown conversion should go considerably more smoothly because both brokerage firms already run the same computer systems. We’ll see. The switchover is scheduled for some time in the first quarter.