Vanguard margin dividend tax reimbursement payment: downside of margin

free4now

Thinks s/he gets paid by the post
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I've had a margin account at vanguard more than a decade, but never done any margin investing. I like the idea of having the margin for quick access to lots of emergency cash. E.g. in case I total a rental car or need to bail someone out of jail.

I just now learned that for a long time (2003?) the IRS has been disadvantaging margin accounts, taxing the dividends as ordinary income if the stock has been lent out. I recently got a letter from Vanguard saying (OCR scanned):

A reimbursement will appear on
your brokerage account statement

On or before May 21, 2021, your Vanguard Brokerage margin account will be credited with a substitute payment .
reimbursement. This payment is to offset the tax consequences of receiving substitute payments taxed at the ordinary
income tax rate instead of the preferential tax rate applied to qualified dividends. If you have more than one margin
account, each affected account will receive this credit.
Vanguard Brokerage clients receive substitute payments instead of dividends when we lend stocks in a margin account
(as permitted in the Vanguard Brokerage Margin Account Agreement) through a stock's ex-dividend date. Substitute
payments received in 2020 were reported in Box 8, "Substitute payments in lieu of dividends or interest," of your 2020
Form 1099-MISC. Eligible substitute payment reimbursements will only be credited to eligible accounts that are open
on the reimbursement date.
Your reimbursement payment will be 8.97% of eligible substitute payments
Because the tax status of each affected account holder isn't known, the current-year reimbursement rate of 8.94%
reflects the 22% tax rate of the majority of taxpayers. The rate also includes an adjustment of taxes since the
reimbursement is taxable income and will be reported in Box 3, " Other income," of your 2021 Form 1099-MISC.
Questions?
If you have any questions, call us at 877-662-7447 from Monday through Friday, during normal business hours.

I started investigating and it seems that the amount of the payment (on 5/20 labelled as Income) was only $3.49, from a brokerage account of nearly one million.

So if this is 8.97 percent then the total seems to be under $40 for the year. Because my early retired IRS income is only about $35k most years, I don't think I have much to worry about. The difference between my zero cap gains rate and the ordinary income rate on $40 is going to be in the ballpark of $3.49 so I don't think I'm losing more than a few bucks a year if that. At least this year. Not a bad fee to keep access to hundreds of thousands of dollars emergency cash.

Just thought I'd post since this is new to me. Hopefully those of you who have looked into this matter will double check my conclusion that I shouldn't worry much about this, or refute as appropriate.

Also, I don't remember getting letters like this in the past; is this compensation a new thing?
 
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Yeah, you lose a little bit on this deal because the difference between your marginal rates on ordinary income and QDivs is 12%. This is costing you about 4.1% of the amount that was in box 8 on your 2020 1099-Misc. If that number is ~$40, then it's only ~$1.60.

If most of their clients are in the 22% bracket, then they only have a 7% difference between ordinary income tax rates and QDiv rates, so the 8.97% rebate covers their costs fully.

If you didn't receive these reimbursements in prior years, it could be becausee this is the first time a stock you owned was lent out over its ex-dividend date. You can check by going back through your 1099-Misc's for the past few years to see if there's anything in box 8.
 
Nice. I definitely have not gotten any 1099-MISC from vanguard in the past. I will look forward to my first!
 
Nice. I definitely have not gotten any 1099-MISC from vanguard in the past. I will look forward to my first!

Hmmm. It seems like you should have gotten a 2020 1099-MISC, probably in February of this year. The letter you quoted says they're reimbursing you now for taxes you paid on distributions that were made last year. If you didn't have a 2020 1099-MISC, then you shouldn't have gotten the reimbursement now.

It might be a good idea to double check the tax forms in your Vanguard account online, and if you don't see a MISC for last year, ask some questions.
 
Thanks that was helpful. I was wrong; I did get a 2020 1099-MISC with the $38.86 box 8 substitute payments in lieu of dividends or interest. It was hidden on the back page of my tax info doc with no mention on the top summary page. And amazingly enough I entered it on schedule 1 and 1040 box 8 when I filed my 2020 taxes. I did a review of the last 5 years and didn't seem to get any 1099-MISC for any of those previous years so looks like I don't have to worry too much about this biting my taxes. Although I suppose there is nothing stopping vanguard from loaning out everything next year.
 
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