BI > MARCH 2006

Taxing Issues

Preparing Forms for Your Club

Q. This past June our investment club was dissolved, and in filling out my taxes I don't know what tax form to use.

Bobby Cook

A. I'm sorry to hear that your club disbanded. But you shouldn't let this be the end of your investment education. If you want to continue as a club member, you have several options. These include:

1. Find a new investment club by attending a BetterInvesting chapter, regional or national event and letting others know you're looking for a club to join.

2. Check for a church model investment club by visiting the 1,000 Churches Connected website.

3. Start a new club by following the steps outlined in BetterInvesting's Investment Club Operations Handbook.

As to filing your taxes, here's the critical information for clubs:

Who

All investment clubs in operation during the fiscal year must file taxes, including those clubs that had any income or expenses, made any securities transactions, saw gains or losses or disbanded. If in doubt, file -- the penalties are too steep not to.

From IRS Publication 541's Penalties section: "A penalty is assessed against any partnership that must file a partnership return and fails to file on time, including extensions, or fails to file a return with all the information required. The penalty is $50 times the total number of partners in the partnership during any part of the tax year for each month (or part of a month) the return is late or incomplete, up to 5 months."

When

Financial institutions, such as banks and brokers, have until Jan. 31 to mail the year-end statements for the previous year. Therefore, it's best to wait until mid-February to close your club's books for the year. Your club's tax filings must be filed with the IRS by April 15.

What

The club will need:

• IRS Form 1099 from each of its financial institutions. These forms provide dividend, interest and other financial information.

The club needs to create:

• A Dec. 31 valuation statement. This statement details your club's overall investment gain or loss for the year, which goes on your personal Form 1040 Schedule B or D, or both, of your tax return.
• IRS Form 1065.
• IRS Schedule K-1.

How

1. Verify all transactions through Dec. 31.

2. Verify all members' addresses and Social Security numbers.

3. Verify the club's tax identification number.

4. Create a valuation statement for Dec. 31 (the valuation statement the club used for its December meeting is not sufficient).

5. If you use accounting software, use its auditing tool and make any necessary corrections.

6. Distribute the club's earnings to each member. Then create a distribution of earnings statement, expense statement and balance sheet for the dates Jan. 1 through Dec. 31. Make these reports available to every member of the investment club.

7. Two copies of Form 1065 are needed -- one for the IRS and the other for the club's records.

8. Three copies of Schedule K-1 are needed for each current and withdrawn member -- one for the IRS, one for the club's records and one for each member. Note the Final K-1 box on the Schedule K-1 of any members who withdrew from the club in the past year. In your case, Bobby, every member would check this box (see illustration below).

Click to enlarge.

9. The club's tax return should be sent to the IRS via certified mail with return receipt requested. Attach the return receipt to the club's copy of its tax filing.

Click to enlarge.

Where.

Where

Because investment clubs are business entities, their tax forms aren't sent to the same place as individual tax filings. Use the table above to determine where your club should send its tax filing.

Though the preceding information may make preparing tax forms seem daunting, it's a relatively simple process. It's especially easy if your club uses club accounting software and a tax printer. The most important thing you must do now is contact the former treasurer of your club and make sure the tax filings are made to the IRS and that you and the other former members receive the proper paperwork for your individual filings.

If your club needs additional help completing the forms, try contacting your local BetterInvesting chapter and ask for help. Many chapters offer club accounting and tax classes. You can also find your local IRS Taxpayer Assistance Center by accessing its website. As with any tax issue, you should seek the advice of a qualified accountant or tax professional.

Instead of printing instructions for doing your investment club's tax return, BetterInvesting now makes them available at the website. Included will be all the necessary tax forms.

Editor's Note: Several readers pointed out that a Dec. 31 valuation statement isn't of use in preparing a tax return.

As one BetterInvesting chapter director wrote: "The Distribution of Earnings Statement (NCA2.5.11/16) or Allocation of Income and Expense Statement (CA3.0.7, CAO) has much of the necessary information about the club's overall gain or loss (and expense, which was not mentioned but must be reported) and the same for individual partners. For clubs that sold securities (even fractional shares), the Transactions Summary and Individual Investment Histories will also be necessary. It is also necessary that all these reports be compared with 1099 forms and year-end summaries received from financial institutions to be sure that all transactions have been entered correctly."

Ask Colleen your club question by writing to colleen@ColleenMulder-Seward.com. Colleen holds an M.B.A. from Wayne State University. Since 2000 she has served on the board of directors for BetterInvesting's Southeastern Michigan Chapter. Colleen also writes the Retirement Intelligence Information Services newsletter for retirementcalc.com.