VERY VERY VERY VERY VERY VERY VERY IMPORTANT!

An incident during this past tax filing season caused me to compose an item to be included in my mid-year letter to 1040 clients.

Here is what I wrote -

“You must include in taxable income the gains from the sale of investments, and can deduct, within limits, losses from investment sales.  The gain or loss is determined by subtracting the purchase price of the investment and the costs of purchase and sale – i.e. commissions, fees and taxes - from the sale proceeds. 

As the result of past legislation, actually good legislation for once, brokerage houses are now required to provide clients with cost basis information for certain investment sales on Form 1099-B.  However, the longer you have held the investment the more likely the broker is not required to identify the cost.  Many brokerage houses will report cost basis information on the sale of all investments, whether or not required to by the law.  However occasionally the broker will report the gross proceeds with no cost basis information.

I cannot properly prepare your tax return without the cost basis information.  You must provide me with the cost basis information – date of purchase and purchase price – of all investments sold.  It is not my responsibility to determine the cost basis.  And during the tax filing season I do not have the time to waste trying to come up with the needed information. 

If the investment was acquired via mergers or spin-offs I may be able to do some basic research during the season, but even then I would need the cost basis information for the underlying investment.

If you receive a Form 1099-B from a brokerage house that does not include cost basis information for each and every investment sale do not just send it to me and expect me to pull numbers out of the air.  Contact your broker and have him or her provide you with the missing information.  If I get a Form 1099-B without cost basis information for all sales I will NOT begin work on the return until you provide me with all the missing information.

For your information, according to T.C. Memo 2003-259, if a taxpayer cannot provide proof of the cost basis of a stock or other investment sold it will be considered to have a "0" cost basis.  As a result, the entire gross proceeds will be fully taxable.

It is very important that you open and read all the tax documents you send me.  Don’t just put an envelope unopened or unread in the package you are sending to me.”

Insert “your tax professional” for “me” in the above.

TTFN

COST BASIS REPORTING

Last week over at ACCOUNTING TODAY Roger Russell stated the obvious - “Complexity of Cost Basis Reporting Requires Tax Expertise”.

Roger identified the problem –

“Every new piece of legislation meant to simplify certain tax areas generally adds complexity of one sort or another to the Code. {tax pros} often refer to new tax legislation as an ‘Accountants Full Employment Act.’

A case in point is the cost basis reporting requirement, in place during this past tax season. While complicated enough by itself, the situation is exacerbated by differences in the requirements for brokers and investors.”

As a tax professional, perhaps the biggest challenge, and time consumer, I faced during the past tax season was the new Schedule D/Form 8849 format.

Roger explained –

“Beginning on Jan. 1, 2011, it became mandatory for brokers and other financial intermediaries to report cost basis information on Form 1099-B to investors and to the IRS for equities acquired on or after that date. The new requirement, spelled out in the Emergency Economic Stabilization Act of 2008, also covers mutual funds acquired on or after Jan. 1, 2012, and will cover debt securities, options and private placements acquired after Jan. 1, 2014.”

And as I explained in my post “That Was The Tax Season That Was” –

“A new Form 8949 was added to report the individual short-term and long-term transactions in three separate categories – sales where the cost basis was reported to the IRS on Form 1099-B, sales where the cost basis was not reported to the IRS on Form 1099-B, and sales that were not reported on a Form 1099-B.  A separate Form 8949 was required for each of the three categories.  The Schedule D served as a summary of the 8949s.”

I went on to detail the biggest problem with this new requirement –

“The various brokerage and mutual fund houses all treated the new Form 1099-B portion of the year-end consolidated tax report differently. 

For the most part this new system required some additional time, but not additional agita.  In many cases the 1099-B reporting was excellently broken down into separate categories of short-term “covered” (transactions where cost basis was required), short-term “non-covered”, long-term, and undetermined term.  And a gain and loss analysis, with cost basis for all, or almost all, transactions provided, was also included in the report in the same format. 

In some the 1099-B received by the taxpayer included the cost basis for all transactions – although you often had to read the fine print to discover if the cost basis shown had actually been reported to the IRS.

The worst cost basis reporting formats came from Morgan Stanley Smith Barney and TD Ameritrade, with TD the bottom of the barrel.  The 1099-B for these brokerages was not broken down to list different categories of transactions (as described above).  Transactions were listed alphabetically, regardless of term or coverage, with cost basis information shown only where required. 

MSSB reports included a gain and loss analysis, but it was merely broken down by short and long term, as had been done in past years.  TD did not include a gain and loss analysis in its consolidated statement.  The client had to go online to generate the analysis, also still in the short or long only format.

The additional work required for clients of these brokerages was not so bad with only one or two pages of transactions.  But several had multiple (as many as 50) pages of transactions (can you say “churning”) – making proper reporting much more difficult and time consuming than in the past.”

Requiring brokerage and mutual fund houses to report cost basis is a good thing.  In tax seasons past the biggest challenge, and time consumer, was determining cost basis for investments sold by clueless clients.  Brokers and funds were often already providing profit and loss statements with much cost basis information, which was helpful, and when this was not automatically included in a Consolidated Year-End 1099 Statement, or some cost basis information was missing, I could in many cases get the information direct from a client’s individual broker. 

Making cost basis reporting mandatory will eventually save lots of time during tax season.  However, it will take a long time to fully phase in to maximum reporting.  By the time that comes I will be retired.

And I expect we will never have 100% cost basis reporting.  What about the stock that was inherited from a relative, or was received as a gift when the taxpayer was a child?  It is easy enough to determine the cost basis for inherited investments, assuming you know the date of death, and future regulations could require brokerages to determine cost basis based on date-of-death value at the point the investment is transferred into the account.  But determining the basis of a gifted investment can be almost impossible.

In the meantime to make things a little easier perhaps the IRS could establish a required pro-forma format for all Form 1099-Bs from all brokerage and fund houses, and all houses could come to an agreement that Profit and Loss statements included in the Consolidated Year-End 1099 Statement be done in the same pro-forma format (if industry-wide agreement is at all possible). 

Ideally, all 1099-Bs (and P+L statements) would be “broken down into separate categories of short-term “covered” (transactions where cost basis was required), short-term “non-covered”, long-term, and undetermined term.” 

And, while I am as happy as a pig in reality tv transferring broker-provided profit and loss statements to Form 8849 (and in the past Schedule D) as is, how do I really know that the information provided by the broker is correct.  And what is my responsibility as a tax pro to make sure the information is correct? 

The alternative is to have all clients keep detailed, contemporaneous, and ongoing records of all investment purchases.

Oh well, I can dream, can’t I!

TTFN    

THE NEW SCHEDULE D

Have you heard about the new Schedule D?  I first learned of the change from a table-mate at the recent NJ-NATP Annual Meeting.

For as long as I have been preparing 1040s (since February of 1972) individual capital transactions were reported on Schedule D.  Part I was for short-term gains and losses and Part II was for long-term activity.  A supplemental Schedule D-1 was later created if more room was needed to list transactions.

Individual transactions, short-term and long-term, will now be listed on a new Form 8949 – Sales and Other Dispositions of Capital Assets.  The new Schedule D will be a summary of the Form 8949 entries.  There is no more Schedule D-1. 

The change comes because, as per “The Emergency Economic Stabilization Act of 2008”, beginning with tax year 2011 brokers must report on Form 1099-B the cost basis of any common or preferred stock, exchange-traded funds (ETFs), American Depositary Receipts (ADRs) and Real Estate Investment Trusts (REITs) purchased on of after January 1, 2011.

For future reference, effective January 1, 2012, information about mutual funds and dividend reinvestment plans will also be recorded and reported, and effective January 1, 2013, options, fixed income, and any other security otherwise not included in the previous tax years must be recorded by the brokerage and reported to the IRS.

This is a great new requirement.  When fully phased in it will save tax preparers lots of time during the season.  I have always said that one of the biggest problems I face in preparing returns is determining a cost basis for investments sold by clueless clients.

It is also good for the IRS to have this information provided by the broker.  In my 40 tax seasons I have never seen the Service question the cost basis for a stock sale.

I hope that the regulations for satisfying this requirement, and the brokerage software programs, will make sure that 20 years from now, when a taxpayer sells a stock purchased in 2011, the cost basis reported on Form 1099-B will correctly reflect the effect of all subsequent mergers, spin-offs, etc. 

In addition to short and long term, capital transactions reported on Form 8949 will also be broken down into three categories –

(A)  gains and losses with the cost basis reported on Form 1099-B,

(B)  gains and losses with no cost basis reported on Form 1099-B, and

(C)  gains and losses for which no Form 1099-B was received.

A separate Form 8949 must be completed for each of the above categories.

While a draft of the forms are available, there are no draft of the instructions available yet – so I could not learn more about the Form 8949, such as what is the “Code” that goes in box (b).   

I have several clients whose capital transactions for the year take up as many as 50 pages of a supplemental Profit and Loss report included in the brokerage firm’s Consolidated Year-End package.  In such a case I create my own supplemental schedule, which I attach to the return, by “cutting and pasting” the P+L, with the totals carried forward to the Schedule D. 

I wonder how the new 2011 Consolidated Statement will deal with the changes.  Will Form 1099-B report the cost basis for all sales for which the broker has the information in their system, or just for investments purchased in 2011?  Will the Profit and Loss report identify and summarize transactions in the above three categories? 

I am worried that the new procedure may add hours to the prep time for clients with already time-consuming multi-page “cut and paste” Schedule D (and now Form 8949) schedules.   

TTFN