A new law that requires financial firms to report profit and loss information on securities transactions to clients and the Internal Revenue Service starts taking effect next year. This will make it more important than ever to consider the tax consequences before you sell an investment, not when you’re filing your 1040.
The reporting requirements will cover only securities that were purchased in taxable accounts after a certain date and subsequently sold. They will apply to:
» Stocks purchased on or after Jan. 1, 2011.
» Mutual funds, including most exchange traded funds, and stocks purchased as part of a dividend reinvestment plan on or after Jan. 1, 2012.
» Options and fixed-income securities, such as bonds, purchased on or after Jan. 1, 2013.
Securities acquired before those dates are generally not covered, nor subject to the new IRS reporting requirements.
The law was buried in the 2008 bill that created the Troubled Asset Relief Program, or TARP. It is designed to generate tax revenue by making sure investors pay the appropriate tax on securities they have sold.
Today, firms report the gross proceeds from clients’ securities sales to the IRS and to clients on Form 1099-B. But they don’t report the clients’ cost basis, or how much they paid plus or minus certain adjustments.
As a result, the IRS has no idea how much investors gained or lost or their proper tax. It’s up to the investor to get and accurately report this information.
Under the new rules, firms must add certain information to Form 1099-B for covered securities, including cost basis, gain or loss, and whether it is short term or long term. This will make it much harder for investors to underpay their taxes.
“It’s sort of like the government is deputizing the brokers,” says Lee Sheppard, a contributing editor with Tax Notes, published by the nonprofit organization Tax Analysts.
It will also make life easier for law-abiding investors, because tracking cost basis is not easy.
Generally, it’s what you paid for a security. But stock splits, spin-offs and other corporate actions can affect your cost basis per share. If you buy mutual fund shares at various intervals and reinvest dividends and capital gains distributions, tracking cost basis can be a nightmare.
Many firms have provided some cost basis information to clients for a number of years, but they have not been reporting it to the IRS. Clients can use it to calculate their tax or come up with their own cost basis. They only have to show their numbers if they get audited.
People with investment advisers might find that the cost basis they get from their adviser doesn’t match what they get from the brokerage firm holding their account. That’s because there are different ways to calculate cost basis when you accumulate shares at various times and prices and don’t sell them all at once.
In this case, you can sell the shares you acquired first (called first-in-first-out, or FIFO), the shares you acquired last (last-in-first-out, or LIFO) or identify specific shares.
With mutual funds, you can also use your average cost per share.
You are supposed to tell the broker at the time of sale what method you chose, but many investors don’t. Instead, when they file their taxes, they assume they sold whatever shares give them the best result and use that in their profit/loss calculation. Under the new regime, that won’t be possible.
Stocks,Mutual funds,options,bonds,basis,tax
