Over the years, I have probably prepared thousands of tax returns, from the straightforward to the very complex. Tax returns that are a few pages in length to those exceeding 300 pages. No matter the size of the tax return, there are usually stock sales that take place on these tax returns from simple investments to a heavy buying and selling that comprise over 500 trades in any one year. The common factor that seems to occur is that the brokers list the description of the stock sold, the trade and sale dates, the sales price and commissions; but they fail to list when that particular stock was bought and the purchase price. Therefore, I can not calculate the gain/loss or whether the sale was long term or short term.
Under the Obama legislation, cost reporting shall now be the burden of the Broker to calculate and report to you as well as the IRS. This new law will cover all stocks purchased from January 1, 2011 forwards. It will also cover mutual funds and dividend reinvestment plan stock (or similar arrangements) acquired on or after January 1, 2012; and for debt instruments, options and other covered securities acquired on or after January 1, 2013. The purpose of the new law is to allow the U.S. Treasury to increase revenue by $6.67 billion over a ten-year period.
What Does This Mean to Me?
As this year winds down and you are trying to decide which stocks to sell to have a capital loss on your tax return or to contribute to your chosen charities, you will need your basis. As you know, Sales Price minus Adjusted Basis results in capital gain or loss. Generally, when a broker is instructed to sell stock, the Broker will treat the stock sold as being reported on the First In First Out (FIFO) basis for tax purposes. So, is you bought 100 shares of IBM for each of the last 5 years, the first shares bought will be treated as the first shares sold with its relevant basis. If you sold 80 shares; then those 80 shares would be treated as the shares bought in the first 100 lot five years ago and that would be the basis. Now, many boutique Brokers have intelligent software what will find the specific stock with the highest basis so you will experience the lowest capital gains. However, you will experience that the Brokers that service the average person for the lowest commission will elect FIFO basis as the default unless you specifically call and tell your Broker which specific stock shares to sell.
All too often, I find myself in a confrontation with the IRS on the issue of basis on stock that was sold. I realize that the Brokers that appeal to the masses with low commissions are also the Brokers that do not provide a heightened service to its customers. You should know that when you talk with your Broker that the entire phone call is being recorded. If you say that you had advised the Broker to sell certain stock shares, then that conversation will have been recorded and kept in the custody of your Broker. It has been my experience that this recording is in the Broker’s custody for over 5 years. Therefore, before you claim that your Broker should have known your wishes for certain stock to be sold, the IRS can file a Summons for that recording. My suggestion is that you follow-up your oral conversation with a written request for those specific stock to be sold to allow you and the Broker to have a written record. All of this communication, oral and/or written, just be before the actual stock is sold!
As your tax consultant prepares your 2011 tax return in 2012, the cost basis will have already been reported by the Broker to you and the IRS. It is so important to know that this basis may indeed be wrong. It may be wrong because the Broker did not have the original basis because you transferred in your stock to the current Broker from another Broker or you got the stock via a gift or inheritance. All of these possibilities for an incorrect basis has happened to clients I have represented. Once you notice the incorrect basis, call your Broker immediately so the Broker can correct the basis reported to you and the IRS. Without such a correction, the IRS will send you their “instant audit” letter advising you that your basis was incorrect from the reported basis and you owe additional tax and related penalties.
Also know that unless you advise your Broker on what basis method to use for reporting, such as FIFO or Weighted Average, the Broker has the option to determine the method to be used for you to determine basis of stock sold.
For your end of the year tax planning, you will need to get out those dusty files and determine the basis of your stock that you intend to sell, gift or give to charity to determine the gain or loss or charitable contribution you are intending to report on your 2011 tax return. Then, you will need to follow through with your Broker to ensure the correct specific stocks are utilized in these transactions to produce the intended tax consequence. This follow through will also need to be in writing and since the burden of proof is on you; please send your writing via Certified Mail or some other form of mailing wherein you can prove the mailing and receipt of your written communication to your Broker.