 |
 |
|||
 |
||||
 |
||||
 |
||||
 |
 |
 |
||
 |
||||
Tax Tips New IRS Cost Basis Rules February 2011 To our Clients and Friends, As an investor, you may be familiar with the process of recording cost basis—the amount you originally paid for securities sold in a given tax year—on your income tax return. But there's a new wrinkle being introduced in 2011 that you may not yet be aware of: For the first time, brokerage and custodial firms will also be required to report the cost basis of the securities you sell. The IRS will then match the figures you record on your returns with the figures brokerage and custodial firms record, assessing penalties if it discovers inaccuracies or underreporting of capital gains. These new cost basis reporting rules, part of the Emergency Economic Stabilization Act of 2008 (commonly known as the “bailout bill,” signed into law by President Bush), affect a broad swath of investors and will be phased in by investment type over the next several years:
This means beginning January 1, 2011, you or your tax preparer will need to make sure the cost basis for any equity security you sell in 2011 is accurately reported on both the Form 1099-B you receive from your brokerage or custodial firm and Schedule D of your income tax return. There are a few other details worth noting, and we anticipate that you might have additional questions about these new rules, how they work, and what your responsibility is in adhering to them. To help address some common questions, we've put together a brief FAQ below. Of course, if you have other questions or would like to discuss the new rules further, we encourage you to contact your broker. Who will be impacted by these new rules? All investors owning equity or debt securities, mutual funds, or derivatives. Determining cost basis can sometimes be complicated, especially if I've sold a security I purchased at multiple price points. How will this work under the new rules? To keep things simple, most firms will determine cost basis according to standardized, IRS-accepted methods—even though doing so may not necessarily produce the best tax results for you. One of the more common methods is called first-in, first-out (FIFO). When you sell shares of a particular security or fund, the FIFO method identifies your earliest-purchased shares as being sold first and thus uses the purchase price for those shares as the cost basis. Another method many firms will use is simply to average the cost of all the shares you've purchased. For example, let's assume you've sold 100 shares of a security for a total of $1,000. You bought 100 shares in 2006 for $400, another 100 shares in 2007 for $800, and another 100 shares in 2008 for $900. If you sell 100 shares, you might reasonably claim that your cost basis is $900 and that your capital gain would thus be only $100. But if your brokerage or custodial firm uses the FIFO method on its Form 1099-B, it records your cost basis as $400—the original price you paid back in 2006—and hence your gain would be $600. Alternatively, if the 1099-B is based on average cost, your gain in this example would be $300. Why can't I simply report the lower gain on my tax return? If the gain you report on your Schedule D is lower than the one reported on the 1099-B from your brokerage or custodial firm, the IRS may assess additional taxes or penalties. Can my brokerage or custodial firm vary the cost basis methodology it uses on Form 1099-B? For example, what if I want some securities reported under the FIFO method but others under the average cost method? Your brokerage or custodial firm will use its standard methodology—typically FIFO or average cost—unless you tell it otherwise. This will require you (or your advisor) to proactively elect a cost basis method when submitting a trade. What if I want to use the average cost method one year but FIFO the next? In the case of individual securities, you must either specifically identify shares sold or accept the FIFO method. Note also that you can switch from FIFO to average cost but not the other way around. In the case of a mutual fund, you can choose FIFO, average cost, or identify specific shares only if you've never used the average cost method for that fund. However, note that if you elect to use the average cost method to calculate cost basis for a given mutual fund, you'll need to use that method in perpetuity for that mutual fund in all of your accounts—no matter where that fund is held. To avoid inadvertent lock-in of a suboptimal cost basis method, you should discuss with your advisor which method makes the most sense. Your advisor should be able to help ensure that your cost basis is reported in a tax-efficient manner. What if I have inherited, gifted, or very old securities & I've lost track of the cost basis? Your financial advisor should be able to help you determine an IRS-approved cost basis for these types of securities, providing you or your tax preparer with the information you'll need to report accurate capital gains on your tax return. What if I have accounts with multiple brokerage or custodial firms? Each firm needs to be aware of what's been sold in your other accounts. This is so the different firms can properly report to the IRS on what are known as wash sales. Wash sales occur when an investor sells a security at a loss, then buys that security (or something substantially similar) within 30 days of the sale, causing the IRS to disallow the loss. This applies whether the security is bought within the same account, within another of your accounts, within your IRA or 401(k), or within an account owned by a related party (such as a spouse or a privately held business). To simplify matters—and to avoid putting yourself in the position of directing traffic among multiple accounts and advisors—use one investment manager to coordinate and integrate all your investments. This can help ensure the best tax elections and reduce costly miscommunication errors. I'm a business owner. Will these new rules affect my company in any way? All entities selling securities will be subject to these new rules. Additionally, owners of privately held businesses are subject to wash-sale rules vis à vis their business—or any related person or entity. Is there any action I should take now? Yes. First, make sure your investment managers, brokerage or custodial firms, and advisors have correct cost basis information for your current holdings as of January 1, 2011. Second, if you have multiple managers or custodians, make sure they communicate with each other about your securities and their cost basis. And third, consider consolidating your accounts with one investment manager to help simplify cost basis reporting and reduce the chance of inaccuracies on your tax return—and possible penalties from the IRS. With best regards,
|
Past newsletters : Subscribe to the newsletter : |
|||
 |
||||
 |
|
|
|
|
