What are the negative implications of the 2011 cost basis reporting law?

Question

The United States has a new law requiring brokerages to report the cost basis of sales on IRS Form 1099-B. For stocks purchased after January 1, 2011, financial services firms will have to report the cost basis for any of those stocks sold. The law rolls out reporting requirements over the next three years. 2011 is for stocks. 2012 brings the reporting requirements to dividend-reinvestment programs and mutual funds. 2013 brings it for bond, option, and other purchases.

Cost basis is the purchase price of the security at the date/time of transaction. It's common (and smart) when selling shares to specify exactly which shares to sell. One reason for this is to minimize capital gains by first selling the shares that you paid the most for. Doing this of course requires knowing the cost basis for all your shares and that gets heavy on the bookkeeping.

I think having this information tracked and reported by the brokerage firms will make life easier on the investors. Great news. However, what are the negative implications from this? It's certainly costly for the brokers. Are we already seeing repercussions?

Answer 1

The negative is if you were claiming higher basis that true, you were avoiding income tax on the gain. Bad for you. This law is good for me, as it means tax revenue will rise by the amount of tax that the fraudulent filers should have been paying.

Note: I view the loose rules now as an easy opportunity for fraud. Currently, the sale prices are tracked, so your tax return needs to reflect at a minimum, the gross sales of securities. Cost basis can easily be manipulated. I operate under the assumption that compliance with our laws is desired, and I answer questions in that spirit. I don't answer questions of the nature "what are my chances of getting caught..." with anything other than,"here's what the tax code says, as I interpret it." I don't include this as a topic to be debated, for me it's a fact, and I'd not entertain discussion of an opposite view. I'm sure there are forums open to that view. I just don't go there.

Answer 2

Anything reported directly to the IRS is cross-checked against your returns and generates an automatic "audit" (CP2000 letter) if there is a discrepancy. Currently the primary capital gains related check is to make sure your 1099B forms add up to the sum of the totals on Schedule D lines 3 and 10 (short and long-term total sales.) With the new law, they will also have purchase prices, short/long term info, and wash sales that they can cross-check against your info. If you do a lot of trades, this stuff can get fairly complicated to track... and screw up.

So, the negative implication to you as an honest taxpayer is that the IRS will be much better at catching your minor mistakes without a full audit.

Answer 3

This makes a LOT more work for the taxpayer, even with E*Trade's automated Form 1099b.

I am in the middle of this year's taxes and the Form 1099b splits up many sells into partial sells. A single sell expressed as a limited order might result in 7 to 10 individual sell blocks at slightly different prices. That part is OK - I can match up the 2010 first-in-first-out shares to figure out what each sell block has for cost basis.

But on top of that, ETrade's 1099b takes a single block sell and then splits it randomly into as many as 5 odd lots that add up to the total.

For example, I sold 2900 shares on February 1, 2011 with a limit order and they executed as 2000 shares at 5.40, 200 at 5.36, 400 at 5.37, and 300 at 5.4001. Each of the aforementioned blocks matches between the ETrade Excel export and the online transaction summary. So far so good.

Then ETrade sumbits the 1099 where each of the above is further split into separate line items on the 1099b. For example, the trade with selling price of 5.40 is not just one entry of 2000 shares, but 500+19+279+280+922, each with a separate row entry that has to have a cost basis inserted manually by me since the buys were back in 2010 (note also the buys were not in tiny lots as noted above).

E*Trade is multiplying my tax accounting work by about 5 times !!!!!!

Answer 4

Ultimately it means more work for you, the taxpayer, because when your brokerage reports the cost basis of the securities you sell, it is so. It's up to you to make sure your brokerage gets it right, given the new restrictions, and the restrictions are designed to extract more taxes from you. For example, brokerages aren't responsible for keeping track of cost basis for shares you owned prior to the cutover.

More details here.

Answer 5

You have the option of selecting the cost-basis methodology in advance with your broker, so I see this as a generally positive thing.

The one area that i am personally wary of is that basis calculations in the event of a brokerage transfer. Today, most of my holdings are with a broker I have used for some time, so cost basis information has been kept for me anyway. In the past, however, brokers have not tranferred this data when transferring securities between accounts. This could be a problem for some folks.

Other than that, it's a measure that will ultimately reduce paperwork requirements and result in more equitable taxation. I don't like paying taxes, but if we have to, we should have some expectation that everyone is playing by the same set of rules.

Answer 6

One of the negative consequences will be increased cost to the brokerages as you have indicated.

Another unintended consequence could be that investors begin to shun stocks since more of their investment information will now be shared with an insatiable government. Investors could begin to move their investments to other countries where they can maintain some privacy and attempt to keep their investment gains out of the reaches of the criminal class.