2011 Means Big Changes to Investor Reporting
The Emergency Economic Stabilization Act, signed into law on October 2008, made some dramatic changes to the way investors will report gains and losses to the IRS. Or rather, how they will no longer report them. Beginning with stock purchased after January 1, 2011, and gradually taking effect in stages through 2013, you will no longer be the responsible party to report the cost basis, as well as gains or losses, on securities you sell.
Here are the fundamentals. When you sell a stock, bond or other security in an account other than an IRA, your brokerage firm will send you a form 1099. This will detail the proceeds of the sale; the information goes to both you and to the IRS. It has always been your responsibility to calculate your cost basis, what you paid for the security. The difference between these two figures is reported on your tax return as a gain or loss, classified as either long term or short term, and can be used to offset other gains and losses. Losses can also be used to shelter up to $3,000 of ordinary income, and can be carried forward as well. However, the IRS has estimated it may be losing millions of dollars of tax revenue as the result of investors improperly reporting gains and losses. To close this gap, the provisions of the Economic Stabilization Act of 2008 which apply to reporting security sales begin to take effect January 1, 2011.
First, you should know that stocks or securities acquired before that date are not affected. You continue to report on these as you always have. The new regulations will phase in over a period of three years, with the new reporting requirements beginning for stocks purchased after January 1, 2011. Beginning January 1, 2012, the new rules will apply to mutual funds and dividend reinvestment plans acquired after that date. Beginning January 1, 2013, the new rules will apply to all other securities, including bonds and options.
The new regulations can make things a little complicated. On some sales you will be responsible for calculating cost basis, while on others you will need to use the cost basis provided by your custodian. A sale of a single security could include shares purchased after 1/1/2011, which your custodian will report on, and shares purchased before 1/1/2011, which you will still be responsible for.
How can investors prepare for these changes? First, establish an accurate cost basis for all the securities you own outside sheltered and IRA accounts. This may require some research and letter writing, especially if it involves reinvestment plans, or if you have changed brokers and brokerage firms over the years. You also need to know what reporting method you have used on security sales in the past so you remain consistent. Mutual fund sales always use an average cost basis, but for other securities there are many acceptable methods. Beginning with stock sales in January 2011, you will need to specify what method you want your custodian to use in calculating cost basis. Many custodians have chosen one reporting method, such as first shares in, first shares out, as a default, but there are many others available to you. A careful review of your overall tax situation with your CPA or preparer will help point you in the right direction.
Steven Weber, Registered investment advisor, and Gigi Harris, Dir., Client Communications, are members of the Bedminster Group, a fee-only advisor providing investment and financial counsel to clients in the Low Country since 1997.