New Cost Basis Reporting
As you gathered your income tax information for the 2011 tax year you may have noticed that some of your investment 1099s looked a little bit different this year. This is largely due to the fact that 2011 was the first year that the new expanded basis reporting rules went into effect for the Form 1099-B. The manner in which your financial institution complies with this reporting can directly impact the amount of your tax liability at the end of the year. Keep reading to learn how you can be proactive regarding this reporting to minimize your tax bill.
The Form 1099-B is provided to you and to the IRS each year by your financial institution to report the gross proceeds from the sale of securities. Under new IRS regulations this form is now also required to report your costs basis for "covered securities". Cost basis is generally the purchase price of the security plus or minus adjustments that may occur while you hold that security. There are three classes of covered securities which each have a different effective date for the new reporting:
- 1) Equities – The cost basis of equity securities (stock) acquired on or after January 1, 2011 is now required to be reported on the Form 1099-B.
- 2) Mutual Funds & Dividend Reinvestment Plan Shares - The cost basis of these securities acquired on or after January 1, 2012 will be required to be reported on the Form 1099-B next year.
- 3) Other Securities including Fixed Income and Options – The cost basis of these securities acquired on or after January 1, 2013 will be required to be reported on the Form 1099-B for 2013.
The default method of complying with these new requirements is for the financial intuition to use a "First In - First Out" method. This means that for the sale of a specific security the basis and acquisition date reported to the IRS will be the basis and acquisition date of the first lot of that security purchased. The problem with this method is that generally the first lot of a certain security you purchase will have the lowest cost basis and therefore create the largest gain to be reported as taxable income.
There are several other options for your tax lot relief method which may result in a better tax consequence for you. You should consider your specific tax situation and to consult with your tax advisor regarding which method would be most beneficial for you. In order to use a different method you must have communicated your method to the financial institution either by electing a new default method or to advise them of your desire to use a different method for a specific transaction before the date of that transaction.
As a simple example of how making this determination could affect you, consider a situation where you sold 1,000 shares of IBM stock on 12/15/11 for $200,000. If you had purchased three different lots of 1,000 shares of IBM stock as presented below you would have a very different tax liability depending on which one was considered to be sold for tax purposes. If you are using the default "First In - First Out" method your oldest lot of stock would be the one taxed giving you a tax liability of $22,500. If you used a "Highest Cost" method you would have the smallest gain, but would be subject to short term capital gains tax rates which would produce a tax liability of $10,500. If you were utilizing a "Highest Cost – Long Term" method your tax liability would only be $6,000.
Acquisition Date Cost Basis Gain TaxRate Tax Liability
1/30/88 $ 50,000 $ 150,000 15% (Long Term) $22,500
6/15/09 $160,000 $ 40,000 15% (Long Term) $ 6,000
1/15/11 $170,000 $ 30,000 35%(Short Term) $10,500
Again, if you have questions about how to leverage the appropriate method for your tax saving purposes, please contact your tax advisor or your MKS&H tax representative at 866.649.1902. We will be happy to help in clarifying which strategy would benefit you the most.
Article Provided By MKS&H's Senior Tax Accountant Tim Stolz, CPA