Gaps in Broker Reporting of Basis

May 14, 2010

It isn’t here yet, but it’s coming soon. Beginning with the 2011 tax year, those Forms 1099-B you receive from your broker for sales of stock will include not just the amount you received in the sale, as it does currently, but also your cost basis. The added information will be a convenience to those who are inclined to comply with the tax law, and a deterrence to those who are not. Basis reporting won’t be comprehensive, however, and it will be interesting to see how taxpayers respond to the gaps.

Laws that require more reporting are popular in Congress because they offer a way to increase revenue without raising taxes. Rules of this kind can also provide a measure of comfort that law-abiding taxpayers aren’t shouldering an added burden as a result of cheating by others. Yet these rules also have a perverse effect. People who might otherwise understand they have a duty to report all their income begin to think in terms of a duty to prepare a return reflecting only┬áthe income appearing on these forms, ignoring rules that require them to report more.

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The basis reporting rules will have a number of gaps, some of which relate to the wash sale rule. This is often viewed as a simple rule that prevents you from claiming a loss on a sale of stock if you buy shares of the same stock within 30 days before or after the sale. The rule is actually quite complicated, with some gray areas where its application isn’t entirely clear.

Congress wrote the broker reporting rules with an understanding that comprehensive coverage of all aspects of all rules wouldn’t be possible. In concessions to practical reality, the law doesn’t require brokers to apply the wash sale rule in situations where it would apply to a sale of one stock and purchase of another, or where it would apply to a sale in one brokerage account and a purchase in a different one.

Application of the wash sale rule to a sale of one stock and purchase of a different one is a relatively rare event. Generally this will happen only when the prices of the two stocks have become closely linked as a result of a pending merger. It makes sense to excuse brokers from a duty to determine when pending mergers would call for application of the wash sale rule to transactions involving two different stocks.

The exception for transactions occurring in different accounts makes sense as well, because brokers have no way of tracking sales or purchases their clients may make in accounts maintained elsewhere. This exception may lead some investors to believe it would be wise to maintain accounts at different brokers to work around the wash sale rule.

The exception for broker reporting isn’t an exception for individual taxpayers, though. If you sell at a loss in one account and buy shares of the same company in a different account within the wash sale period, you still have to report the transaction as a wash sale even though it may not show up that way on Form 1099-B. What’s more, although it may be difficult for the IRS to detect this activity, someone found to have taken this approach could face added penalties that apply to persons engaged in tax evasion.

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