Investors who forget what they paid for shares of stock will get help starting next year, courtesy of the Internal Revenue Service.
That’s when the U.S. tax-collection agency will require brokerages to track the cost basis on equities bought after Jan. 1, and send taxpayers and the government an annual form recording it when investors sell shares.
Brokerages already are required to report the proceeds from sales of securities to the IRS. Next year, they’ll also have to provide information on the purchase price, known as the cost basis, of stocks.
“We’ve been really hammering it home with our clients,” said Brian Keil, director of cost basis and reporting at San Francisco-based Charles Schwab Corp. “We expect our clients are going to get a 1099-B form in 2012 and they could have an outcome that they don’t expect.”
Investors who buy shares of the same company on different dates or prices will see the biggest change, said Eric Smith, a spokesman for the IRS. They’ll need to identify which shares they’re selling before the sale settles, which typically means within three days for stocks.
About 46 percent of U.S. households owned equities in 2010, including stocks, mutual funds, exchange-traded funds and variable annuities, according to the Investment Company Institute, a Washington-based mutual-fund trade group.
“This law change is designed to improve tax compliance while, at the same time, reduce the record keeping and paperwork burden for millions of investors by ensuring that they receive the information they need to easily report their gains and losses correctly,” said Smith.
Before this rule, the government didn’t have a way to verify if an investor was reporting the true gain on a sale unless there was an audit, said Greg Rosica, a tax partner at Ernst & Young who is based in Tampa, Florida.
The regulations take effect at later dates for other trades. Starting Jan. 1, 2012, brokers will have to record the cost basis for mutual funds and stocks held in dividend reinvestment plans, which require investors to reinvest at least 10 percent of dividends paid. Cost-basis reporting also applies to the majority of ETFs in 2012, the IRS said.
The rules take effect for options and fixed income securities, such as bonds, acquired on or after Jan. 1, 2013, according to the IRS.
“Clients today often meet with their accountant, or when they are doing their taxes, and look backward,” said Keil of Schwab, the largest independent, publicly traded brokerage by client assets. “They select which lots they would have used with a lot of hindsight. That’s not going to be the case anymore.”
Brokerages including Schwab, Fidelity Investments and TD Ameritrade Holding Corp. will offer investors choices for reporting cost basis including using the last stock bought or highest cost, the firms said.
Investors may tell the company to always sell shares minimizing gains, for example, or specify shares for a particular trade before it settles, according to the IRS.
For taxpayers who don’t choose, the brokerage must record the purchase price of the first shares bought, known as first- in-first-out or FIFO, according to the IRS. The firm may choose cost averaging as its default for mutual funds and stocks held in dividend reinvestment plans, the IRS said.
Brokerages will be required to transfer cost-basis information for stocks bought after Jan. 1, if an investor switches firms, said Gregg Murphy, senior vice president of brokerage products for Boston-based Fidelity. Firms incur a $100 penalty for sending an incorrect form to the taxpayer and a separate $100 penalty for sending an incorrect form to IRS, according to regulations.
Investors should review their tax situation before choosing a reporting method, said Sheryl Eighner, a director in the personal financial services group at PricewaterhouseCoopers LLP in Chicago. Taxpayers may want to identify certain shares if they need to offset gains with losses, for example, she said.
Depending on the amount of appreciation between the date a security was bought and sold, choosing the right reporting method could result in a smaller capital gains tax, David Sands, a tax partner at New York-based Buchbinder Tunick & Company, said. Picking the wrong one could result in a bigger payment than necessary, he said. Gains on stocks, corporate bonds and mutual funds held at least a year generally are taxed at a maximum 15 percent federal rate. Short-term gains are taxed at an individual’s ordinary rate, currently as high as 35 percent.
The tax-cut plan signed by President Barack Obama on Dec. 17 extended through 2012 Bush-era tax reductions on income, capital gains and dividends. The capital-gains tax was scheduled to increase as of Jan. 1 to as much as 20 percent and dividends were set to be taxed as ordinary income before Congress acted.
“It’s very beneficial for the client,” Stuart Rubinstein, managing director of client engagement in Omaha Nebraska-based TD Ameritrade’s Jersey City office, said of the IRS regulation. “They don’t need to do any record keeping, because it’s going to be done for them.”
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