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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?

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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.

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    Hmmm. Why do you think there will be a lot of errors, and why would you think more would be against you than in your favor? – JoeTaxpayer♦ Jun 21 '11 at 21:52
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    @Muro That's bunk. If the reporting measure reduces tax evasion, then it increases tax revenues. An increase of tax revenues benefits honest filers since it reduces the likelihood their tax rate will be increased in the future to make up for the lost revenue. – Chris W. Rea Jun 22 '11 at 12:32
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    My premise, true or false, is that any evaders are having a negative effect on the honest ones. It never would occur to me this isn't obvious. – JoeTaxpayer♦ Jun 22 '11 at 13:46
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    @Muro - you assume that government is some evil entity created just in order to make your life miserable. If so the argument is meaningless since nothing will convince you that taxation is good unless you change your mind about the necessity of government. – littleadv Jun 22 '11 at 20:24
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    @Muro - if this is your assumption then there's no place for discussion. You can go back to your cave and prepare for the next hunting of a mammoth then. – littleadv Jun 22 '11 at 20:38
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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.

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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.

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  • all that you describe is the work you're supposed to be doing as it is without the law. The law actually means less work for you and more for the broker. As to the intention of the law to reduce tax fraud - I see nothing negative in that. – littleadv Jun 21 '11 at 21:50
  • It means (slightly) less work for me if the broker is correct. It means more work for me if they aren't, because I have to get them to issue a corrected 1099-B, and to do that I have to prove that I'm right. – mbhunter Jun 21 '11 at 21:59
  • so? Proving you're right is easy - just show the statements. You've done all these calculations anyway, because you had to until now, so really - what's the additional work that is required for you? I can only think of less work from me (I check all the statements, and so far I had never have found an error in any of my bank statements). – littleadv Jun 21 '11 at 22:11
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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.

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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 !!!!!!

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  • What my CPA did was aggregate all that back into averaged cost basis. As long as it adds up to the right prices, it doesn't matter if you report each transaction separately on Sched. D or aggregate them into one. I wouldn't do that myself (but then again, automatic import of the ETrade 1099 solve 90% of the problem), but the CPA knows better, I guess. That's why I pay her. – littleadv Apr 16 '12 at 8:28
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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.

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    Re the brokers - the brokers I use (sharebuilder and Etrade) already have, write down, and provide this information, it just doesn't appear on 1099-B. The only change they need to implement is in the program that prints out that form, no additional cost. Re the conspiracy theory - not only is it speculation, it can be easily confirmed to be false. Nowhere investors have privacy about their investments, even in Swiss banks they don't allow anonymous accounts any more. US Citizens must even now report the capital income regardless of where the brokerage is, including the cost basis. – littleadv Jun 22 '11 at 20:29
  • @littleadv - you recognize that the broker must make a change to the program that reports 1099 info to the IRS but then say this can be done at no additional cost? Do programmers work for free at brokerage accounts? I know the cost may be minimal but it is still a cost. There are ways to obtain privacy with investments. You just have to operate outside of brokers, banks, and government. I think more people will begin doing this as the government becomes move invasive. – Muro Jun 22 '11 at 20:33
  • being a programmer, and having some experience working in a bank and changing programs due to regulatory requirements - I assure you: this is a no cost change. Even if they hire contractors just for this change, and not use their own programmers on retainer - the cost will be meaningless in relation to their overall revenue. Not something you can claim as "increased cost", and if at all - it's a one-time cost. I would argue it to be no more than $10K including testing, which is not something a company of the size of Etrade would care about, they spend more on wasted paper in a day. – littleadv Jun 22 '11 at 20:35
  • -1 for apparently equating the government with the criminal class – Ganesh Sittampalam♦ Jun 24 '11 at 9:27

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