If you actively trade equities and equity options and or securities in more than one account, unless you use proper software on all your individual taxable and IRA accounts, you will probably handle wash sales wrong and under-report or over-report your taxable income. In these cases, you can’t solely rely on 1099-B reporting because brokers use a different set of tax compliance rules than taxpayers in calculating and reporting wash sale losses.
The IRS cost-basis reporting saga continues
Accounting for trading gains and losses is the responsibility of securities traders; they must report each securities trade and related wash-sale adjustments on IRS Form 8949 in compliance with Section 1091, which then feeds into Schedule D (capital gains and losses). Form 8949 came about after the IRS beefed up compliance for securities brokers starting in 2011, causing headaches, confusion and additional tax compliance cost. Congress found tax reporting for securities to be inadequate and thought many taxpayers were underreporting capital gains. The cost-basis rules are almost fully phased-in. Options and less complex fixed income securities acquired on Jan. 1, 2014 or later are reportable for the first time on Form 1099-Bs for 2014. Inclusion of complex debt instruments on 1099-Bs is delayed until Jan. 1, 2016.
Broker-issued securities Form 1099-Bs provide cost-basis reporting information, but they often don’t provide taxpayers what they need for tax reporting. For example, brokers calculate wash sales based on identical positions (an exact symbol only) per separate brokerage account. But Section 1091 requires taxpayers to calculate wash sales based on substantially identical positions (between stocks and options and options at different exercise dates) across all their accounts including IRAs — even Roth IRAs.
Taxpayers report securities proceeds, cost basis, adjustments, holding period and capital gain or loss – short term vs. long-term (held over 12 months) on Form 8949. According to the form’s instructions, taxpayers without wash sale and other adjustments to cost-basis may simply enter totals from broker 1099-Bs directly on Schedule D and skip filing a Form 8949. After all, the IRS gets a copy of the 1099-B with all the details.
But, there is a protracted ongoing problem for many taxpayers with securities sales. For 2014 tax reporting, many 1099-Bs may not report wash sales or other cost-basis adjustments leading taxpayers or their tax preparers to choose the short-cut option: to enter totals on Schedule D and omit the headache of preparing a Form 8949. But, we know very well that taxpayers are supposed to calculate wash sales differently from brokers, and there could be wash-sale adjustments that taxpayers should make on Form 8949, which probably changes the net capital gain or loss amount.
Section 1091 wash sale loss rules for taxpayers
Per IRS Publication 550: A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you:
- Buy substantially identical stock or securities,
- Acquire substantially identical stock or securities in a fully taxable trade,
- Acquire a contract or option to buy substantially identical stock or securities, or
- Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA.
An example of how wash-sale rules differ between brokers and taxpayers
IRS regulations require brokers to calculate and report wash sales per account based on identical positions (it’s reiterated in Form 1099-B instructions). Here is an example of broker rules: an account holder sells 1,000 shares of Apple stock for a loss and buys back 1,000 shares of Apple stock 30 days before or 30 days after in that same account. According to the 1099-B, that’s a wash-sale loss deferred (added) to the replacement position cost-basis. But, if the account holder buys back Apple options instead of Apple stock, according to broker rules it’s not a wash sale because an option is not “identical” to the same company’s stock – however the taxpayer must report it as a wash sale. Broker computer systems are programmed to calculate wash sales based on an identical symbol, and stock and options and options at different exercise dates have different symbols. In that same example, if the taxpayer bought back Apple stock in a separate account, including an IRA, the broker would not treat it as a wash sale, but according to Section 1091, the taxpayer must treat it as a wash sale.
Don’t assume that substantially identical positions are worse for wash-sale calculations; they could actually be better. Subsequent transactions with profit can absorb prior wash sales before year-end, which can fix a wash-sale problem. So a gain on an option can absorb a wash-sale loss on a stock. Note that Apple stock and Apple options are substantially identical, but Apple stock and Google stock are not substantially identical.
Ways to avoid Form 8949
Business traders qualifying for trader tax status are entitled to elect Section 475 mark-to-market (MTM) accounting elected on a timely basis. Section 475 business trades are not reported on Form 8949; they use Form 4797 Part II (ordinary gain or loss). Although Section 475 extricates traders from the compliance headaches of Form 8949 (and Section 475 trades are exempt from wash sale rules), it does not change their requirement for line-by-line reporting on Form 4797.
Form 8275-R disclosure
If you or your local tax preparer decide to cut corners and disregard Section 1091 taxpayer rules for calculating wash sales across all accounts based on substantially identical positions — choosing instead to rely on broker 1099-B reporting in spite of known broader wash-sale conditions (explained in Chapter 4) — then you need to “disclose items or positions that are contrary to Treasury regulations” on Form 8275-R included with your tax return filing. We asked a leading malpractice-insurance carrier for tax preparers about this issue and they said, “there is coverage for regulatory inquiries but not if the firm is investigated for preparer penalties.” Whether you knowingly or ignorantly cut corners relying on 1099-Bs for active securities traders, it’s a circular 230 infraction and ignorance is not an excuse. Use our guides and suggestions to do it right.
Software for wash sales
When you consider a securities trade accounting software and Web-based solution, ask the vendor if they calculate wash sales based on Section 1091 and if not, you may want to skip that solution.
TurboTax ads say they make taxes simple and they imply you can just import your 1099-B. You’ll spend a lot of time finding their small fine print about having to make Section 1091 adjustments on your own.
Don’t tackle this minefield on your own, get professional help
Every case is different and our CPAs will look for ways to work with what you provide us, and in some cases, we can make manual adjustments. For example, if you don’t have open wash sales at year-end, we may be able to find ways to generate proper tax forms using 1099Bs, broker tax reports, and software solutions that you provided to us. Green NFH also offers a securities trade accounting service using proper software to be fully compliant with Section 1091.
We used several excerpts from Green’s 2015 Trader Tax Guide for this blog.