March 2012

Extensions: Some traders may qualify for IRS penalty relief

March 29, 2012 | By: Robert A. Green, CPA

Postscript March 20, 2013: To accommodate taxpayers in the last recession, the IRS allowed taxpayers to use “economic hardship” as a reason for granting relief from late-payment penalties. For 2011, taxpayers could file Form 1127-A (2011) “Application for Extension of Time for Payment of Income Tax Due to Economic Hardship” as explained in our blog below. As of this date, the IRS has not issued a Form 1127-A for 2012, so taxpayers need to qualify for penalty relief under the general Form 1127, “Application for Extension of Time for Payment of Tax Due to Undue Hardship.” Form 1127 instructions state ‘File Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return… and Do not file Form 1127 (instead).’

It’s getting too late to focus on complete tax return filings due by April 17. (April 17 is the tax deadline this year since April 15 is a Sunday and April 16 is a federal holiday in Washington D.C.) Instead, focus on filing an automatic extension to get an additional six months to file. While extensions are fairly basic one-page filings – listing estimated tax liability, taxes paid to date and balances due – you should be aware of several important strategies, pitfalls and relief from the IRS. Partnership tax extensions are also due April 17, 2012, granting you five more months to file by Sept. 17, 2012.

New for 2011 tax returns: Form 1127-A relief
Some business traders and other taxpayers may qualify for new relief from the IRS provided by filing new tax Form 1127-A, Application for Extension of Time for Payment of Income Tax for 2011 Due to Undue Hardship. If you qualify to use Form 1127-A rather than the automatic extension Form 4868, you will be exempt from nasty penalties associated with paying less than 90 percent of taxes owed by April 17, and related rules mentioned below.

An automatic extension is for filing later, but paying taxes owed by April 15. This new form allows a qualifying taxpayer to pay later without penalties. But, you still need to file Form 1127-A correctly and on time.

On Form 1127-A, “financial hardship” is defined as:

· wage earners (or spouse) who have been unemployed at least 30 consecutive days during 2011 or in 2012 up to the April 17 filing deadline, or 

· self-employed individuals who experienced a 25% or greater reduction in business income in 2011 due to the economy. 

Many traders may qualify for this financial hardship clause and the AGI income and tax liability thresholds. Leaving a job to pursue trading full time and losing money may be the ticket. Click here to learn more about Form 1127-A. Check with us if you have any questions.

Great year in 2011, but lost the money in 2012
Some traders can’t pay their taxes because they lost 2011 trading gains in Q1 2012 before April 17, 2012. That’s a different situation than “financial hardship” mentioned above. If you can’t pay your taxes, use one of the following strategies with a Form 4868 extension filing.

Securities traders need to file extensions
Due to the cost-basis reporting crisis on 2011 tax returns, we are advising securities traders to file for automatic extensions, rather than try to rush tax returns filings (with problems) by April 17. Securities traders need more time to request corrected 1099-Bs from their brokers and hopefully fully reconcile differences in trade-accounting reporting on Form 8949. We don’t want traders to be audited by the IRS or to receive tax notices caused by reconciliation differences with 1099-Bs.

File for an automatic extension
It’s important to file an automatic extension by April 17, whether you can pay the taxes owed or not. Paying what you owe is the safe way to avoid penalties. If you can’t pay 90 percent, according to Form 4868 instructions your extension can still be valid if you demonstrate reasonable cause and these conditions in the eyes of the IRS:

1. Properly estimate your 2011 tax liability using the information available to you
2. Enter your total tax liability on line 4 of Form 4868, and
3. File Form 4868 by the regular due date of your return.

No. 1 might be the most difficult condition to satisfy. Many traders are unsure of their 2011 trading gains, due to botched wash-sale loss reporting by brokers on 1099-Bs or other reasons. Many traders may underestimate their taxable income and pay too little with their extension. Will the IRS think that you “properly estimated your 2011 tax liability using the information available to you”? We suggest relying on TradeLog if you have it rather than conflicting and botched 1099-Bs.

No. 3 is the easier one. If you skip the extension, you will trigger both late-filing and late-payment penalties.

Penalties explained on Form 4868
Late Payment Penalty: The late payment penalty is usually ½ of 1% of any tax (other than estimated tax) not paid by April 17, 2012. It is charged for each month or part of a month the tax is unpaid. The maximum penalty is 25%. The late payment penalty will not be charged if you can show reasonable cause for not paying on time. Attach a statement to your return fully explaining the reason. Do not attach the statement to Form 4868. You are considered to have reasonable cause for the period covered by this automatic extension if at least 90% of your actual 2011 tax liability is paid before the regular due date of your return through withholding, estimated tax payments, or payments made with Form 4868.

Late Filing Penalty: A late filing penalty is usually charged if your return is filed after the due date (including extensions). The penalty is usually 5% of the amount due for each month or part of a month your return is late. The maximum penalty is 25%. If your return is more than 60 days late, the minimum penalty is $135 or the balance of the tax due on your return, whichever is smaller. You might not owe the penalty if you have a reasonable explanation for filing late. Attach a statement to your return fully explaining the reason. Do not attach the statement to Form 4868.

Be conservative and pay extra with the extension
We suggest being conservative with the extension payment — pay 100 percent of the estimated 2011 tax liability. That gives you a cushion if your estimates are wrong. If you aren’t sure about qualifying for trader tax status in 2011, then we suggest you prepare the extensions based on investor tax status. Or, consult with Robert Green, CPA as soon as possible.

Consider 2012 Q1 estimated taxes too
Taxpayers with material income in Q1 2012 — which is not subject to tax withholding — should consider paying closer to 125 percent of their 2011 extension balance due. When they file their actual 2011 income tax return, they can apply the 2011 tax overpayment credit toward 2012 estimated taxes. This strategy has served our firm well for decades. Rather than pay Q1 estimates separately, pay more with the 2011 extension instead. Be conservative with the tax cash paid to the IRS, but be aggressive and legal with the tax return filings, as that is where the real money is.

What to do if you can’t pay on time?
If you can’t pay 90 percent of your tax liability by April 17, first see if you qualify to use Form 1127-A (see above) for special relief on paying later without penalties. But, file this form on time. If you don’t qualify, file Form 4868 (Automatic Extension). If you are short cash, pay what you can, and try to impress the IRS with reasonable cause when you request penalty abatement after filing your tax return.

When you file your actual income tax return, the IRS will automatically send you a tax notice assessing the appropriate penalties, plus interest expense. After you receive that tax notice, send the IRS a “penalty abatement request” letter stating your reasonable cause and how you acted in good faith. Hopefully, you can get some or all penalties abated. Interest expense is statutory, so the IRS can’t abate it. The current IRS interest rate on late payments is 3% per annum.

State extensions
Some states don’t require an automatic extension if you’re overpaid, as they accept federal extensions. Generally in all states, if you owe taxes, you need to file a state extension with 90 percent payment, too. Check the extension rules in your state. States tend to be less accommodating than the IRS in waiving penalties, so it’s usually wise to cover your state first if you are short on cash.

Don’t forget new Section 475 MTM elections are due by April 17
Making a Section 475 MTM election could be tricky based on using unreliable trading gain or loss tax information from the cost-basis reporting mess. This information can affect your decision to file or skip the Section 475 MTM election. Generally, we recommend Section 475 MTM on securities only, providing the business trader doesn’t have capital loss carryovers. Traders need capital gains to use up capital loss carryovers — not Section 475 MTM ordinary income. On the other hand, wash sales from 2011 can be converted into Section 475 MTM ordinary losses in 2012 with a MTM election. Consult a trader tax expert about this election. It’s beyond the scope of this article.

Section 475 MTM exempts traders from Form 8949 and wash sales. GreenTraderTax has recommended Section 475 MTM for securities business traders since Congress opened this door in 1997. All these years, it exempted business traders from wash sale rules – which have always been a pain to understand and apply – and that onerous capital loss limitation of $3,000 against ordinary income. Now, Section 475 MTM also exempts business traders from Form 8949, as Section 475 is reported on Form 4797 Part II ordinary gain or loss.

Note: You can’t attach a Section 475 MTM election to an e-filed automatic extension. You must paper-file the extension with a Section 475 MTM election statement attached.

Bottom line
Focus on what’s important now for April 17: filing a valid extension, seeing if you qualify for Form 1127-A relief and considering a Section 475 MTM election for 2012. Consider a consultation with our Robert A. Green, CPA to discuss these issues and more. Don’t bury your head in the tax quick sand — that’s always the worst choice.

Darren L. Neuschwander, CPA contributed to this article.


See smoking guns on botched 1099-Bs from securities brokers in our Mar. 28 Webinar recording

March 28, 2012 | By: Robert A. Green, CPA

Our March 28 Webinar shows smoking guns on botched 1099-B reporting from brokers, apples and oranges in the rules between brokers and taxpayers and why it’s irresponsible to file a complete tax return based on these 1099-Bs. Any accountant who signs a tax return with these unreconciled differences is skirting on the edge of malpractice. Don’t rush to file a return with these errors and problems. The early bird won’t get the worm; he may get audited by the IRS.

See our three important Webinars on cost-basis reporting herehttp://www.greencompany.com/EducationCenter/Trader-Tax-Center/Cost-Basis-Reporting.shtml#webinars

In the March 28 Webinar, our TradeLog chief accountant shows a 1099-B reporting more than $50 million of incorrect wash sale loss deferrals because the broker reported potential wash sales rather than actual wash sales. TradeLog, however, reports the correct wash sales amount of under $20,000. TradeLog prepares Form 8949 and shows this $50 million plus net “adjustment,” really an overall difference, including the wash sale errors. We think it’s foolish to file a tax return with that type of large difference — it will surely attract undue attention from the IRS. Why not force the broker to fix the wash sale reporting first? Few brokers will reply to these requests before April 15.

See how a second broker’s 1099-B doesn’t match TradeLog’s cost-basis reporting information. We simply can’t trace the broker’s cost basis amounts to any correct raw data in TradeLog — which downloads actual trades — and we can’t imagine what the broker did wrong here. We know brokers sliced and diced raw data into all sorts of categories in an attempt to comply with new IRS rules and we’ve seen several cases of bad accounting, where brokers adjust proceeds when they should adjust cost-basis and vice versa. Watch us demonstrate how this same broker provided the client with a “Realized Gain or Loss Report” in his 1099-B Supplemental Information (a section that is not sent to the IRS). This report continues a perpetuation of the unexplained errors stated above. If the client relies on this report, his tax return will be very wrong.

We usually don’t name names, but we do for these two large online brokerage firms. It’s time they fess up.

While TradeLog software is the best solution in most cases, you need to teach it how to handle your broker’s 1099-Bs. There are many switches to turn on or off so TradeLog can simulate how your broker handled the cost-basis reporting rules. If you find differences, this is the first place to revisit. For example, did your broker report all ETFs or just securities ETFs (RICs)? The latter is correct. As we explain on the Webinar, it’s not uncommon to find download errors which require correction. Plus, TradeLog doesn’t calculate corporate actions — you need to calculate those by hand.

This year more than ever before, you need a trained TradeLog accountant and CPA firm like Green NFH, LLC to review your TradeLog data files, your accompanying Form 1099-Bs and other Supplemental Information provided with 1099-Bs. On almost every file to date, we’re finding incorrect accounting items that require our assistance, investigation and adjustment. Don’t waste days or weeks pulling your hair out; get the help you need from a person highly experienced in finding the differences.

File a valid extension by April 17 to give us six more months to get this right. We can help with your extension if you sign up for our tax preparation service very soon. Otherwise, Robert Green CPA can consult you on your extension before April 17. Don’t forget about the very important Section 475 MTM election due by April 17 with the extension filing, too. For information on extensions and Section 475, see our March 10th blog.

Our Petition to Rally Congress is having impact! 559 People Have Sent 1,323 Letters and Emails. We need 20,000 signers and 50,000 letters and emails. Please sign, and also share it with others. 


Petition: Securities Traders Need Tax Relief on IRS Cost-Basis Reporting Rules

March 26, 2012 | By: Robert A. Green, CPA

Green’s Forbes blog version: Time For Congress To Iron Wrinkles Out Of IRS Cost-Basis Reporting Rules.

Please read, sign and send our petition posted on RallyCongress.com. To get relief from Congress and the IRS, we need your help. Please spread the word with all traders and investors.

Overview:
New “cost-basis reporting” rules for 2011 are not functioning properly. Botched implementation is unfairly causing millions of taxpayers to significantly overpay their tax bills. The IRS should have issued the same set of rules for brokers and taxpayers, but did not. How can the IRS now send tax notices and audits to hundreds of thousands of taxpayers over 1099-Bs prepared under one set of rules, while holding taxpayers accountable to another set of rules? Taxpayers did not sign up to be deputy accountants for this mess!

Full Petition:

Dear Congressman:

As an investor in securities, I need your help on my 2011 tax return. The IRS has phased in “cost-basis reporting” rules on broker-provided Form 1099-Bs, in accordance with Section 403 of “The Emergency Economic Stabilization Act of 2008” enacted by Congress on Oct. 3, 2008.

Implementation of the cost-basis reporting law has turned into a huge mess for honest taxpayers. Leading CPA firms for securities traders have reported that the new 1099-Bs are very hard for taxpayers and even CPAs to decipher.

I’m asking you to please direct the Treasury and IRS to:

• Not match 2011 individual tax return filings to flawed Form 8949s and botched 1099-Bs, prepared under a different set of rules than what taxpayers must follow;

• Reconcile cost-basis reporting rules for brokers and taxpayers;

• Waive tax notices for Form 8949 reconciliation differences with 1099-Bs for 2011 returns; and

• Grant valid extensions prepared in good faith dealing with these problems.

For example, many brokers incorrectly calculate wash sales on 1099-Bs by reporting “potential wash sales” rather than actual wash sales. Often a potential wash sale goes away when a trader eventually does not buy the position back at year-end or within a 30-day window, or absorbs the loss on subsequent profitable trades. With these error-prone 1099-Bs, many taxpayers are reporting nonexistent wash sale loss deferrals and that raises their tax bills considerably.

For 1099-B preparation, the rules are not the same for brokers and individuals, either. Brokers report wash sales based on “identical positions” (stocks only), whereas taxpayers must report wash sales based on “substantially identical positions,” which means between stocks and options, too. Tax year 2011 is the first that many brokers are making an attempt to report wash sales, and the IRS may be relying on 1099-Bs to match tax returns. The wash sale issue is extremely botched and worthy of hitting the reset button.

Look at a bunch of 2011 Form 1099-Bs and you will see the scope of this tax-reporting crisis. Brokers are adjusting cost-basis when they should adjust proceeds and vice versa. Congress and the IRS should have required “standardization” in application of the new rules and they should have also used the same rules for both brokers and taxpayers. It’s not fair to blame the brokers completely, as they were under great pressure to deal with guidance which came late from the IRS. Wash sale analysis must be cut off on Jan. 31, so how can brokers issue Form 1099-Bs by Feb. 15? There isn’t time. These rules need to be rethought.

Phasing in the rules for brokers but not for taxpayers has also made the tax compliance gap greater. Brokers only report cost-basis for purchases of securities in 2011, which leaves out wash sale losses deferred from 2010, again short-changing taxpayers who rely on 1099-Bs.

The new individual tax form 8949 is a nightmare for taxpayers and preparers. It has Parts A, B and C and covered vs. non-covered and reportable vs. non-reportable items. All brokers handle them differently. For example, ETFs that are Registered Investment Companies (RICs) are reportable, whereas commodities ETFs that are publically traded partnerships (PTP) are not. I imagine you can’t even prepare your own tax return based on these rules.

I thought a 1099-B was a “tax information” statement to help me prepare my tax returns. Why does the cost-basis legislation state a taxpayer should not rely on a 1099-B?

I’m using reputable trade-accounting software, which downloads my transactions and calculates correct trading gains and losses, including wash sales across all my accounts. But, it’s almost impossible to reconcile that correct trade accounting to the botched 1099-Bs and Form 8949. I am filing an extension, so I can wait until Oct. 15 for your help here.

For more background on the scope of this problem, I suggest visiting http://www.greencompany.com/EducationCenter/Trader-Tax-Center/Cost-Basis-Reporting.shtml

Thank you for your cooperation and help.

Sincerely, 


Brokers are only reporting potential wash sales, not final wash sales

March 20, 2012 | By: Robert A. Green, CPA

Postscript March 4, 2013. Important update about the term “potential wash sales.” We explain this term in a better way on our updated blog dated March 4, 2013 Caution, downloading securities Form 1099-Bs into TurboTax often leads to incorrect tax filings. Look for the heading “Potential wash sales” towards the bottom of the blog.

See our Cost-Basis Reporting area in our Trader Tax Center for more content, blogs, Webinars, Video and our Petition to Congress.

During our March 20 Webinar, we realized that many brokers only seem to report “initial wash sale loss deferrals” (potential wash sales), rather than final “wash sale losses.”

Brokers’ 1099-Bs list individual wash sale losses and then total wash sale loss amounts, often in the hundreds of thousands, or even millions. That’s simply impossible in most cases, because many traders have far less money in their accounts to begin with. Final wash sales can’t be higher than the account size. We now have a better understanding of how this problem arose.

Potential wash sales are only half the story. Trade-accounting software like TradeLog follows a wash sale condition from beginning to end. Often, when a wash sale loss is triggered, it goes away when the trader sells replacement positions at a large enough gain to absorb the deferred wash sale losses. Wash sale losses are added to cost basis on the replacement position. Another way to make wash sale losses go away is to “break the chain” on a string of wash sale losses, by not buying back a substantially identical position for 30 days before, or after.

Here’s an example: A trader day trades X stock every trading day of the year and loses money on most of those trades. He stops trading on Dec. 15 and does not trade again until Jan. 25. The trader triggered wash sale loss conditions on most days of the year. This trader broke the chain of wash sales on Dec. 15 by selling all his positions, and not buying any of them back until after 30 days. The result is zero wash sales for 2011 taxes. Unfortunately, his broker will probably report every one of the potential wash sale losses and total them up, too. A trader cannot use this 1099-B wash sale information as it’s only half the story on wash sales.

See our last blog for more information on cost-basis reporting, and several other problems with wash sale losses on 1099-Bs. 


IRS, why force taxpayers to reconcile securities-broker 1099-Bs to tax returns, when your rules are apples vs. oranges?

| By: Robert A. Green, CPA

See our Cost-Basis Reporting area in our Trader Tax Center for more content, blogs, Webinars, Video and our Petition to Congress.

Green’s Forbes blog version: Who Can’t Count, The IRS Or Your Broker?.

Contrary to public perception, securities brokers’ cost-basis reporting on 1099-Bs rarely matches taxpayers’ net trading gain or loss generated from their trade accounting program. This is because the IRS gives brokers one set of rules for preparing 1099s and gives taxpayers an entirely different set of rules.

Why the difference? The IRS does not ask securities brokers to report net taxable gain or loss on 1099-Bs, but they require taxpayers to do that on the new Form 8949 for 2011 tax returns.

The apples and oranges in the rules are counterintuitive to taxpayers, causing great confusion and extension filings. Historically, the IRS led taxpayers to believe the idea of 1099s was to confirm a taxpayer’s income or loss and to provide a means for IRS computers to check up on taxpayer compliance. Sometimes, the IRS matches net income — one example is with Section 1256 contracts. And other times it reconciles with proceeds — such as with securities. But the new 2011 rules require brokers to report cost basis on 1099-Bs, too.

Some of the problem is due to phase-in and transition. Securities brokers report 2011 cost basis on stocks only. (A few brokers elected to report 2010 cost basis on 2011 1099-Bs, too, even though it wasn’t required.) In doing so, brokers’ systems left out wash-sale deferral cost basis from 2010. That means out of the gate, 1099-B 2011 wash sale reporting is incorrect. If 1099-Bs botch wash sales, how can cost-basis reporting be correct for 2011? It can’t. This issue may be better in 2012, when brokers report 2011 and 2012 cost basis.

A wash sale example
If you bought and sold stock symbol X on Dec. 22, 2010 for a material loss, and you repurchased that same stock symbol on Jan. 18, 2011, it’s a wash sale. But, your broker probably did not report the deferred wash sale loss cost basis; it likely only reported the actual purchase price on Jan. 18, 2011. If you report on your taxes the figures from your broker’s 1099-B, you will overstate your 2011 capital gains and that wash sale loss from 2010 will be lost forever.

1099Bs were rushed out too early, yet too late for tax season
Proper wash-sale reporting must have a cut-off date of the end of January, which is 30 days after year-end. How else can you tell if there is a wash sale on Dec. 31? 1099-Bs must be issued by Feb. 15. That leaves just 15 days to do the accounting, make corrections, send PDFs to printers, mail them on time, and deal with great confusion on the new cost-basis reporting rules.

For 2011 1099-Bs, many brokers filed for a 30-day extension until March 15. But S-Corps file by March 15, and there’s only one month left until the April 15 individual tax deadline. Sure, individuals can file extensions, but they owe 90 percent of their taxes on that date for valid extensions. Otherwise, they are subject to penalties.

There simply isn’t enough time to get this all right. Something has to give.

Corrected 1099s are not the answer
Some brokers issued their 1099-Bs by Feb. 15, knowing they will likely have to issue corrected 1099-Bs later on. It takes more time to figure out wash sales and income allocations — like return of capital vs. dividends. We don’t like this practice, since corrected 1099-Bs cause confusion with taxpayers. Too many taxpayers wind up using the wrong 1099-Bs on their tax filings. Some taxpayers rush to file early for refunds, and have to return the money later on with amended tax returns.

Who is at fault? 
Cost-basis reporting is a major new initiative from the IRS, and a new demand on securities brokers. In prior blogs, I pointed out many discrepancies on Form 8949 trying to reconcile trade accounting with 1099-Bs. The differences are large, and I was quick to blame securities brokers for botching some reporting, especially wash sales. But, many of the differences are attributable to brokers following one set of rules written for 1099-Bs, and taxpayers dealing with another set of rules. Plus, the IRS causes more confusion with “covered” vs. “non-covered” securities and brokers confuse things by including some non-covered items in covered. In retrospect, I think it’s more the fault of the IRS system than the brokers, who themselves are struggling with these new demands. It’s one thing to make an error and another to follow the rules and then have problems over apples and oranges.

While the IRS may have a laudable goal in mind, due to the phase-in transition, mixed-up cut-off dates, and apples and oranges between brokers and taxpayers, it’s a minefield of confusion. Instead of improving taxpayer compliance, it could get worse for 2011 with these new rules.

IRS, please don’t require taxpayers to reconcile differences
The IRS caused this mess, so it should not force taxpayers to explain the line-by-line differences on Form 8949. We ask that the IRS simply accept trade accounting as is, and only match proceeds on securities as it has done in prior years. Don’t try to match the unmatchable cost basis for 2011. If the IRS doesn’t waive matching, it will send hundreds of thousands of nasty tax notices to taxpayers. That will lead to great expense and very upset taxpayers. Perhaps, matching will get easier for 2012 tax returns, so we can reassess at that time.

Why are 1099B rules different? 
Brokers prepare 1099-Bs based on detailed rules from the U.S. Treasury. While these rules might resemble tax-filing rules for taxpayers, they are often very different. In my next blog, I will explain how some forex dealers issue 1099s for Section 1256 contracts on forex forwards. Yet, taxpayers must start with Section 988 ordinary gain or loss and they are only entitled to Section 1256g lower 60/40 tax treatment if they file a contemporaneous internal election, and with other conditions as well. This Section 1256 contract 1099 is prepared by the broker with realized and unrealized gains and losses, but taxpayers only report realized ordinary gain or loss if they remain in Section 988. If you ask brokers about this problem, they will explain they are not responsible for a taxpayer’s tax return filings — they only need to follow detailed 1099-B rules for a default investor, without any regard for their client’s facts, circumstances, tax and accounting treatment, or elections. How would a broker know about internal elections, anyway?

Wash sales are bound to be wrong
When it comes to wash sales, there are a multitude of things that can and will go wrong, and that messes up cost basis and reconciliations for securities traders (unless they use Section 475 MTM and are exempt from wash sales).

First, many brokers are using back-office tax-accounting solutions that may botch wash-sale reporting, since they have not focused on it much in prior years. Second, there is the cost-basis rules transition problem mentioned earlier, with brokers omitting 2010 wash sale cost basis deferred into 2011. Third, most brokers rushed 1099-Bs to the printer before doing an end of January wash sale calculation (covered earlier). Fourth, most brokers report wash sales between “identical positions” (the same symbol only), whereas, taxpayers are required to report wash sales between “substantially identical positions” (such as between stocks and options). How can the IRS ask brokers to calculate wash sales according to identical positions only and taxpayers by substantially identical position? Even if brokers could get all the above right, broker-provided wash sales would still be wrong because brokers only report wash sales in one account, whereas a taxpayer must report wash sale analysis across all taxable accounts, including IRAs.

TradeLog is the answer for tax reporting
Don’t get side tracked with broker-provided 1099-Bs and other reports for your tax return preparation. Securities traders need TradeLog to download and match all their trades. TradeLog generates a Form 8949 attachment, but don’t be alarmed by a large discrepancy between this and your 1099-Bs. Those differences are due to the problems mentioned here and many more not listed in this blog. TradeLog calculates wash sales correctly.

Full disclosure, we sell TradeLog on our site and receive a commission. We sell TradeLog because it’s the only program on the market that our CPAs trust, and we have to sign tax returns, subject to preparer penalties, too. TradeLog works well because it’s a third-party solution that downloads trading transactions directly from your broker through a filter.

Broker accounting
Back-office system providers — like Scivantage Maxit (for ScottTrade and others), Broadridge Aspire (for Penson), and Sunguard — integrate their enterprise solutions into their brokerage firm clients’ platforms. Enterprise solutions are part and parcel with brokerage firm reporting; they’re set up to generate 1099-Bs for the firm, not the taxpayer’s net trading gain and loss reports.

We spoke with Cameron Routh of Scivantage. Mr. Routh has been involved with securities trade accounting software and brokers for a long time, and he is a wealth of knowledge when it comes to these problems. Mr. Routh explained that Scivantage and other enterprise solutions integrate with brokerage data systems to generate brokers’ 1099-Bs and other reporting, based on brokerage firm rules, not a taxpayer’s rules. While traders can retrieve a Sciadvantage utility to generate a 2011 Form 8949, it won’t have 2010 cost-basis information and that means it won’t have wash sale deferral carryovers, either.

Even Mr. Routh agrees that the best solution for a trader in 2011 is TradeLog, run separately from the broker.

Single account election
Mr. Routh pointed out that brokers were given the choice to make a “single account election” to report cost basis more accurately, including prior year cost basis. Most brokers declined this election, because they don’t want to bite off more than they can chew. Brokers don’t have sufficient information on hand for prior year accounting method (FIFO, special identification, average cost basis) and more. With older positions, firms would have to go back a very long time and that’s asking for trouble.

Phase-in problems will continue
More items become covered securities in 2012 (mutual funds) and 2013 (stock options). So, expect the same types of transition problems with these items in the future.

Bottom line
In the spirit of “closing the tax gap,” Congress asked the IRS to do cost-basis reporting. Like all things legislative, it looked much easier on the design board. Regulations were difficult and late, and implementation uncovered the poor design. Like all major undertakings, this one needs some tweaking. But, please IRS, don’t take this out of the hide of taxpayers. Waive the matching for a few more years, until this is in better shape. There shouldn’t be so many huge gulfs; please don’t force taxpayers to be the accountants when dealing with this mess.


Please IRS, don’t match tax returns with new cost-basis 1099-Bs

March 15, 2012 | By: Robert A. Green, CPA

See our Cost-Basis Reporting area in our Trader Tax Center for more content.

Green’s Forbes blog version: IRS Can Really Cause Problems With New Cost-Basis 1099-Bs.

In addition to my Forbes blog “Beware Botched 1099-Bs, Form 8949 At Tax Time” and interview in the WSJ article “Dodging a ‘Cost Basis’ Crisis,” my partner Darren Neuschwander, CPA and I had a long interview Wednesday with Theresa Carey, contributor to Barron’s. Ms. Carey writes the important Electronic Investor column, and her “Annual Online Broker Review and Ratings” was Barron’s cover story this past week.

What can be done to help traders with this problem?
Our CPA firm and a leading accounting industry group want the IRS to hold off matching cost-basis reporting to 1099-Bs for securities for the 2011 tax year. That should alleviate the problem for many. If the IRS doesn’t honor this request, we expect it will mail hundreds of thousands of tax notices causing great alarm, distress and cost to taxpayers. That’s unfortunate, since most discrepancies are not worth auditing. We’re finding that trade accounting is usually correct and broker 1099-Bs are wrong.

There is precedent for this request: Neuschwander says this is very similar to the recent controversy over new 1099-K rules for reporting credit card transactions. After blow back from the credit card and retail industries, the IRS reversed course and said it would not match issued 1099-Ks to taxpayer income tax return filings. That was done to prevent an avalanche of inappropriate tax notices, alleging errors where none probably existed. Kudos to the IRS.

Can brokers and traders get similar relief from the IRS on cost-basis 1099-Bs?
Probably yes, but it will take significant cooperation; brokers need to fess up to this mess, too. At the moment, brokers are hunkered down dealing with a barrage of customers calling their support lines, asking questions, complaining about errors and demanding corrected 1099s. We hope brokers acknowledge the problems and work with the media and their customers to follow retailers’ success with the 1099-K issue.

We are sharing this story with our contacts in the media and we hope they educate the public and IRS about the severity of this problem. We also hope the media coverage helps brokers make the right decisions going forward. Together, we can get the IRS to not match cost-basis 1099-Bs. Brokers and the IRS care about their customers and they should do the right thing in this case.

It’s unfair to blame this cost-basis reporting mess on brokers alone.
The IRS was late in communicating its new cost-basis reporting detailed rules. Brokers and accounting industry groups didn’t realize the IRS would require a brand new complicated Form 8949 until it was too late to properly address it this tax season. Form 8949 with Parts A, B and C, for covered, non-covered and other was difficult for brokers to conceive. The IRS should have communicated it very early on and given brokers standards for reporting. It’s very clear this cost-basis reporting was poorly managed. The pressure of tax season deadlines was also a contributing factor.

There are two types of problems — one is unacceptable and the other one can be wiped away.
Many brokers botched wash sales loss deferrals. There are no excuses, except that wash sale rules are very complicated and poorly designed by the IRS. In some situations, leading brokers are reporting several hundred thousand dollar wash sales, when traders didn’t have more than one quarter of that amount to lose in the first place. It’s doesn’t make sense. The errors we are noticing are unacceptable. The IRS can’t fix that type of error. If taxpayers file wash sales reported by some brokers, many will significantly over pay their tax bills. Consult with our firm and use TradeLog software to help in this situation.

Even when brokers report wash sales as best they can, the figure still is not 100% correct, because wash sale analysis must be calculated across all your brokerage accounts, including IRAs. No one broker can do that now.

Form 8949 reconciliations don’t have to be a problem if the IRS looks the other way.
If the IRS turns off its (assumed) matching program for new cost-basis 1099-Bs, then we will be less concerned with this huge discrepancy problem. Again, we need the brokerage industry and media’s help in getting this relief for taxpayers from the IRS. If we blame brokers, they may go into their shells and not help us. Our goal is to turn off the IRS computers on this matching program to prevent it from sending out TP-2000 notices to potentially millions of taxpayers over 1099-B and Form 8949 matching errors. Those audits could be very painful and protracted.

File extensions and skip the dance.
Everyone agrees: File valid extensions and let the dust settle on this huge mess before filing actual tax returns with Form 8949. We expect brokers to issue corrected 1099s and we hope the IRS reverses course too.

You don’t want a refund that you later have to repay the IRS with interest and taxes. You also don’t want to pay taxes now that you don’t owe. Plus, you don’t want to do this crazy dance of reconciling with botched 1099-Bs when we expect brokers to fess up and fix this mess later on.


Big Concerns with Botched 1099-Bs and Discrepancies on Form 8949

March 10, 2012 | By: Robert A. Green, CPA

See our Cost-Basis Reporting area in our Trader Tax Center for more content, blogs, Webinars, Video and our Petition to Congress.

Green’s Forbes blog version: Beware Botched 1099-Bs, Form 8949 At Tax Time.

As the leading CPA firm for preparing income tax returns for active online traders, we are spotting significant discrepancies between 2011 Form 1099-Bs provided by securities brokers – which include cost-basis information for the first time – and trade accounting software results. We have noticed scary differences on almost every file we have reviewed. It’s hard to pin point the main area of concern — so far, our CPAs are reporting big differences all across the map and it varies greatly by broker, too.

We’re putting tax filings on hold and filing extensions instead to have time to investigate these discrepancies. We expect brokers to issue wide-scale corrected 1099-Bs, and we wouldn’t be surprised to see corrections later this year. Hopefully these problems will be resolved in time to file tax returns by the extended due dates (Oct. 15 for individuals and partnerships; Sept. 15 for S-Corps).

Ms. Karen Blumenthal, reporter for the Wall Street Journal, interviewed Robert Green and Darren Neuschwander in her March 10 column: “Dodging a ‘Cost Basis’ Crisis.” Here’s an excerpt: “Try not to rush your return. Investors were supposed to receive the new 1099-Bs by Feb. 15, but a number of firms sought extensions of up to a month to get correct data out to investors. Corrected forms could still arrive in coming weeks. Robert Green, whose accounting firm Green & Co. represents active traders, says he has seen numerous errors and discrepancies between 1099-Bs and his clients’ calculations and will be seeking extensions while the differences are sorted out.”

What’s the problem?
As we reported previously in Cost-Basis Reporting on IRS Form 8949 Is a Nightmare, the new IRS Form 8949 replaces the Schedule D-1 attachment to Schedule D (Capital Gains and Losses). Taxpayers may no longer enter their securities trades onto Schedule D or D-1. In prior years, brokers just reported proceeds on stocks, so reconciling the total was not a big deal. An options trader had a higher amount since option proceeds were not reported on 1099-Bs.

Ms. Blumenthal points out in her article some valid reasons for discrepancies on Form 8949 such as a taxpayer choosing a different trade-accounting method vs. what his or her broker reported on 1099-B —FIFO vs. specific identification method or average cost basis, for example. But we are noticing much bigger problems than that, and many are not explainable. For example, many brokers botched wash sale reporting.

Wash sales are a big problem. One leading broker reported a $450,000 wash sale loss, but the trader couldn’t have lost more than the $50,000, the total she had in her account during the year. The broker’s wash sale program must be piling up wash sale loss deferrals without any adjustment or analysis of subsequent positions. Another top broker kept an old wash sale open from earlier in the year, even well after the client fully absorbed that wash sale loss deferral with subsequent capital gains on that same symbol. Another top broker told our software partner that they adjust wash sales to proceeds, when they should be adjusting wash sales to cost basis only. These wash sale errors are ridiculous and will likely result in tax notices.

1099-B reporting errors are wide-scale. Another top broker includes open short sales at year-end in 1099-B proceeds on stock. That was allowed in prior years, but not in 2011.

Brokers are choking on these new cost-basis reporting rules. We need more time to see more 1099-Bs and many brokers haven’t even issued 1099-Bs yet. Many brokers requested a 30-day extension from the IRS so traders may not get their 1099-Bs until the end of March or even later. That’s just the first 1099-B, too. Traders need time to isolate discrepancies with their own trade accounting and to investigate differences with brokers. You can imagine these brokers will be swamped with calls and emails, all during the March 15 (S-Corp) and April 15 (individual and partnership) tax deadlines. This is lunacy.

Reconciliations are much harder this year. In 2011, securities traders must reconcile their total and line-by-line trade accounting for securities trades to their 1099-B. The beefed-up and often botched Form 1099-Bs are making this very difficult for many traders. The IRS deputized traders as their accountants to find these expected discrepancies with brokers — choking on the application of these new rules in the first year — and the IRS forces taxpayers to explain all differences. With brokers making a huge mess of the new cost-basis rules, this is quite the task!

Will this undermine your faith in your trade-accounting software? Can you safely file a tax return with large unexplained discrepancies on Form 8949? Won’t that significantly increase your chances of a tax exam, or lead to tax notices? What a nightmare.

File an extension
It’s such a big problem that our CPA firm Green NFH, LLC decided to put our clients with these unresolved problems on extension by the due date of April 15. We want our clients to formally request corrections from their securities brokers, with our help of course. We want brokers to explain discrepancies, and to correct them when required by the IRS. All tax information documents like 1099-s or W-2s can be corrected and resent to the IRS and the taxpayer. So far, brokers are refusing to correct their 1099-Bs for many of these errors and that further concerns us. We want more time for the IRS, media and customers to pressure brokers into fixing their mess. There’s never a rush to file a full tax return by April 15. For decades, many of our clients have filed extensions, as it takes more time to file trader tax returns in the best way possible. In this case, the “early bird will get audited,” so filing later is wiser.

File a valid extension by April 15 using trade accounting software like TradeLog. You automatically then have six months longer to file your full tax return by Oct. 15. That should give you and your broker sufficient time to work through Form 8949 discrepancies and hopefully arrange for corrected 1099-Bs.

A valid extension requires payment of 90 percent of tax liability by April 15. Use “good faith” to calculate or estimate your trading gains and losses and other taxable income. When you file your full tax return by the extended due date and your payment is over 10% of your tax liability, you trigger late-filing penalties (4.5% per month) and late-payment penalties (0.5% per month), plus interest expense. Not filing can trigger penalties of 100% of the balance due. If your tax extension is deemed invalid because you owe over 10 percent of your liability, try to argue that you used “good faith” and seek abatement of penalties from the IRS. It’s best to use TradeLog and prepare correct extensions with the payment of 90 percent of your estimated tax liability by April 15.

Don’t forget new Section 475 MTM elections are due by April 15, too. Making a Section 475 MTM election could be tricky based on using unreliable tax information. It can affect your decision to file or skip the Section 475 MTM election. Generally, we recommend Section 475 MTM on securities only, providing the business trader doesn’t have capital loss carryovers. Traders need capital gains to use up capital loss carryovers, not Section 475 MTM ordinary income. On the other hand, wash sales from 2011 can be converted into Section 475 MTM ordinary losses in 2012 with a MTM election. See our year-end tax planning content and consult a trader tax expert about this election. It’s beyond the scope of this blog article.

Section 475 MTM exempts traders from Form 8949 and wash sales, too. GreenTraderTax has recommended Section 475 MTM for securities business traders since Congress opened this door in 1997. It’s our claim to fame. All these years, it exempted business traders from wash sale rules – which have always been a pain to understand and apply – and that onerous capital loss limitation of $3,000 against ordinary income. Now, Section 475 MTM also exempts business traders from Form 8949, as Section 475 is reported on Form 4797 Part II ordinary gain or loss.

Entities are exempt from Form 8949, too. Another way to avoid the Form 8949 nightmare is by trading in an entity, with or without trader tax status. The IRS does not currently require entities to use Form 8949. Pass-through entities do receive 1099-Bs, but entities may still report line-by-line securities trades on Schedule D and Schedule D-1 attachments. Entities are very tax beneficial to business traders, unlocking opportunities for retirement plan and health insurance premium AGI deductions. Consider a trading entity soon this year.

Congress and the IRS botched this cost-basis rule
This is a classic case of government trying to fix things, but making them worse, at least in the short run. Congress wanted to “close the tax gap” and the IRS claimed that too many securities traders were making errors on cost-basis reporting and underpaying their capital gains taxes. So, Congress and the IRS enacted the cost-basis reporting rules in 2008, allowing brokers to begin a three-year phase-in. Most would think that was plenty of time, but apparently it was not. Plus, the rules seem to be poorly designed. Even after full phase-in, many instruments are still not “covered” on 1099-Bs, and trade accounting will continue to have large discrepancies with 1099-Bs. Hopefully they can be easily explained in 2013.

Should the IRS hold tax notices or even retract Form 8949? Why didn’t the IRS hold off on Form 8949 until 2013, after the cost-basis reporting rules fully phase in? Why ask taxpayers to reconcile a much bigger difference in 2011 than will be required in 2013? Isn’t it unfair and outrageous if the IRS sends tens of thousands of tax notices from Form 8949 discrepancies? Imagine having to endure a protracted IRS exam with the agent tracing every single confirmation and more. I hope the taxpayer advocate gets involved here and this fiasco is put on hold.

Further help may be on the way
The AICPA recognized this wide-scale problem with IRS cost-basis reporting rules and it recently formed a new task force to tackle the problem. Kudos to my partner Darren Neuschwander, CPA: The AICPA invited him to join this task force, and they have their first meeting very soon. Mr. Neuschwander was also on the AICPA committee for dealing with the IRS on its cost-basis reporting rules. 


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