January 2015

How Will You Handle Wash Sale Losses On Securities This Tax Season?

January 23, 2015 | By: Robert A. Green, CPA

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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. 


Tax Treatment Of Forex Losses In Wake Of Swiss Surprise

January 17, 2015 | By: Robert A. Green, CPA

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If you are one of many who got caught on the wrong side of the forex trade when the Swiss National Bank (SNB) surprised the markets with a huge policy change this week, you probably incurred significant losses. Here’s a quick primer on how to handle these losses on your tax returns.

First, it’s important to segregate your losses into two camps: the forex trading loss (Section 988 or capital loss) incurred on your open positions that were liquidated or closed by you or your broker, versus losing a deposit in an insolvent financial institution (Section 165). The latter also happened to traders who made money on this market event.

Forex tax treatment
By default, forex trading losses are Section 988 ordinary losses, unless you filed an internal contemporaneous capital gains election at any time before this new trading loss was incurred. In that case, it’s a capital loss subject to capital loss limitations of $3,000 per year against ordinary income. With a capital gains election in place, if you trade major currencies and don’t take or make delivery, you probably use Section 1256(g) lower 60/40 capital gains rates.

If you qualify for trader tax status (business treatment), Section 988 losses are business losses includible in net operating loss carry backs and forwards. But without trader tax status, you’ll need other income to absorb the forex ordinary loss, because the negative income part is otherwise wasted. If you’re using Section 1256(g), you can file a net Section 1256 loss carry back election for 2015 to carry the loss back three years to offset Section 1256 gains in those years. (Read more about forex tax treatment in our Trader Tax Center).

Deposit loss tax treatment
Hopefully, other banks and brokers will rescue teetering forex brokers and not too many forex traders will lose their deposits in insolvent financial institutions. That would be unfortunate since there is no FDIC or SIPIC money-protection on forex accounts. If U.S. and foreign forex brokers fail, hopefully the firms have private insurance that pays out the deposit holders in full for their deposit losses. If there is less than full recovery of deposit losses through insurance or otherwise, sustained losses are subject to Section 165 tax treatment.

We addressed similar issues when we covered the MF Global insolvency and recovery efforts over the past few years.

Excerpt from our Trader Tax Center
Many investors, traders and hedge funds got sideswiped by the MF Global and PFG bankruptcies over the past few years. Unfortunately, futures and forex account holders are not afforded government protection like bank account holders with FDIC protection and securities account holders with SIPIC protection. Tax treatment is far better when the IRS declares the loss a “theft loss”and allows application of IRS Revenue Procedure 2009-20, originally enacted to provide tax relief for investors in the Bernie Madoff Ponzi scheme. Theft losses receive ordinary loss treatment plus acceleration of losses on tax returns. Otherwise, Section 165 applies to deposit losses in insolvent financial institutions like MF Global. Investors are stuck choosing between capital loss treatment, which may trigger capital loss limitations, or itemized deduction treatment with various restrictions and haircuts. Business traders with trader tax status benefit from business ordinary loss treatment. Taxpayers with Section 165 losses must wait for the loss to be “sustained”so trustees have ample time for fund recovery. MF Global futures account holders recovered their losses in full, although forex account holders may have some sustained losses. (Read our blogs, PFG investors can deduct theft losses on 2012 tax returns with Rev. Proc. 2009-20 safe harbor relief, and MF Global & PFG Best deposit losses have nuanced tax treatment.)

I imagine bankruptcy trustees for these failing forex brokers will seek to recover funds from customers who incurred forex trading losses in excess of their deposits, unless the account agreements say otherwise. I also envision there will be arguments over who bears responsibility for excess losses, the broker or customer in cases where brokers liquidated positions and sometimes too late.

Disregard of CFTC rules
Many American forex traders disregarded CFTC rules (for retail off-exchange forex) by trading with non-registered offshore brokers offering leverage far above CFTC limits of 50:1 on major currencies and 20:1 on minor currencies. Several offshore brokers and a few U.S.-based forex brokers are facing financial strain or insolvency as a result of offering excess leverage to their customers during the SNB shockwave. When markets are extremely volatile the broker and customer may not be able to exit a trade before incurring a significant loss well in excess of the customer’s deposit amount. Let’s see how the money protection issue works out offshore.


Tax Treatment For Precious Metals

January 7, 2015 | By: Robert A. Green, CPA

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The collectibles tax rate on precious metals is high, learn how to improve after-tax returns.

There are many different ways to invest in precious metals and tax treatment varies.

Physical precious metals are “collectibles” which are a special class of capital assets. If collectibles are held over one year (long-term), sales are taxed at the “collectibles” tax rate — the taxpayer’s ordinary rate capped at 28%.

It’s different for regular capital assets like securities: individuals in the 10% and 15% ordinary income tax brackets pay 0% on long-term capital gains (LTCG); individuals in the 25%, 33% and 35% tax brackets pay 15% on LTCG; and individuals in the top 39.6% bracket pay 20% on LTCG.

This translates to materially higher tax rates on collectibles for all taxpayers in all tax brackets vs. regular LTCG tax rates. For this reason, many CPAs recommend clients invest in physical precious metals inside their IRAs. Congress and the IRS loosened the rules allowing IRAs to invest in precious metals.

If collectibles are held one year or less, the short-term capital gains ordinary tax rate applies no different from the regular STCG tax rate. Realized gains and losses in collectibles are reported on Form 8949 and Schedule D along with other capital gains and losses, which means the capital loss limitation of $3,000 against ordinary income applies on individual tax returns. There are special ordering rules for collectibles vs. other capital asset classes.

If you prefer the regular LTCG rate in your taxable accounts, you can get exposure to precious metals by investing in securities tied to the precious metals industry. These securities are no different from other securities with STCG up to 39.6% and LTCG rates up to 20%.

Traders appreciate precious metal futures since they are Section 1256 contracts with lower 60/40 tax rates and mark-to-market (MTM) accounting on a daily basis. Sixty percent is LTCG and 40% is STCG for a top blended rate of 28%, which is 12% less than the top STCG rate. MTM means you report both realized and unrealized gains and losses. The $3,000 capital loss limitation still applies. Alternatively, you may file a Section 1256 loss carryback election on top of Form 6781 when filing your tax return.

More about collectibles
When you invest in physical precious metals including bullion (coins and bars) or physical-backed precious metals ETFs — structured as grantor trusts which means you effectively own the bullion — the “collectibles” tax rate and rules apply.

Per Thomson Reuters Checkpoint tax research service:

  • “Collectibles gain or loss is gain or loss from the sale or exchange of a collectible which is a capital asset held for more than one year, but only to the extent such gain or loss is taken into account in computing gross income. (Code Sec. 1(h)(5)). Any work of art, rug or antique, (precious) metal or gem, stamp or coin, alcoholic beverage, or any other tangible personal property specified by IRS for this purpose is a collectible.” Precious metals jewelry meets the definition of collectibles.
  • “The term 28% rate gain means the sum of collectibles gain and losses and section 1202 gain (certain qualified small business stock), less the sum of collectibles loss, the net short-term capital loss for the tax year, and the long-term capital loss carryover to the tax year.RIA observation:As a result of the way the 28% rate gain is defined, a long-term capital loss carryover from an earlier tax year will always be used first to offset it.”

Examples: If X sells a collectible after one year and is in a low ordinary income tax bracket of 15%, then the collectibles tax rate is 15%. Conversely, if Y is in the ordinary tax bracket of 33%, the collectibles ordinary rate is capped at 28%. It’s not a blanket 28% rate for all taxpayers.

Nonphysical precious metal investments
If you want to avoid the higher collectibles tax rate and benefit from lower LTCG rates, consider investing in securities tied to precious metals, but not physically backed by precious metals.

For example, the popular gold ETF symbol GLD is a physical-backed precious metal ETF structured as a grantor trust and it’s deemed a collectible. Conversely, the gold mining ETF symbol GDX is a registered investment company (RIC) taxed as a security.

Here are some other examples of securities tied to precious metals: gold mining equities like symbols ABX and GG, gold mining ETFs (RICs) like GDXJ, gold mutual funds (RICs) like symbols SGGDX and TGLDX and gold mining exchange-traded notes (ETNs — debt securities) like symbols UBG and TBAR. Securities are not a pure-play investment in precious metals.

U.S. closed end funds (CEF) are also trusts treated as collectibles. But non-U.S. closed end funds like symbols CEF and GTU are offshore corporations subject to Passive Foreign Investment Company (PFIC) rules. For PFICs, consider a “qualified electing fund election” under Section 1295 filed on Form 8621 to enjoy LTCG tax rates. But unless you are making a significant investment, it may not be worth the extra tax red tape and oversight.

Section 1256 lower 60/40 capital gains tax rates
Traders always like Section 1256 because they get lower 60/40 tax rates even on fast trades; they don’t have to wait one year for lower LTCG rates. Gold futures contracts on U.S. futures and commodities exchanges qualify for Section 1256 tax treatment as regulated futures contracts (RFCs).

In their Journal of Accountancy article “Tax-Efficient Investing in Gold” dated Jan. 1, 2015, Steven H. Smith, Ph.D. and Ron Singleton, CPA, Ph.D. write that its also popular to invest in gold futures ETFs like symbols DGL and UGL, and gold futures ETNs. Our content on ETFs points out that sales of commodities/futures ETFs — structured as publically traded partnerships — are taxed like securities. Investors often receive a Schedule K-1 passing through Section 1256 contract income which requires an adjustment to cost basis as part of a sale transaction.

Breaking news from the IRS on IRAs and precious metals
Per Thomson Reuters tax service on Jan. 7, 2015, “IRAs can invest in trusts holding gold: In a private ruling, the IRS held that IRAs and individually directed accounts maintained by qualified retirement plans can invest in trusts holding gold without being treated as a distribution under IRC Sec. 408(m) (1). According to the IRS, the rules that prohibit direct investments by IRAs in gold do not apply if the gold is held by an independent trustee. In this ruling, shares in the trust are marketed to the public, including IRAs and individually directed plans, and are traded on a stock exchange. However, if the shares are redeemed for gold, the IRS says the exchange will be treated as an acquisition of a collectible (i.e., treated as a taxable distribution to the owner) except to the extent IRC Sec. 408(m)(3) is satisfied. PLR 201446030.”

The trend is your friend
When IRAs were created in 1974, Congress prohibited IRA investments in collectibles. In 1986, Congress allowed U.S. gold and silver coin investments and in 1998 it expanded that to pure (99.5%) bullion. In 2007, the IRS issued a PLR 200732026 that did not consider physical-backed precious metal ETFs like the GLD a collectible as held by IRAs — a clever way around the prohibition.

Expenses
Owning significant gold bullion requires expenses for storage and insurance. Holding a few gold coins in a safe deposit box has negligible cost. Even with securities and futures tied to precious metals, expenses are factored into the investment structures. Try to have IRAs and retirement plans pay their own investment expenses.

Bottom line
The price of gold had huge appreciation in the decade ending in 2012 and it’s been a rocky road down in price since then with volatility. Don’t lose sight of tax losses and the dreaded capital loss limitation, which applies to collectibles, precious-metal-tied securities and futures. At least you’ll get the benefit of losses inside a traditional IRA or retirement plan since it reduces your taxable distributions in retirement.

Postscript Feb. 26, 2015 about the option on GLD ETF
Many tax professionals treat the option on GLD (gold ETF) as a Section 1256 contract principally because it’s a non-equity option trading on a CFTC qualified board of exchange. Options on commodity ETFs structured as publicly-traded partnerships (PTP) are Section 1256 contracts. The GLD is a publicly-traded grantor trust, not a PTP. We understand that on their 2014 Form 1099Bs, Fidelity is treating the option on GLD as a stock option (a security) perhaps because if a taxpayer sells physical gold short term it’s a short-term capital gain just like a security. This may relate to the GLD being a grantor trust with disregarded ownership of the underlying assets – as if the owner of the ETF owns the gold bullion directly. A well respected tax information site Twenty-First.com lists the option on GLD as Section 1256 and it states “If the ETF is not set up as a RIC, but as a trust (like GLD) or a limited partnership (like USO), then listed options on the ETF would be treated as a non-equity option under Section 1256.” Click here for our content on ETFs.


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