Cost-Basis Reporting Update: How To File Form 8949 With 1099-B Differences

July 11, 2012 | By: Robert A. Green, CPA

Join noted trader tax CPAs Robert A. Green and Darren Neuschwander, Managing Members of Green NFH, LLC for their “Webinar on July 17, 2012” (or watch the recording afterward) as they discuss the latest IRS cost-basis-reporting developments for securities traders. Green and Neuschwander will discuss the below FAQs, show tax return examples, explain our rationale, and show traders and professionals how best to proceed on this challenging issue.

The background
Many securities traders filed 2011 tax extensions and they are awaiting our guidance on how to file their tax returns containing differences between trading profit and loss on Form 8949 and broker-issued 1099-Bs. The differences are sparking IRS tax exams. Most clearing firms struggled to issue multiple corrected 1099-Bs, and many of those still got it wrong. See our recent Webinar on ““Botched 1099-Bs, Form 8949 Differences, Tax Prep Tips, Extensions & MTM Elections”” (Mar. 28, 2012).

Many traders already filed their 2011 tax returns based on 1099-B reporting and overpaid their taxes by thousands of dollars. They should learn how to fix the errors and file amended tax returns to get refunds.

Wash sales are a big problem
1099-Bs grossly overstating wash sales seem to be the biggest culprit for errors — we saw this to the tune of millions of dollars on one taxpayer’s Form 8949. Oddly, many brokers inappropriately adjusted gross sales proceeds for wash sales adjustments, when they should have only adjusted cost basis. Many brokers reported ““potential” wash sales” in cost-basis, rather than actual wash sales, which are much lower.

FAQ this Webinar will address:

1. Question: Is it safe to file a 2011 individual income tax return/Form 8949 containing differences between your own trading profit and loss and amounts reported on Form 1099-Bs?

Answer: Instructions for Form 8949 ask for trade-by-trade reconciliations of proceeds and cost-basis, comparing your own accounting results with Form 1099-Bs. That’s almost impossible to do for active traders with botched 1099-Bs, which seems to be par for the course on 2011 tax filings.

The only good securities trade-accounting solution that we know of is TradeLog. While TradeLog can reconcile total proceeds and cost-basis from Form 8949 to Form 1099-B amounts, it does not have the capability to reconcile each line-by-line or trade-by-trade amount to Form 1099-B. TradeLog shows the total reconciliation difference for gross proceeds and cost-basis on Form 8949. It’s the “plug” number the IRS’s computerized 1099-B matching programs look for.

These Form 8949 unreconciled amounts vary greatly. Some are under $1,000 and others are in the millions, especially when potential wash sales versus actual wash sales are involved.

While we often have some good clues or ideas on what contributes to material unreconciled differences, we can’t be certain since it’s only a total difference rather than a line-by-line difference. It can take weeks of work to figure it out. Plus, it’s often a wild goose chase with no concrete results generated.

Rationale for our answer: Since Form 8949 instructions ask for a reconciliation of differences, we display them — no matter how big or small — on Form 8949. We use the reconciliation feature in TradeLog. Some clients and tax preparers may decide to skip the TradeLog step to avoid showing a huge reconciliation item on Form 8949, thinking that may reduce the chances of an IRS exam. We disagree, as the Form 8949 instructions ask for the reconciliation, and with that plug number, the Form 8949 will match the 1099-B when the IRS runs the computerized matching program. Not showing the reconciliation may indicate the preparer is unaware of the rules and that may cause the IRS to think the return is otherwise flawed, too.

We believe it’s a mistake to delete the plug number reconciliation difference from Form 8949. The IRS could construe it to mean a tax preparer is obstructing IRS oversight and disrespecting its new cost-basis reporting rules. That’s unwise. Bottom line, leaving in the reconciliation amount helps with matching and it complies with the rules.

2. Question: What happens if the IRS audits the trader over Form 8949?

Answer: If you’re examined by the IRS, plan to give the agent your TradeLog reports, brokerage statements, and Form 1099-B. Let the agent spend weeks comparing these documents. They will see TradeLog is correct and the 1099-Bs are sliced and diced with errors. This won’t cost the client much money or time, since the CPA does little work during the exam. The IRS can fool around on its dime and time.

If you get this type of tax notice, contact us for help. We will try to get the exam “reconsidered” and point the IRS back in the direction of the broker, who it should examine instead of the trader. This only takes a few hours of our time, so it doesn’t cost much.

3. Question: How should I deal with these unreconciled differences throughout the tax return filing?

Answer: You should highlight the differences from Form 8949 vs. 1099-B footnotes, and perhaps supporting worksheets. There’s no reason to try and bury them. The taxpayer and tax preparer should clearly state what steps they took in: doing their securities trade accounting; how they prepared Form 8949; how they reconciled with the 1099-B; and what the unreconciled differences might be — as best as they can explain it. Accountants would be foolish to try and cover up a problem or not comply with these rules. We suggest that tax preparers obtain representation or acknowledgement letters from clients about this problem and process, too, so there are no misunderstandings about scope and outcome later on.

If the unreconciled difference is under $1,000, you can probably skip long-form footnote explanations; a simple note on how you used TradeLog or other software should suffice. (TradeLog offers a footnote to use as well, explaining what it does and does not do in this regard.)

4. Question: How do I e-file a tax return with a Form 8949?

Answer: If you e-file your individual income tax return, we generally paper file the Form 8949s with attachments of the TradeLog reports and related footnotes. The transmittal form is Form 8453.

E-filings for individuals currently don’t permit PDF attachments, making the separate Form 8453 filing necessary. Although we can import TradeLog files into our software, we choose not to because there are other complications that can arise.

5. Question: Does the IRS require taxpayers and tax preparers to investigate unreconciled differences between Form 8949 and 1099-Bs? If yes, do they need to explain those differences on their tax return?

Answer: The IRS cost-basis rules call for taxpayers and tax preparers to “verify” Form 8949 to their 1099-Bs. But, verifying information like inaccurate wash sales perpetuates tax problems. The term “verify” indicates taxpayers and preparers should be sure the underlying trade information is correct, like comparing Form 8949 to actual trade confirmations. Unfortunately, 1099-Bs rarely agree with trade confirmations for 2011.

6. Question: Where do we find more information on known issues on Form 1099-Bs?

Answer: Both TradeLog and GreenTraderTax provide resources on known issues with various brokers on their 1099-Bs. “Click here”. Do your best to explain as many difference in general that you can and include that in a few sentences in the footnote. We may show some examples on the Webinar.

7. Question: Do traders have to keep pressing their brokers to correct 1099-Bs?

Answer: No, but they should try their best to do so — that earns points with the IRS.

One of our clients spent 40 hours of his time finding every individual difference and he presented all the evidence to his online broker. He forced his broker to fix every error on the 1099-B. That client’s Form 8949 now has no differences.

Few clients have the time to do this. If you find some errors, try to get your broker to issue a corrected 1099-B to narrow the unreconciled differences. But, in the end, it could prove to be frustrating, time consuming, and the broker may not cooperate. Make an attempt and document it in your footnotes.

8. Question: How can I avoid this Form 8949 mess in the future?

Answer: Consider forming an entity for business trading and investing in securities. Currently, entities don’t file a Form 8949. See our recent Webinar on ““The Best Entities for Traders and Investment Management Businesses.””

Individual business traders who elect Section 475 MTM file their trades on Form 4797, not on Form 8949. That solves the problem for business trades, but you still need Form 8949 for segregated investments. You can house both in an entity. Section 475 MTM is exempt from wash sale loss treatment. Caveat: It must be elected by April 15 of the current tax year. New taxpayers can elect it within 75 days of inception.

Or, trade futures and other Section 1256 contracts which are reported in summary fashion on Form 6781, rather than on Form 8949. Futures are not subject to wash sale treatment. See our recent Webinar on ““Tax Benefits from Trading Futures & Section 1256 Contracts.””

Is this an example of government overreach and regulation with poor thinking? Why ask brokers to spend time and money compiling more information for IRS consumption when the aggregated information is going to be incorrect (wash sales)? Aggregation is for the old economy with manual work, not the new high tech world. The IRS could have simply asked brokers to include an annual statement in the same manner as a monthly statement, containing all debits and credits for buys and sells of capital assets. It wouldn’t have needed to phase-in the rules, causing great additional confusion.

Are local tax preparers, including CPAs, subjecting themselves to professional liability claims and IRS preparer penalties? Shouldn’t their professional liability insurance carriers insist they not take the apparent easy way out by relying on 1099-Bs? We hear most accountants start tax preparation by importing 1099-Bs into their tax software after scanning them with OCR recognition. They are baking inaccurate tax information into their cake. Verifying afterward that their tax software used the 1099-B correctly misses the point because the ingredients are wrong to begin with. We help accountants select and use the proper solutions — TradeLog and more — for this filing crisis. We are currently evaluating another software solution for finding differences and we should report on this soon.

Who should attend the Webinar?
If you trade securities, or have a client who does, don’t miss this important Webinar. This crisis is huge and most accountants, tax attorneys, brokerage firms, software providers and the media are short changing and under-reporting it. The IRS wants to close the tax gap, but, causing taxpayers to overpay taxes by perhaps a billion dollars in connection with these inaccuracies isn’t the answer. We see this huge crisis as an ethical issue for the IRS, Congress, brokers, and accountants.

Please sign our petition
We will update our Petition to Congress soon calling on the IRS to recall or repeal these poorly crafted rules. We’ll suggest that the IRS ask brokers for an annual statement of all buys and sales. Don’t ask taxpayers to file a Form 8949 until brokers have filed the annual statement on the 1099-B correctly for several years and the IRS has consumed it properly. This is a very simple data dump, and we don’t need the extra cost and confusion. The cost-basis crisis is a microcosm of the entire government vs. private section economy. Use computers to exchange data and take all the people — middle men accountants and rule makers — out of it.

We asked Congress for IRS relief in our last Petition ““Securities Traders Need Tax Relief on IRS Cost-Basis Reporting Rules”” on and through other initiatives. Please sign it today. The IRS recognizes only a fraction of the problem, and it provided fractional relief. Specifically, to delay the 2013 phase-in rules one year to 2014 for cost-basis reporting on options and debt instruments. We’re urging the IRS to rethink the rules and start over right. Is this why our tax code is an abomination of complexity?

Watch a MoneyShow video interview with Robert A. Green, CPA on this subject from the June 2012 Traders Expo Dallas: “Tax Flubs That Can Cost You Thousands”.

If you have further questions or need our help in addressing your personal situation, consider a consultation with us. We have a summer promotion on “consultations” and “entity formation services”.

TradeLog Accounting Services
We offer “TradeLog accounting services” which include preparation of your Form 8949, dealing with the unreconciled differences as best we can in short order, and preparation of your related footnotes. If you have a local CPA, engage us to handle this difficult part of your tax return — your local CPA will really appreciate it.

Bottom line
Don’t file an incorrect tax return and over pay your taxes by thousands of dollars, due to botched wash sale reporting, or other 1099-B errors. And, don’t cause yourself an unnecessary IRS exam, either. Get informed, use the right software solutions, and get help from trader tax experts who understand the nuances of cost-basis reporting.