The Internal Revenue Service has released a revised Schedule D and a supporting schedule, Form 8949, “Sales and Other Dispositions of Capital Assets,” that concerns the reconciliation of the taxpayer’s basis records on capital gains and losses with the brokers’ records of the same gains and losses.
It has done so because in 2008 the U.S. Congress passed the Emergency Economic Stabilization Act of 2008, also known as the “bailout bill.” One of the least-noticed provisions of this much-noticed bill placed new requirements on financial intermediaries to report adjusted cost basis figures to the IRS. Brokers were already subject to 1099-B income reporting forms of course, but this amounted to a mandate for significant compliance system upgrade.
Congress provided that the upgrade was to take place in three steps, applying to equity stock acquired on or after January 1, 2010, to mutual funds and dividend reinvestment plans (DRP) shares acquired on or after January 1, 2012, and to other specified securities types including debt issues and options acquired on or after January 1, 2013.
There are some limits on the types of adjustments brokers must make in adjusting the basis or holding period of securities. For example, they are not required to adjust the basis or holding period for constructive sales, straddles, or mark-to-market adjustments.
The new IRS releases recognize that discrepancies will exist between a taxpayer’s records of securities transactions and those of the broker, and attempt to adjust for that. An example: wash sale basis adjustments, which may involve two distinct brokers where the re-acquisition will involve substantially identical securities from those of the loss account.
PricewaterhouseCoopers LLC has in turn released a report cautioning that the new IRS documents won’t reconcile “differences that result when a taxpayer and a broker do not agree on the particular lot that has been relieved.” Thus, it remains important that they not differ that they address lot relief methods explicitly.
When brokers execute trades, they must follow the lot relief method directed by their clients. In the absence of such instructions, they may default to FIFO, the first-in, first-out method. In the special case of DRP shares, they may default to the average cost method.
In recording an open trade, the brokers will report just one transaction per security or trading day (purchase, sale, short, or cover) though this may amount to aggregating multiple trade orders throughout the day with an average price assigned to each share. Discrepancies become possible because funds may forego such aggregation, recording each trade separately.
This tracking of lots and the related issue of the volume of trades is relevant to “a fund’s status as a trader or investor in securities,” PwC says, and the fund ought to pay careful attention to maintain appropriate records that will “support any conclusions in this regard.”
One a trade has been confirmed “and the security’s settlement date has passed,” PwC writes, the lot relieved by the broker – in following the directions on file or default FIFO method in the absence of instructions otherwise – is the one deemed sold or covered.”
Accordingly, PwC recommends that funds examine the documentation they have on file with their brokers regarding lot tracking and relief methods. They should also review their operations to confirm that they have a process in place to track trade confirmations and reconcile with broker reporting.
PwC also says in a footnote that properly documented C corporations typically will not receive Forms 1099-B. the IRS acknowledges this in its newly issued form.