New Rules for Reporting Capital Gains

The 2011 tax return reporting of capital gain transactions has been substantially modified.  The new procedures are implemented in accordance with the Emergency Economic Stabilization Act of 2008.  The change is expected to increase tax revenues by $6.7 billion over 10 years by increasing the amount of information brokers must report to the IRS on Form 1099-B (or substitute statement) upon the sale of investments.  For publicly traded securities, brokers must now report in addition to the sales date and price, the tax basis and whether the sale is a short-term or long-term capital gain or loss.  The additional information will be used by IRS computers to monitor compliance by taxpayers who might otherwise under-report their capital gains.  The basis information is reported on "covered securities."  Covered securities are defined as follows:

1. Stocks purchased after 2010,
2. Mutual funds and exchange-traded funds (ETFs) purchased after 2011, and
3. Options and bonds purchased after 2012.

In determining the tax basis of covered securities sold, brokers will use either a "first-in, first-out (FIFO)" or "average cost" method.  You have the right to elect to use the "specific identification" method wherein you tell the broker in writing which shares are to be sold.  Most brokers request that you communicate your method to them prior to the sale.  Significant differences in the basis amount can result, depending upon the method used.

Details of capital gains and losses are no longer reported on Schedule D or D-1.  Instead, use new Form 8949, Sales and Other Dispositions of Capital Assets.  Summary amounts are carried from Form 8949 to Schedule D.  The new form requires transactions be sorted into three separate categories using a separate Form 8949 for each category.  If you have both short-term and long-term sales, you could have six separate Forms 8949!  The segregation into categories facilitates IRS computer auditing of your capital gains and losses.  The three categories are:

1. Transactions reported on Form 1099-B with the tax basis reported to the IRS,
2. Transactions reported on Form 1099-B but the tax basis is not reported to the IRS, and
3. Transactions not reported on Form 1099-B.

Brokers may mistakenly report incorrect tax basis to the IRS.  Form 8949 requires any corrections to the tax basis reported to be separately disclosed along with designating a pre-determined code as set forth in the instructions to explain the reason for the correction.

These new reporting rules will increase the cost and burden of compliance.  The rules essentially require taxpayers to do the work normally associated with preparing for an IRS tax audit.