We’re getting down to ‘crunch time’… just a few weeks to go before April 15 (or for those of us in the states that recognize Patriots’ Day as a holiday, April 16.) It’s around this time that advisors across America start to get a steady stream of calls that go a bit like this:
“Hi- it’s Claire (or Claire’s accountant). There’s a stock being reported on our tax form as sold, but they’re calling it a ‘Non-Covered holding’ and showing it as a ‘zero’ cost basis. It’s resulting in my owing a bunch of taxes. How can we fix that?”
One thing is for sure: you can‘t fix that by ignoring that holding on your tax return. Just because they call it a ‘non-covered holding’ doesn’t mean its sale is not being reported to the IRS. It is, and they’ll be expecting you to account for it. Failure to do so will result in the IRS proposing a pretty significant tax obligation as a result.
Things were different in the ‘old days’… and by ‘different’, I mean it was worse! Prior to 2011, there was no such thing as cost basis reporting on the 1099. Since then, however, the IRS mandates that the brokerage firm holding your stocks, bonds, mutual funds, ETFs, etc. keep track of the cost basis and resulting gains and losses.
The IRS setting in place this reporting requirement is a godsend to taxpayers, and their advisors and accountants, saving them countless hours of chasing down this data. It’s probably a good deal for the IRS as well; by putting the cost basis responsibility on the tax payer, it surely encouraged situations where the cost reported was substantially inflated (resulting in lower taxes).
So today, the job is easier – but not completely without issues. Most sales of holdings since 2011 result in the capital gain being reported on the 1099 issued by the brokerage house holding the investment – but there are still routine situations where the investment was purchased before 2011. In that case, it’s not unusual for the reporting of cost basis to be incomplete. On one tax form, there may be both ‘covered’ positions (with basis reported and gains calculated) AND ‘non-covered’ positions without this data. Even the same investment may have a ‘covered’ and ‘non-covered’ component.
Since it is the taxpayer’s ultimate responsibility to report the cost basis – and resulting gains and losses – correctly, retaining accurate records is important. Unfortunately, however, shareholders often do NOT have this data sitting neatly in a file somewhere and finding the correct cost basis to report becomes a large chore. If you find yourself in this situation, there are things you can do. They include:
- Contact your broker or advisor. Just because the cost basis isn’t reported on the 1099 form doesn’t necessarily mean that it hasn’t been tracked. Often, the brokerage house holding the investment will be able to provide a rundown of the basis and resulting gains.
- Sleuth the information out yourself. Sometimes, this can be easier than you think. Take, for example, Dan, who inherited 100 shares of XYZ stock from his mother when she died. Even though Dan’s mom had purchased the stock decades ago, the cost basis gets ‘stepped up’ to the value on her date of death. There are plenty of sources for historical stock or fund values, including Yahoo finance and Google.
- Account for re-investment. In Dan’s case above, the assumption is that Dan’s mom bought 100 shares of XYZ, died with 100 shares, and that eventually Dan sold the 100 shares. If only it could be so simple… many times, investors have dividends re-invested in a stock or fund. Keep in mind that each re-investment is another purchase – and another addition to the cost basis. Especially in the ‘old days’, I can point to many a late nights working with clients to try to account for each reinvestment over a long holding period.
- Account for corporate actions. Mergers and spinoffs can pose especially challenging situations. In 1984, the Department of Justice mandated that AT&T be broken up into 7 different ‘baby bells’ and some of those have since broken up, merged, or undergone other things like changes of names. Any time I see ‘Verizon’ as a holding, I know there may be a complicated situation behind it. There are actually software packages that were created to help determine cost basis over significant situations like this. Of course, just like any software, the maxim of ‘garbage in, garbage out’ applies. If you don’t have the original purchase information or have done partial sales along the way, it can be a challenge
- Take the zero. In some cases, the amount of time it will take to put together a reasonably accurate cost basis is huge and the savings are minimal. If you sell a stock for $1,000 and figuring out the cost basis is going to take hours of your time (or that of your accountant or advisor), take into account that if you don’t report the basis, the full $1,000 will be considered a gain, and taxation will occur – but only at the 15% long-term capital gains rate. For some, that $150 tax is a bargain compared with the time and hassle of cobbling together the cost basis.
- Don’t wait until you sell. Now that you’ve read this, it’s time to go into your records to find out what you own and identify any holdings with missing cost basis data. If you take the time to make sure it’s all accounted for now, you won’t have to run around at ‘crunch time’ and your early spring will be that much more enjoyable.
- Coordinate your charitable giving. Often, I’ll recommend gifting highly appreciated stock instead of giving cash to a charity. Since 501(c)(3) operations don’t pay taxes on the gains, the appreciated asset is worth more to them than it is to you. The same applies to holdings where you can’t find the cost basis. By gifting shares instead of cash, you will have not only leveraged your gifting, you’ll save yourselves hours of frustration by not needing to find missing cost basis data.
Sometimes, complete data just is not available. Exact purchase dates and subsequent re-investments are simply not accounted for. In cases where best-effort ‘estimations’ need to be made, we encourage folks to keep good records on how they came to the number they generated. Ultimately, it is the IRS who gets to decide whether the numbers you’ve generated are reasonable and accurate. In the event they examine your calculations, you’ll want them to be as ‘reality-based’ as possible!