New Basis Reporting Rule For Stock Transactions

The IRS will now receive information from brokerage houses that gives more details concerning the trading activities of investors.  In the past, the IRS received 1099 information returns that reported the sales prices of stocks in investors' accounts.  Basically, the IRS would receive a report on the sales price only of a stock.  The investor, however, would usually receive a report that was much more detailed, to include the purchase price of the stock. 

A very critical component of any stock sale is the basis, or typically the purchase price.  The basis is sometimes adjusted subsequent to certain events (splits, etc.)  The basis is the portion for which a taxpayer will not pay tax.  Hence, sales price minus the basis is the taxable gain.  Let's look at an example of how a taxpayer has potentially underpaid tax on a transaction. 

Jimmy Hofstra buys a share of stock for $50.  The share price goes up to $150.  Jimmy sells the stock, and reports the transaction on his tax return.  Only, Jimmy decides to "fudge" the basis number and puts "$100" for the basis amount.  Now Jimmy will be reporting a gain of $50 instead of a gain of $100.  Obviously, he will pay less tax.  And herein is a component of the "tax gap." 

Taxpayers have reported incorrect basis amounts for as long as the Treasury Department has required reporting of the transactions.  Some have been mere oversight, while many have been intentional.  I'll share another example.  Someone may every now and then report capital losses of around $3,000.  We know that capital losses are limited to $3,000 unless capital gains are greater.  But in the absence of capital gains, one may only deduct $3,000 of capital loss against ordinary income, such as wages.  Nevertheless, this someone reports the loss and pays less tax.  The only trouble is, there is no transaction.  That's right, the "transaction" is totally fabricated.

Now, this fellow knows that this amount flies under the radar screen.  The IRS typically goes after transactions that they figure will net them $2,500 or better in tax under audit, so an audit is unlikely.  Hence, this guy is playing a lottery of sorts.  The odds of the IRS ever discovering these transactions are in his favor.  If the IRS ever inquires, which is typically by letter, he can simply pay the tax.  By the way, this is just one area in which fraud is easily perpetrated against the government.

So what is an old three letter, alphabet soup agency supposed to do?  Use a new provision that forces brokers to report basis amounts.  Jimmy Hofstra will now be boxed in.  But the person in my second example may evade taxation still, if he reports a transaction other than a brokered stock sale.  Whatever the case, stocks purchased during 2010 and thereafter will have a basis amount and sales price reported to the IRS upon the sale of the shares.  So when a taxpayer reports a "sales price" and a "purchase price" of shares of stock on Schedule D of the 1040, the IRS will match that information with what is received from the brokerage house. 

The take away is the IRS can now verify that you have indeed reported the correct basis in your stock, so mistakes and outright evasion will now be caught in an efficient manner.  All of this, however, creates more work for your broker, the costs of which will be surely passed to you.