Doing taxes is a royal pain in the butt for anyone let alone active traders. The headaches arise from Form 1099-B, which brokerages use to report your trades to both you and the Internal Revenue Service. The IRS compares the brokerage's report with your tax return to flag discrepancies and looks for unreported income.
Brokers are required to mail these forms to you by Feb. 15 and the IRS by March 31. Deadline extensions and multiple revisions are more common than not. It seems really unnecessary. After all, the brokerages handled each leg of a trade. So they should know exactly what you paid and sold at.
The revisions are often minor but create major headaches. Thankfully as of this year, brokerages don't have to send out corrected forms if an error comes to less than $100 in income, the Wall Street Journal reported.
Revisions are common because brokerages pass on information sent to them from third parties. If one of the mutual funds in your brokerage account issues a correction, your broker must add the change on a new 1099-B and send it to all of its investors.
Brokerages have to deal with IRS guidelines that are very foggy in some areas such as reporting for complex debt. Here are some steps to you can take to alleviate headaches from 1099-B forms.
1. Only file your taxes once. In other words, avoid sending revisions. Don't file your return until all of your information is complete, even if you have to file a request for an extension via Form 4868.
2. Watch your "cost basis" like a hawk. The "cost basis" is simply what you paid when you bought a stock. This gets complicated if you inherited a stock, received it as a gift or transferred it from another brokerage account.
Errors can arise when employees receive stock as part of the compensation. If employees exercise their stock options, part of the cost basis of these options may not be included in Form 1099-B. They may end up overpaying their taxes if it's left out of Schedule D.
3. Fix reporting errors carefully. If your 1099-B form has any mistakes, you best have the issuer correct them before sending the information to the IRS. If you report the correct number yourself, the IRS will spot it as a discrepancy.
If you can't have the issuer fix the error, use the information the issuer gave you on the tax return and then an adjustment according to the instructions on Form 8949.
4. Check "wash sales" at least twice. A wash sale entails selling a security a loss and then buying another that's considerably similar within 30 days. The capital loss gets deferred and can't be used immediately to offset a capital gain.
You must know what counts as a wash sale and what doesn't. For example, selling the SPDR S&P 500 ETF (NYSEARCA:SPY) for a loss and then buying Vanguard 500 Index Fund (NYSEARCA:VOO) does not count as a wash sale because the two ETFs are too similar to each other.
But you can buy GE (NYSE:GE) options within 30 days of selling GE stock at a loss and count that as a wash sale. Unfortunately, brokerage 1099-B forms do not calculate wash sales between equities and equity options. Neither do most trader accounting programs.
"Non-compliant programs report wash sales between identical positions only, matching broker 1099-Bs," Robert Green, founder of GreenTraderTax.com and a certified public accountant, wrote in Forbes. "That compounds the problem and gives clients a false sense of security."
Brokerages are not required to report that on Form 1099-B because wash sale rules are different for brokers and individuals. Nevertheless, you will be responsible for reporting that to the IRS. So it's paramount that you check for wash sales, particularly if you trade frequently.
5. Check for wash sales by using tax-prep software developed specifically for active traders like TradeLog, which is compliant with Section 1091 wash-sale rules for taxpayers. Downloading 1099-Bs into consumer tax-prep programs like TurboTax misses most wash sales because they do not calculate wash sales between equities and equity options. What's more, tax rules for brokers are different than those for individuals.
"Brokers are correct in preparing 1099-Bs but incorrect in telling clients they should import 1099-Bs into their income tax filings," Green wrote. "Brokers calculate wash sales based on identical positions (an exact symbol only) per separate brokerage account.
"But the wash sale loss rules for taxpayers, Section 1091, requires taxpayers to calculate wash sales based on substantially identical positions (between equities and equity options and equity options at different exercise dates) across all their individual accounts including IRAs - even Roth IRAs."
Using TurboTax requires manually adjusting for wash sale losses. That would be a monumental undertaking for active traders with hundreds if not thousands of trades every year.
Please note: This information is provided only as a general guide and is not to be taken as official IRS instructions. Cogenta Computing, Inc. does not make investment recommendations nor provide financial, tax or legal advice. You are solely responsible for your investment and tax reporting decisions. Please consult your tax advisor or accountant to discuss your specific situation.