When it comes to taxes, the IRS serves as judge, jury and executioner. Ignorance is an unacceptable excuse and winning a battle against the IRS is about as likely as guessing all of the brackets for college basketball correctly. Trader tax rules are notoriously confusing for do-it-yourselfers and pros alike, causing people to overpay or get penalized for misreporting gains and losses. Some professional accounting mistakes are not even covered by malpractice insurance, and thus, accountants are liable for them.
Accountants are on the hook for their clients’ mistakes if they recommend using only Form 1099-B to calculate trading income. That’s unless the client meets the following obscure criteria:
Here’s an overview of the different rules for reporting various types of securities.
The IRS made a mess out of trader taxes since 2011. It was made even worse in 2014 with new reporting rules for options. The new rules cover options traded on the open market and those received by employees as compensation.
As of 2014, brokerages have to report on Form 1099-B stock options sales and debt options bought if they involved an exchange of cash. However, brokerages do not have to report options purchased before 2014. They do so at their own will. Therefore, some do, some do not.
Brokerages must report the adjusted cost of such options if they were acquired for cash. This is so the IRS can more easily track taxable gains, Laura Saunders wrote in the Wall Street Journal. Before only traders were responsible for reporting this information and not the brokerages.
If you receive stock options as compensation, exercise the shares and sell them at the same time, your employer has to report the income on the W-2 while the brokerage has to report the proceeds on Form 1099-B. However, the brokerages are not allowed to report on Form 1009-B the investment’s cost, which would naturally lower the taxable gain on the sale. You have to watch out for that. If you miss the omission, you could overpay your taxes.
What if the you ignore the brokerage’s 1099-B report for options sales because the income was already reported on the W-2? It has to be accounted for on Schedule D, the report for capital gains and losses. If it isn’t, the IRS will flag it as unreported income.
Brokerages report all short stock sales as closed on the position’s settlement date. Some brokerages erroneously do this on short options trades while some do not. There is no consistency among brokerages.
What’s more, the taxpayer reporting date for short sales rules only applies to stocks. And that’s only for short sales that closed at a loss. Short sales closed at a gain use the actual date closed, not the settlement date.
According to the IRS, wash sale adjustments should increase cost basis. The IRS only requires brokerages to adjust for wash sales between identical CUSIPs in the same account. Therefore, you are responsible for making all other wash sale adjustments such as those between stocks and options. You must also make adjustments across all of your accounts, including IRAs.
Some brokerages report the profit/loss from short options trades in the gross sales column. This makes the gross sales amount completely useless. Therefore, the 1099-B gross sales amount will never reconcile.
No standardized list of what constitutes a section 1256 contract exists. So some brokerages do not include the sales from certain broad-based options in the gross proceeds total, while other brokers report some of them. This also makes the gross sales total useless for comparison.
Tax treatment for ETFs varies depending on whether their underlying holdings are stocks, commodities futures or precious metals. The IRS has failed to state clearly the tax treatment on options sales of ETFs. Tax treatment of options on precious metals ETFs is also unclear.
You cannot rely on your brokerage’s 1099-B for proper tax treatment.
“Taxpayers invested in commodities/futures ETFs may need to make some cost basis adjustments on Form 8949 to capital gains and losses, ensuring they don’t double count some of the Schedule K-1 pass-through items,” Robert Green, CPA and founder of Green Trader Tax, wrote in Forbes. “If the K-1 passes through income, that income will need to be added to the cost basis on Form 8949, otherwise it will be double counted and thus, will cause an overstatement of tax liability.”
Reconciling your brokerage’s 1099-B is impossible. In most cases, it’s gross sales amount will not match the actual total sales amount reported on Form 8949.
To make sure trader taxes are done correctly, it’s imperative accountants and do-it-yourselfers use a tax-prep software that was especially designed to handle the complex IRS rules for active traders. TradeLog is the only trader tax software that takes the IRS’s inconsistencies into account.
TradeLog’s 1099-B reconciliation report helps you to find potential problems with your data, such as duplicate or missing trades. TradeLog accurately accounts your trades despite what is reported on your 1099-B, thereby providing an accurate Form 8949 report.
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.