In a recent webinar with active traders we did a poll and 97% who responded had situations where the 1099-B may not be complete in wash sale reporting. Often this is because the trader has more than one taxable account, or an IRA account, or he trades option contracts. At the root of the problem are differing wash sale rules that the IRS has for 1099-B and for taxpayers. What are the differences and why is the 1099-B often worthless as a result?
Wash sale rules are important because they prevent individuals from evading capital gains tax from trading activities. For this reason the IRS felt that brokers should report cost basis on the 1099-B along with wash sale adjustments. But there was one major problem: brokers could not possibly account for all wash sale scenarios. For example, if a trader has multiple trading accounts with more than one brokerage house, there is no easy way for brokers to account for wash sales across all accounts. Therefore, the IRS made a small exception for brokers - one with big consequences.
In the IRS instructions for 1099-B reporting, brokers are only required to adjust for wash sales “if both the sale and purchase transactions occur in the same account with respect to covered securities with the same CUSIP number.” - 2012 IRS Instructions for 1099-B page 7.
However, the wash sale rules for taxpayers are much more involved. IRS Publication 550 states that wash sales can occur on substantially identical stocks or securities, on option contracts for a stock or security whether purchased in the same account or across multiple accounts owned by you or your spouse or corporation you control, and even in an IRA account! We explain the many complications of wash sale rules and how they affect active traders in our Trader Tax Resources online.
This means that many active traders receive a 1099-B that only reports some of the wash sales, which requires the trader to determine all additional wash sales that occurred and make necessary adjustments.
Someone at the IRS must have thought this would not be too difficult, likely they’ve never had to generate Schedule D reporting for a trader with hundreds or thousands of trades. The reality is that this process is very difficult. To make matters worse, because the 1099-B does not provide full verifiable details about the adjustments made by the broker, the trader often cannot determine which additional wash sales need to be made! Many popular tax software programs do not (and cannot) make these required additional wash sale adjustments, placing the responsibility back on the taxpayer to manually complete.
How do traders generate accurate tax reporting in light of these problems? Solutions like TradeLog software allow active traders and investors to use actual trade history (which is obtained from the broker but does not have adjustments made to it). Using trade history, a trader is able to generate Schedule D reporting including IRS Form 8949 following the wash sale rules for taxpayers. TradeLog software automates much of this process and is able to adjust wash sales between stocks and options, across all taxable accounts, and even make special wash sale adjustments that occur because of IRA trades.
What about the 1099-B? In our special report, The 1099-B Problem: Why IRS Regulations Have Failed to Meet Cost Basis Reporting Needs, we show why the current 1099-B reporting requirements are seriously flawed. We also give recommended solutions that would make the 1099-B truly useful for tax reporting purposes. Many groups have been working to raise awareness of the flawed 1099-B requirements. We hope that the IRS can fix this problem and make the 1099-B worth the time and expense involved in producing it by brokers! You can learn more about the special report and TradeLog software from our homepage.
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.