1099-B Cost Basis Reporting

As investors and traders begin receiving 1099-B forms for 2011, they will quickly notice some major changes. These changes are a result of cost basis reporting requirements which brokers are now required to comply with. This tax topic discusses the background of and purpose of this required reporting, how it affects traders and investors, and how to understand the new 1099-B reports.

Cost Basis Reporting Legislation

On Oct. 3, 2008 Congress passed the Emergency Economic Stabilization Act which was signed into law by President George W. Bush. Section 403 of Division B of the act makes cost basis reporting mandatory for brokers. Beginning in 2011 brokers are required to keep track of cost basis for stocks; in 2012 they will add basis for mutual funds, and 2013 for options and debt instruments. The IRS will also require brokers to account for corporate actions affecting cost basis as well as very limited reporting of wash sales. When securities are transferred between brokerage accounts – brokers will now be required to report the cost basis information to the broker with the transfer.

Each year, beginning with the 2011 tax year, the broker provided 1099-B will include the required cost basis data. This information will be reported to the tax payer and to the IRS. It’s important to note that the 1099-B is considered by the IRS as third-party information which is provided to assist taxpayers and also aid enforcement. The instructions with the 1099-B will inform taxpayers of their duty to verify the information reported by brokers and to adjust the reported information when necessary to reflect the taxpayer’s correct information. This duty applies equally to covered and non-covered securities.

Although brokerage firms will be held accountable for reporting within IRS requirements – this does not in any way reduce the taxpayer accountability for accurate tax filing. In fact, read on to learn why this reporting is being required in the first place!

Why Brokers Must Report Cost Basis?

In 2006 the Government Accountability Office of the IRS reported to the Senate Finance Committee that 38% of individual taxpayers with securities transactions misreported their capital gains or losses in 2001. In 2001 alone it was estimated that misreporting of capital gains by that group accounted for $17 billion of the $350 billion total tax gap. In the two years that followed Congress forged the legislation to help the IRS close that tax gap and collect that missing revenue.

The purpose of this new legislation is NOT to remove accountability from you as a taxpayer. Rather, the new reporting requirements provide the IRS with a tool for enforcement – they now can more easily identify the estimated 7 million traders who are failing to accurately report capital gains and losses on their Schedule D!

In the past all that the IRS was provided from your broker was total proceeds from sales; but this is only half of the information needed to calculate gains and losses. J. Russell George, Treasury Inspector General for Tax Administration, thus said this: "IRS compliance efforts are also limited by the lack of available information on the cost basis of investments, which could be used to verify investment gains or losses. Such information would allow the IRS to better focus its enforcement resources on non-compliant taxpayers."

In other words, the IRS will now receive two numbers for each trader in securities: total cost basis, and total sale proceeds – the difference will give them an idea of what you should be reporting as a gain or loss. This number can then be used as an audit flag to help identify ‘mistaken’ capital gains or losses.

Learn how cost basis reporting affects traders & investors.