There’s a reason that the stock market continues to make news: over half of Americans own individual stocks, mutual funds, or stocks in a 401(k) or IRA. According to a 2011 Gallup poll, 54% of Americans hold stocks in some form despite fears of a shaky market.
While reasons for investing in the stock market vary almost as much as the number of securities available, stocks have traditionally been valued as long term investments. Generally, when you purchase a share of stock, you’re buying a piece of a company. You, along with other shareholders, are banking on the fact that the company will continue to grow and that the value of your share will increase over time. In that regard, it’s a bit like legalized gambling.
Some stocks pay dividends, which are taxable in the year issued, but many do not. The real value of stock for many shareholders is growth. When the stock is sold, the difference between the sales price and basis is subject to capital gains tax.
Basis is, at its most simple, the cost that you pay for an asset together with any adjustments. With respect to stock, basis may be difficult to calculate since shareholders may hold stock over a period of many years; inherit or gift stock; or participate in a dividend reinvestment plan (DRP). Additionally, companies may split, merge or spin off their shares.
Remarkably, prior to this year, there were no statutory requirements for brokers or other financial service providers to identify basis for tax purposes; it was up to the individual taxpayer. That changed in 2011 as a result of the Emergency Economic Stabilization Act of 2008 (sometimes referred to the “bailout bill”). Brokers are now required to file an informational return with the IRS each year which reports gross proceeds from the sale of stock together with the taxpayer’s adjusted basis.
Beginning on January 1, 2011, brokers were required to report the basis of stocks purchased after that date. If the stock is in a mutual fund, exchange traded fund (ETF) or part of a DRP, the effective date for reporting is pushed off to January 1, 2012. The basis for debt securities, options and private placements must be reported after of January 1, 2013.
Brokers must not only report basis as the amount of cash paid or credited for the purchase of stock but must also reflect adjustments for commissions and fees as well as other events that affect basis, such as a stock split. Additionally, sales must be identified as short term or long term for capital gains purposes.
Of course, stock sales are rarely done in neat packages: shareholders don’t buy and sell the same number of shares each time. Selling less than an entire position in an account can cause confusion because it’s difficult to figure the cost basis for the shares which were sold compared to the shares which remain.
Under the new regulations, the basis for most stocks will be reported using the first-in, first-out (FIFO) method, meaning that shares which were acquired first will be considered sold first unless the customer specifically identifies the shares to be sold. The rules for mutual funds and DRP stock are a bit different: the adjusted basis of those shares will be reported according to the broker’s default method unless the customer says otherwise. To keep things simple, taxpayers may average the basis of stock held in a DRP; exceptions and special rules apply so ask your broker if you’re not sure whether your account qualifies for averaging.
For the most part, the burden to report the basis of stocks now falls squarely on the financial industry, making reporting capital gains and losses easier for taxpayers come tax time. Information about basis will be reported to taxpayers, as noted above, in a staggered fashion beginning this year on a form 1099-B, Proceeds from a Broker or Barter Exchange Transaction, or on a consolidated report. Those forms, showing those shares affected by the 2011 reporting requirements, should be popping up in your mailboxes now. If you don’t see yours, be patient: brokers have until February to get them to you.
However, this doesn’t mean that taxpayers should become complacent. Keeping excellent records is still a must, as is reviewing monthly statements and sale confirmations. You should also consider meeting with advisors on a regular basis rather than waiting until the end of the year to address any concerns about sales or tax consequences. Since taxpayers can choose a reporting method or identify specific shares for sale, planning opportunities for offsetting gains with losses abound. With some careful attention, the result of the new legislation could be a lower tax bill.
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