Why Is the 1099-B Cost Basis Not Reported to the IRS?

Understanding the intricacies of tax reporting can be daunting, especially when it comes to Form 1099-B and its cost basis information. This form is crucial for taxpayers who have sold stocks or other securities, as it details the proceeds from these transactions. However, not all cost basis data is reported to the IRS, which can create confusion during tax season.

Why Cost Basis Might Not Be Reported

Cost basis inconsistencies on Form 1099-B stem from factors like security classifications and evolving tax regulations. The IRS mandates brokers to report the cost basis for “covered securities,” which are those acquired after specific dates. For instance, stocks purchased after January 1, 2011, and mutual funds or dividend reinvestment plans acquired after January 1, 2012, are considered covered. Securities acquired before these dates, termed “noncovered securities,” do not require brokers to report their cost basis, leaving the responsibility to taxpayers.

Calculating cost basis can also vary depending on the method chosen, such as First-In, First-Out (FIFO), Last-In, First-Out (LIFO), or the average cost method. Brokers may lack the information needed to apply the taxpayer’s preferred method, particularly for noncovered securities, which can lead to discrepancies.

Transferring securities between brokerage accounts adds another layer of complexity. Receiving brokers may not obtain complete cost basis details, especially for noncovered securities. This makes record-keeping essential for investors to ensure accurate reporting. The IRS holds taxpayers accountable for providing accurate cost basis information, even if brokers do not report it.

Covered vs. Noncovered Securities

The distinction between covered and noncovered securities significantly affects tax reporting. Covered securities require brokers to report cost basis information to the IRS, as mandated by the Emergency Economic Stabilization Act of 2008, which aimed to enhance compliance. These rules apply to securities acquired after specific dates, depending on the type of asset.

For covered securities, brokers typically use FIFO unless the investor specifies otherwise. This simplifies reporting for investors and reduces discrepancies. Noncovered securities, on the other hand, require taxpayers to independently track and calculate their cost basis, which can be challenging.

Situations like transferring assets between brokerage accounts or inheriting securities can obscure original purchase details, making accurate record-keeping crucial. The IRS allows taxpayers to use reasonable methods to determine cost basis for noncovered securities, but the burden of proof remains on the taxpayer.

Methods to Calculate Your Cost Basis

Calculating the cost basis of securities is central to determining capital gains or losses upon their sale. The Internal Revenue Code provides several methods for this calculation, each affecting tax liability differently.

FIFO

The First-In, First-Out (FIFO) method assumes the oldest securities purchased are sold first. In a rising market, this typically results in lower capital gains due to the lower cost basis of older securities. For example, selling 100 shares under FIFO would prioritize shares purchased at $50 over those bought at $70. However, in a declining market, this method could lead to higher tax liabilities.

LIFO

The Last-In, First-Out (LIFO) method assumes the most recently acquired securities are sold first. This can be advantageous in a declining market, as it often results in lower capital gains due to the higher cost basis of newer securities. Using LIFO in the same scenario would prioritize selling shares purchased at $70 first. While less common for securities, LIFO can be useful in specific market conditions.

Average Cost

The average cost method is commonly used for mutual funds and dividend reinvestment plans. It simplifies cost basis calculations by averaging the cost of all shares purchased, resulting in a single cost basis per share. For instance, if an investor buys 200 shares at varying prices, the total cost is divided by the total shares to determine the average cost. Once chosen, this method must be consistently applied to all subsequent sales of the same security.

What to Do if You Lack Records

If you lack detailed records, reconstructing your cost basis is possible with available documentation like bank statements, brokerage summaries, or financial reports. These can help piece together your transaction history.

Your brokerage firm or financial advisor may also have historical records of transactions not reflected in current statements. Additionally, online tools that use historical stock price data can assist in estimating cost basis, though these should be used cautiously to ensure compliance with IRS guidelines.

How to Report to the IRS

Accurate cost basis reporting is essential for tax compliance. When selling securities, brokers report the proceeds on Form 1099-B. However, taxpayers are responsible for accurately reporting their cost basis and calculating capital gains or losses on Schedule D and Form 8949.

Form 8949 reconciles broker-provided data with your records. Each transaction must include details like acquisition and sale dates, proceeds, and cost basis. Transactions are categorized as short-term (held one year or less) or long-term (held more than one year), as this impacts tax rates.

If your 1099-B lacks cost basis information, you must calculate and report it manually. Ensure your calculations match the chosen method (FIFO, LIFO, or average cost) and align with IRS rules. Discrepancies between your data and the broker’s report can trigger IRS scrutiny, so double-check entries. Tax software can simplify this process by automatically populating necessary forms.

Repercussions of Inaccurate Reporting

Inaccurate cost basis reporting can result in severe financial and legal consequences. Discrepancies may lead to penalties, interest, or audits. For example, under Internal Revenue Code Section 6662, taxpayers can face a 20% penalty on underpayment caused by negligence or disregard of IRS rules.

Mistakes can also complicate future filings. An incorrect cost basis can lead to errors in capital gains or losses in subsequent years, especially for investors with large or complex portfolios. To avoid these issues, maintain detailed records and reconcile them with broker statements. If errors are discovered after filing, promptly file an amended return using Form 1040-X to correct inaccuracies and minimize penalties.