New Basis-Reporting Laws Make Life Easier for the IRS

When people sell shares of a stock, they must figure out their cost basis in the shares they sell so that they can calculate the gain or loss on the sale.  Determining the basis of the shares sold can be difficult when people sell a block of stock comprised of shares that were purchased at various times.  In 2008, amid the financial crisis, Congress passed the Emergency Economic Stabilization Act, part of which required financial intermediaries such as brokers to report to the Internal Revenue Service the cost basis of stock sold by their clients.  While the law was enacted in 2008, it is new in the sense that its reporting requirements apply to equities purchased after 2010, mutual funds shares purchased (including through dividend re-investment) in 2012 or later, and bonds purchased after 2013.

While the law should eventually simplify the process of determining cost basis in a stock sale, it may create some confusion in cases where a person sells shares of stocks, some of which were purchased in 2012, and others of which were purchased in (for example), 2000.  In such cases, only a portion of the sale- the shares purchased in 2012- will be subject to the new reporting requirements.

In addition, the new law requires people who sell shares to quickly inform their broker or bank which block of shares they are selling, rather than waiting until tax season.  Identification of the lot sold can be critically important; for example, a person may own 1,000 shares of a stock, with 500 shares having an individual cost basis of $20 and the other 500 having an individual cost basis of $40.  If the person sells 500 of the 1,000 shares when the stock price is $35, the result could be a loss of $2,500 or a gain of $7,500, depending on which lot of stock the seller designates as being sold.

From the IRS’s point of view, the new law is welcome in that it strengthens the previous “honor system” of reporting cost basis and thereby eliminates the potential for dishonest taxpayers to manipulate their tax reporting.  By requiring financial intermediaries to provide the IRS with cost basis information, the new law ensures that the agency will not have to devote resources towards investigating taxpayers’ treatment of their stock sales.