Cost Basis of Stocks Can Vex Taxpayers

The calculations can get complicated. Here's some guidance.
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Investing provides substantial income for many taxpayers, but government auditors say the process of reporting such gains is costing the U.S. Treasury billions.

The problem, according to a June 2006 report from the Government Accountability Office, is taxpayer confusion related to the basis of securities. Based on 2001 data, the GAO found that 36% of taxpayers who sold securities that year misreported their capital gains or losses.

The problem in many cases, both in 2001 and today, is that taxpayers don't know the basis for their holdings or failed to adjust it properly.

If you're struggling with basis calculations as the 2007 filing deadline looms, you have a couple of options. And if Congress and the White House get their wish, brokers one day will be offering more help in determining securities' basis amounts.

Compiling Basis Data

First, let's look at the problem.

When you sell a holding, you figure your capital gains or losses using the sale price and the asset's basis. Your broker, as required by law, sends you a statement noting the disposition price. But it's up to you to provide the basis amount. And that's where the trouble begins.

"Conservatively, I'd say 30% to 40% of taxpayers I've dealt with over the years do not have sufficiently correct data about their cost basis," says Mark Washburn, a CPA in Tyler, Texas.

In these cases, Washburn, who also is senior lecturer in accounting for the College of Business and Technology at the University of Texas in Tyler, works with clients to determine how they acquired the stock. The key is just how much information the investor can provide.

Corporate Transaction Complications

But the accuracy of data also is sometimes complicated by corporate transactions. These include mergers, spinoffs and distributions, and stock splits, all of which could have a significant tax impact.

CCH Capital Changes, part of Wolters Kluwer Financial Services, tracks such transactions and compiles an annual list of

Top Ten Corporate Actions

that could have tax consequences for individual investors.

"A full understanding of these events is necessary to properly book shareholder accounts," says Richard Ryndak, senior tax analyst for CCH Capital Changes. He cites last year's

ABN Amro


deal as an example of the various factors that could pose tax-reporting problems.

In this taxable exchange, shareholders of the Dutch company received shares of

Royal Bank of Scotland

(RBS) - Get Report

as well as cash in euros. To accurately compute gain or loss, taxpayers must convert share values and euros into U.S. dollars, as well as determine the actual date of exchange. Because shares were accepted over several weeks and, given the fluctuations in share prices and exchange rates, gain or loss likely varied significantly among shareholders.

Some brokers are equipped to handle these types of calculations, Ryndak says. But even the broker might run into trouble unless he or she handled the sale and knew the exact dates.

Required Broker Basis Reporting

Some help sorting through such complications is available to both individual investors and brokers via subscription services such as CCH Capital Changes and portfolio management software programs such as GainsKeeper (also a Wolters Kluwer product).

But federal lawmakers believe the best approach is enhanced third-party reporting of investment transactions. As part of the House foreclosure relief bill now under consideration, housing provision costs would be paid for in part by mandatory cost basis reporting by brokers for transactions involving publicly traded securities. The provision would apply to stock acquired after Jan. 1, 2010; for other securites (e.g., bonds), the effective date would be Jan. 1, 2012. The Joint Committee on Taxation staff estimates that such enhanced reporting would raise $8.05 billion over 10 years.

A "sure thing" is a rarity, of course, when it comes to federal legislation, especially in an election year. Although President Bush supports increased basis reporting and a similar version was approved by the House last December, the Senate's housing assistance measure does not contain basis language.

But Stevie Conlon, tax director for GainsKeeper, believes the measure is closer than ever to becoming law. "If the

legislative alignment is right, it could become law quickly," says Conlon, whose Capitol Hill sources have been willing to offer "a much stronger view about a provision's chances than most people are usually willing to give on tax bills."

Options Until Then

While such added transaction data could help investors more accurately figure their tax liability on future sales, what is a filer today, facing the April 15 deadline and uncertainty about a security's basis, to do?

In addition to utilizing specialty software or subscription services, taxpayers can check local law or technical libraries for stock historical data.

You also can request an extension to file. Of course, you'll still have to pay any taxes you estimate you owe.

Washburn recommends that investors still working through transaction-basis issues go ahead and file using the data they have.

"If they think they can get more accurate information later but don't have accurate information at the moment, make the most reasonable estimate now and file the return," he says. "Then when they get the more accurate information, they can come back and file an amended return."

Kay Bell, a free-lance writer and editor in Austin, Texas, has been writing about taxes for a decade. She has two tax blogs, Don't Mess With Taxes and Eye on the IRS.