RTS #041 Does anything really have a zero basis?

Paying taxes on the same income twice might be one of the worst ways to tip the IRS. Paying taxes on income that should never have been taxed is right up, and when the stars align just right (or is it just wrong?), taxpayers can end up doing both in the same year.

Reporting from custodians has gotten significantly better over the last decade (mostly due to increased regulatory requirements), but that DOES NOT mean your clients can fully rely on a 1099-B to make sure their capital gains and losses are being reported correctly. This can result in sales being reported with a zero basis (which for most taxpayers is never the reality) or an incorrect basis that is too low (which might be even more dangerous since it doesn’t raise the same red flag as a zero basis).

Here is how we most commonly see this crop up:

• Investments that have transferred between custodians – Especially for positions that have been held for years and for clients that have switched Advisors, this can easily crop up. The position is moved to the new custodian without basis being communicated and the new custodian simply reports the eventual sale with a zero dollar basis and a gain that is inaccurate. This will appear in a separate category on the 1099-B indicating that basis was not reported to the IRS, but the 1099-B will still show a zero basis.
• Investments that are the result of equity compensation – equity compensation is typically taxed through a W-2 at the time it vests, so only the change in value between vesting and sale should be taxable. The problem is this isn’t always clear on the 1099-B. At times, the custodian will bury an “adjusted basis” 30 pages deep in the document, but this gets missed by DIYers and professional tax preparers alike. If this gets missed the taxpayer is hit twice on taxes because they already paid for a portion of the “gain” through their W-2.

When either of these situations come up for your clients it can be a source of huge frustration. The information can be challenging to track down, and they may not work with a tax preparer who is going to be proactively involved in that process (or who simply doesn’t have the time during this hectic part of the year). This then becomes a great value add opportunity and an opportunity to apply the dishwasher rule (making sure you get credit for the value you are adding). If you track down $10,000 in basis that would have otherwise gone unreported, that’s potentially $2,300 of tax savings that you should let your client know who helped with.

Stock transactions with $0 basis and sales of stock of companies the taxpayer has worked at should be on everyone’s tax return review checklist (we definitely cover it in our upcoming masterclass on reviewing tax returns).

What can you do about it?

It’s our constant refrain, but it applies in so many situations: get every client’s tax return every single year. Reviewing tax returns using a 37-point checklist to make sure you are helping your clients get the most out of their tax experience is a great start. Next level is tracking in your CRM and specifically looking for tax planning you do with clients on their next tax return. That could be related to cost basis but should encompass any proactive planning you do together. Tax planning isn’t over until it’s been reported correctly to the IRS.

Happy Tax Planning!