An update note to tax preparers and traders about incorrect 1099-Bs and 2011 tax filings
By Robert A. Green, CPA
Many tax preparers and traders have put 2011 tax return filings on hold, awaiting corrected 1099-Bs from securities-broker clearing firms. Unfortunately, many clearing firms are struggling and they simply can’t provide a 1099-B that tax preparers can rely on. How should preparers and traders proceed, considering that 2011 extended tax returns are due Sept. 17 for pass-through entities and Oct. 15 for individuals?
Taxpayers can’t hold out for corrected 1099-Bs any longer; they probably will never come. By law, taxpayers are responsible for reporting their securities trading gains and losses correctly on Form 8949, no matter what shape their 1099-B is in. If the broker has botched the 1099-B, it may help a taxpayer seek abatement on late-filing and late-payment penalties, but it won’t excuse taxpayers from reporting their trading gains and losses and paying the taxes they owe, including interest if late.
When taxpayers receive an incorrect Schedule K-1, they can file a Form 8082 "Notice of Inconsistent Tax Treatment" when they report a different amount or different tax treatment. But Form 8082 is not necessary with botched 1099-Bs in connection with the new IRS cost-basis reporting rules.
Our firm ended the tax-filing bottleneck a month ago. It’s time to start filing 2011 tax returns and to go with the army you have. That means using TradeLog software for trade accounting and any available broker profit and loss reports if they are in good shape and they can help you double-check TradeLog.
We work with the most recent "corrected" Form 1099-B our clients received, but mostly just to reconcile the totals and explain the differences on Form 8949 and in our tax return footnote. We published an example tax return footnote for TradeLog accounting on our blog dated Aug. 17, 2012.
We know key departments of the IRS are aware of the cost-basis reporting problem, and the AICPA has asked the IRS not to issue tax notices and exams when Form 8949s and 1099-Bs don't match up. We asked the IRS for this same relief in our Petition to Congress. But we don’t know if it will honor this request. So, in the TradeLog tax return footnote, we explain that Form 8949 totals do reconcile with Form 1099-Bs after making the adjustments. That’s why we want the last corrected 1099-B available.
Tax preparers: We suggest you use TradeLog and our footnote, and consult with us if you have questions. Otherwise, you need to resign your account. It’s not fair to keep a client waiting, because they could be hit with large penalties, interest and tax bills that don’t make any sense. See our cost-basis reporting resources for more background information. August 17, 2012
Tax Return Footnote: 2011 Form 8949 and Cost-Basis Reporting Rules
By Robert A. Green, CPA
See "An update note to tax preparers and traders about incorrect 1099-Bs and 2011 tax filings"
Here is an example 2011 tax return footnote that we use for our TradeLog accounting clients. We use a modified version of this footnote for our tax preparation clients who use TradeLog software. For background information about the IRS cost-basis reporting issues and problems with 1099-Bs, see our Cost-Basis Reporting Web site page and related links to blog articles, Webinars, videos and more.
Tax Return Footnote: 2011 Form 8949 and Cost-Basis Reporting Rules
Taxpayer files a Form 8949, which accounts for new IRS cost-basis reporting rules required on securities-broker-issued Form 1099-Bs. As an active investor, taxpayer has hundreds if not thousands of securities trades and compliance with the cost-basis reporting rules is a major undertaking as detailed below. This footnote is intended to explain how taxpayer handled the compliance on Form 8949.
Accurate tax reporting is the responsibility of the taxpayer, not the broker
The IRS continues to place the burden of accurate tax reporting on the taxpayer, as is evident by the requirement for brokers to include a reminder to taxpayers that "taxpayers are ultimately responsible for the accuracy of their tax returns (Pub. 1179 4.3.2)." The Information Reporting Program Advisory Committee noted this problem in its 2009 report to the IRS, stating: "Since it is impractical to require that financial institutions be responsible for tracking all possible events and taxpayer-level elections that affect basis, financial institutions should be treated as passive repositories of basis information, rather than guarantors as to its accuracy" (IRS Notice 2009-17).
Taxpayer used TradeLog software, which calculates wash sales according to IRS Publication 550, whereas, brokers do not
Taxpayer used what is considered to be the most reliable securities trade accounting software program on the market, TradeLog by Armen Computing. TradeLog software generates a compliant IRS Form 8949. TradeLog properly accounts for trading activity with securities brokers and reports the activity on taxpayers' income tax returns. TradeLog imports the actual raw trade data of buys and sells from the brokers. TradeLog then accounts for trading gains and losses with short-term versus long-term capital gains holding periods, and it calculates wash sales in accordance with IRS law.
It's important to note that the IRS subjects securities brokers to different tax rules than taxpayers, so you can't prepare a tax return based on a Form 1099-B alone. For example, IRS rules for broker-issued Form 1099s call for wash sales to be calculated based on "identical positions," whereas the IRS requires taxpayers to use "substantially identical positions," which means wash sales between stocks and options, too. TradeLog is one of the only programs on the market that can handle substantially identical positions. Brokers don't have the means of calculating wash sales across different brokerage platforms, but the IRS requires taxpayers to do so.
Most brokers are issuing incorrect Form 1099-Bs
IRS cost-basis reporting rules are new for 2011, and many brokers are interpreting and applying them in different ways, some of which are incorrect as of this date. Some brokers incorrectly adjust the sale proceeds of some trades for wash sales instead of the proper cost basis adjustment. Some brokers include 2010 cost basis of securities, whereas most brokers only report the required 2011 cost basis of securities purchased in 2011. Other brokers don't exclude open short sales from proceeds, as is now required by the IRS. For more examples of Form 1099-B errors, see http://www.tradelogsoftware.com/tax-topics/1099b-problems/.
As stated above, the IRS has one set of rules for Form 1099-Bs (apples) and a different set of rules for taxpayers (oranges). TradeLog focuses on tax reporting for taxpayer's tax return filings and determining the correct taxable income or loss, whereas Form 1099-Bs focus on broker rules. Therefore, based on historical evidence we believe the TradeLog-generated Form 8949 is more complete and accurate than the broker provided Form 1099-B.
Adjustment displayed on Form 8949
Many taxpayers have been finding errors on their Form 1099-Bs and have been requesting their brokers to correct them. While many have received corrected Form 1099-Bs, some brokers have not provided corrections yet, as it might require a major adjustment to their tax-reporting and accounting systems.
TradeLog provides a feature to reconcile Form 1099-B totals (proceeds and purchases), although it does not provide the means to reconcile Form 1099-Bs on a line-by-line, trade-by-trade basis, and the latter is called for in Form 8949 instructions. Without line-by-line reconciliation, if the broker-provided Form 1099-B is incorrect or incomplete, Form 8949 cannot be fully reconciled with it, especially if the results are based on different IRS requirements for the taxpayer versus the broker supplying the Form 1099-B.
If TradeLog finds a difference with Form 1099-B cost-basis, it enters one or more line items for "Adjustment to reconcile difference between accounting software and broker-provided 1099-B" on Form 8949. August 16, 2012
Why do forex forward dealers issue 1099s, yet retail spot forex brokers do not?
By Robert A. Green, CPA and CEO of GreenTraderTax.com
Forbes blog version Keeping Straight With Forex Reporting Requirements
Did you receive a Form 1099 from your forex broker or bank this year? If you traded forex spot, you most likely did not. Conversely, if you traded forex forwards, you probably did receive a 1099, the kind used for Section 1256 contracts, like futures. But, how does this affect your tax filings?
The rules state that a 1099 should be issued for forex forwards, treating them like Section 1256(g) foreign currency contracts. Those same rules state 1099 should not be issued for forex spot trading. Some taxpayers mistakenly think if they don’t receive a 1099, they don’t have to report anything. That is very wrong — you need to report your trading gains and losses and other income, whether you receive a 1099 or not. That includes income from foreign brokers, too. If the 1099 is wrong, you must report the correct amount. It’s best to ask your broker or bank to correct the 1099 when you identify an error.
Spot vs. forwards
Most online forex traders have accounts with retail off-exchange forex brokers, most of whom only offer trading in the forex spot market. Spot settles in one to two days, whereas forwards settle in over two days. Brokers use the terminology T+1 for trade date plus one for a one-day settlement.
Retail forex brokers are not direct participants in the Interbank foreign exchange market. Rather, they are customers of Interbank forex dealers, and they make a derivative market for retail spot traders. Some of these retail forex brokers square their books on customer trades, and net the difference in the Interbank market, while others simply behave like a “house,” acting as market makers for their clients.
Professional and institutional forex traders like larger hedge funds have access to trading directly with forex dealers in the Interbank market. These forex dealers offer well-heeled clients access to forex forwards and options in addition to spot trading. Because forwards settle in over two days, they require more credit from traders, as they are high-leverage activities.
Rolling spot contracts
A leading forex dealer offers a “rolling spot” trading program. Instruments traded in this program are treated like forwards for purposes of 1099 issuance. CFTC Chairman Gary Gensler called these contracts futures-like. We understand that other forex dealers offer similar trading products, too.
These “rolling spot” forex contracts don’t have a fixed settlement date, as they are open ended contracts. While technically they could settle during a spot term of one to two days, they primarily settle during a forward term over two days. This dealer says these contracts act more like a forward contract than a spot contract, and therefore they issued a 1099 for forwards. That called for using a 1099 for Section 1256g (foreign currency contracts), which requires reporting of realized and unrealized gains and losses. This forex dealer marked open positions to market at year-end, too. But, forex by default has Section 988 ordinary gain or loss treatment.
1099s don’t dictate tax treatment
It’s very important to note that Form 1099s don’t dictate tax treatment. 1099 issuance rules call for 1099s based on a default standard — investor status.
One of our clients received a 1099 from this dealer showing a $100,000+ loss treated as Section 1256g. But this client never filed an opt-out election from Section 988 into Section 1256g. Does the issuance of this 1099 dictate the taxpayer’s tax treatment, or do his own facts, circumstances and elections dictate tax treatment? Good news, it’s the latter. See the example footnote below that we plan to include with this client’s 2011 income tax return. In this case, the client prefers Section 988 ordinary loss treatment, rather than Section 1256 capital loss treatment subject to the $3,000 loss limitation against ordinary income. Taxpayers don’t want broker-issued 1099s to force them into worse tax treatment.
Section 475 MTM business traders don’t let 1099s dictate their tax treatment, either
For over a decade our Section 475 MTM business securities traders report their trading gains and losses with ordinary gain or loss treatment on Form 4797, Part II. They mark open trading business positions to market at year-end and report them as well. This tax treatment departs significantly from 1099s issued for a default investor using the cash method of accounting. The IRS understands the difference.
Example tax return footnote for a forex client who received a Form 1099
Taxpayer received a Form 1099 treating his forex contracts like forwards (or forward-like). 1099 issuance rules state that a 1099 should be issued for forex forwards, treating them like Section 1256(g) foreign currency contracts. Those same rules say no 1099 should be issued for spot forex.
As agreed by the issuer of this 1099, Form 1099s do not dictate the taxpayer’s tax treatment, as the issuer is generally not aware of the taxpayer’s facts, circumstances and tax-treatment elections.
By default, forex spot and forward contracts have Section 988 ordinary gain or loss treatment. Traders holding these forex contracts as capital assets may file an internal contemporaneous “capital gains election” pursuant to IRC § 988(a)(1)(B) to opt out of section 988 and into capital gains and loss treatment. If such an election is made, then for forex forwards — and forward-like forex contracts, including spot forex in some cases — taxpayers may use Section 1256(g) (foreign currency contract) treatment, providing it’s in major currencies for which regulated futures contracts trade on U.S. futures exchanges, and the taxpayer does not take or make delivery of the underlying currency. See Treas. Reg. § 1.988-3(b).
Section 988 reports realized gains and losses only, whereas Section 1256(g) reports realized, plus mark-to-market unrealized gains and loss treatment at year-end, too. Section 988 is ordinary gain or loss treatment, whereas Section 1256(g) has lower 60/40 tax rates, with 60% a long-term capital gain, and 40% short-term capital gain treatment.
Taxpayer did not file an internal opt-out election from Section 988, and therefore he must report using the default Section 988 ordinary gain or loss treatment for realized gains or losses, only. If the taxpayer is an investor, he reports that ordinary gain or loss on line 21 of Form 1040 (Other Income or Loss). If the taxpayer qualifies for trader tax status (business treatment), he reports the Section 988 ordinary gain or loss on Form 4797, Part II ordinary gain or loss.
In order for the IRS to match the 1099 filed to taxpayer’s return, we report the Form 1099 (for 1256 contracts) on Form 6781 Part I, and next, we zero the same amount out off of Form 6781, so we can transfer the amount to the correct form and line of the tax return. Forex is reported in summary fashion, not line-by-line fashion as done for securities. The amount we transfer to the correct form and line is the realized gain or loss, only. Only Form 6781 includes year-end unrealized gains and losses too on a mark-to-market basis.
1099 issuance rules have always been confusing and misunderstood by taxpayers. When you receive a W-2, you simply report the tax information provided. It’s rare to find errors. Conversely, when you receive a Form 1099 from a broker or bank, you should not just report what’s displayed. You need to consider your own facts, circumstances and tax-treatment elections to report your correct taxable income, loss and expense. This year, securities traders face a barrage of problems with new IRS cost-basis reporting rules for 1099-B issuers. We are finding huge problems on these 1099s. (See our earlier blogs on this.) When it comes to taxes, take the control away from your broker and consult a trader tax expert when needed. June 20, 2012
Tax Benefits from Trading Futures & Other Section 1256 Contracts
By Robert A. Green, CPA
July 10, 2012 update: One downside of trading futures is investor protection programs like FDIC and SIPIC do not apply. The 2011 bankruptcy of MF Global highlighted this problem.
PFGBest's customer accounts were frozen by regulators on July 9, 2012, and Peregrine Financial Group Inc. may face a similar fate as MF Global with even more customer money missing percentage wise.
The main money protection for futures is a CFTC regulatory requirement to "segregate customer funds." But, with MF Global we learned that management can push the envelope on these rules, and perhaps execute fraud which can lead to missing customer funds. Futures investors need the same money protections afforded under FDIC and SIPIC. See our blogs on MF Global and money protection issues.
Did you know you can lower your tax rate and get other tax breaks by trading futures and other Section 1256 contracts?
Find out how when you join noted trader tax expert Robert A. Green, CPA & CEO of GreenTraderTax.com as he takes you through all the details in his upcoming Webinar for Rockwell Trading (see details below):
Lower tax rates apply to Section 1256 contracts: Section 1256 contracts have lower “60/40 tax rates,” which can be up to 12% less than ordinary tax rates on short-term capital gains. That’s up to a third off!
Loss carryback election: At tax-filing time, all taxpayers may elect to carryback Section 1256 losses three tax years against Section 1256 gains. With mark-to-market accounting included in Section 1256, onerous wash sale rules don’t apply, and that saves traders added tax costs and headaches.
Easier accounting and tax reporting: Securities traders are facing a nightmare at tax time dealing with the IRS’s new cost-basis reporting rules being phased in starting in 2011 and ending in 2014. (Read about the cost-basis reporting crisis for securities traders on the GreenTraderTax.com Website.) But accounting is simple for Section 1256 contract traders. A broker-provided Form 1099-B for Section 1256 contracts is a one-page form and the net taxable 60/40 gain or loss amount is separately stated at the bottom.
Section 1256 includes many instruments: Not just futures contracts, but also non-equity options including options on indexes, options on futures, most ETF options, broad-based indexes, many foreign futures and electing forex traders in forwards and sometimes spot.
Tax benefits for investors versus business traders: Although, Section 1256 tax advantages are not predicated on having trader tax status (business treatment), active traders can unlock additional tax breaks if they qualify for trader tax status. Business traders can also form a trading entity saving thousands more with AGI deductions for retirement-plan contributions and health-insurance premiums.
Watch Mr. Green's Webinar dated June 28, 2012. Click here http://www.greencompany.com/EducationCenter/InteractiveSeminars.shtml