Investors Need to Get Specific with Brokers to Avoid Big Tax Bills

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Stock brokersWhenever tax laws change, it can have an impact on how you manage your investments. One recent new law, though, gets your broker or mutual fund company in on the act -- and they'll need you to make a decision that could make a huge difference in how much you pay in taxes.

The new law requires brokers and fund companies to start providing the IRS with information on how much you paid for shares that you sell. Also known as the "cost basis," this amount helps the IRS calculate how much in capital gains or losses you should report on your tax returns.

The IRS wants this information to help it track tax cheaters. Previously, the IRS relied on you to report the correct numbers. That made it easy for unscrupulous taxpayers to report incorrect amounts, and if the IRS didn't audit their tax returns, they often got away with it.

Getting the Wrong Answer?

The new law went into effect for stocks in 2011, and people are already reporting problems.

Some brokers are reporting incorrect information, and although you can offer corrected values yourself, discrepancies will likely increase your audit risk. For mutual funds, the law takes effect this year, so you can expect problems to multiply during next year's tax season.

The most important way to protect yourself is to specify that the brokerage use the best cost basis method. For simplicity, the typical methods of first-in-first-out or average cost for mutual fund shares may look attractive. But to minimize your taxes, the best choice is to track your cost basis yourself, and when it's time to sell your shares, specifically identify the shares to sell that will produce the lowest tax bill.


The specific identification method can produce big savings. For long-term investors whose stocks have risen in value over time, first-in-first-out usually means selling your lowest-cost shares first -- producing the most gain. If you've bought shares in the same company regularly, that rarely makes sense, as there's almost always at least one period during which shares were expensive. Sell those shares, and you can reduce your taxable gain or even get a loss you can use on your taxes next year.

Having your broker or fund company do the dirty work with gains and losses may sound like a godsend. But their mistakes could cost you plenty, so keep your eyes open and make sure they get it right.

For more on taxes: Motley Fool contributor Dan Caplinger trusts no broker. You can follow him on Twitter here.

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9 Comments

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lsloanpdx

for those who buy stocks with dividend reinvestment and add cash purchases this is a nightmare. some stocks pay dividend monthly and then a couple of cash purchases is 14 transactiaons a year and then if a split. MY GOD THIS DOES NOT WORK, the only simple way that is ALLOWED FOR FUNDS IS YOUR AVERAGE BASIS.

MY 30 YEAR AVE BASIS IN EXXONN IS $10.59 AFTER GOD NOWS HOW MANY DIV REINVESTMENTS AND I THINK 4 SPLITS.

tell your brokerage to sell 1/4 of your shares with the least tax. CANOT do it. and god knows what they come up with.

but ave basis is accurate enough for funds but not stocks

then if you moved your account what basis per trade do they have and do you have?

April 12 2012 at 7:56 PM Report abuse +1 rate up rate down Reply
joematej

The reports only start in 2012. Anything you bought before 2012 will not be able to be traced to a set price. If price average is used you could lose because the market is on the way up.
It all depends on the reason you are cashing the funds in at this time. But if you have been saving for years it will be best to use the first in first out method because the records will only go from Jan 2012 to the date of withdrawal.
If retiring and using it to live off use the last in first out method that way you pay the piper then sing any song you want like the old days..

April 12 2012 at 7:41 PM Report abuse rate up rate down Reply
joejoegolfn

anyone in the stock market today is nuts. It's all rigged

April 12 2012 at 7:25 PM Report abuse rate up rate down Reply
robhllnd2

This should be addressed to all the liars & cheaters out there.

April 12 2012 at 5:51 PM Report abuse rate up rate down Reply
1 reply to robhllnd2's comment
jdykbpl45

Like Obama, Reid, Pelosi, Holder, Bernake, and Corzine.

April 12 2012 at 6:24 PM Report abuse +1 rate up rate down Reply
Gumby

IRS should do away with stupid wash sales... It is computer age today.. I bet that the stupid wash sales was written in the pre electronic age when stockbrokers were scared to death of frequent traders who made killings on trading after selling same stock next day.. Computers know this in an eyeblink today.. In the past, stockbrokers had to wait days if not weeks to consolidate their numbers.. 30 day wait is eternal !!! Computers gave stockbrokers immense advantages over their clients now.. Why do we still have wash sale rules? This is unfair!! Eliminate wash sale rules now! Not fair!!

April 12 2012 at 4:01 PM Report abuse +1 rate up rate down Reply
Gumby

IRS should focus on Apple, Chipolte, Priceline, IBM, Caterpillar shareholders that made killings !!! Make sure they are honest... Dont bother with me with other dog stocks!!

April 12 2012 at 3:56 PM Report abuse +1 rate up rate down Reply
Gumby

Sometimes the stock is split , then taken over by a company which later was taken over by antoher over the years.. it happened to me several times.. Sometimes part of my stock was spin off into a new company which later was bought by another company?? it get really complex!! IRS and SEC should follow those who join herd mentalities meaning those traders who trade on insider tipes or privileged information through boutique trading firms or even full commission brokerage houses that steer clients toward stocks at the right time without having to hold and wait, wait, wait and worrying, worrying too much not to have IRS on top of you!! This is too much! Why did I bother inthe first place??? Back off, IRS!! Just let me report my own dates of bought amount of stock and my own different dates of sold amount of stock or part of stock , whatever! I know what I am doing.. First come first go is not necessary.. I choose which date I want , none of your buisness!!

April 12 2012 at 3:53 PM Report abuse +2 rate up rate down Reply
Gumby

I hold stocks for 5,7, 10, even 25 years... How can my broker report this to the IRS? There is already records of transactions kept at SIPC, SEC, and those other alphabet letter departments that can pool data together to crunch out the numbers and dates .. I often sell part of the shares in any company at any given year, Like if I bought 100 shares then sell 20, 50 , then 10 more and finally the last 20 shares over the years.becauase stock prices often go up after you sell so why sell all at once?? IRS doesnt have a clue!!

April 12 2012 at 3:48 PM Report abuse +3 rate up rate down Reply