Prior to 2006, the "industry practice" for active traders was to
summarize capital gains and losses on securities, rather than adhere to
IRS-required line-by-line reporting. Unfortunately for traders, recent IRS
guidance forces line-by-line reporting. You can solve this problem easily by
using GTT TradeLog. As a last resort, use and attach the GTT accounting
formulas.
An article by Robert A. Green, CPA, dated January 10, 2006
There is much discussion – and public outcry – about new IRS initiatives
forcing taxpayers to report their securities transactions (both purchases and
sales) in a line-by-line rather than a summarized format on Form Schedule D
(Capital Gains and Losses).
The IRS recently updated Schedule
D instructions for the 2005 tax filing year, insisting all trades be listed on Schedule
D-1 (an attachment to Schedule D).
The Schedule D-1 instructions
provide an exception for business traders, allowing them to use IRS-compliant
attachments in lieu of Schedule D-1. After complaints from the tax-paying
public, the IRS extended this exception to all taxpayers. So, anyone can use
IRS-compliant attachments in lieu of Schedule D-1. That’s a relief!
Nonetheless, the IRS will no
longer accept the previous practice of summarizing trades on Schedule D with
only a footnote saying, “details available on request.” It should be noted the
IRS never technically allowed summary reporting in the first place.
Read the IRS Notice — Clarification of the 2005 Instructions for Schedule
D (Form 1040)” here http://www.irs.gov/formspubs/article/0,,id=109875,00.html.
What will happen if you can’t
and/or don’t want to comply in this manner? If the IRS examines you – and they
may be more likely to if you don’t comply here – and you under-report your
capital gains, you may be charged higher penalties for improper reporting. So,
it’s in your interests to comply.
If, for whatever reason, you
can’t do line-by-line reporting, at least use our last resort solution –
accurate reporting methods using our worksheets. Attach these reports to your
return with a full explanation and it will probably save you from higher penalties.
But there are no guarantees.
Get more background information
on these IRS changes at Ed Zollars’ site – http://ezollars.libsyn.com/.
GTT changed its policies for 2005
For the 2005 tax-filing season, our firm changed its
reporting policies.
We will first try to generate
IRS-compliant “line-by-line” reporting on tax returns.
This is generally a simple
undertaking with our GTT TradeLog software.
It may also be possible using
client-generated worksheets, online brokerage reports, or other software
programs or service providers. We review what clients provide and try to use
it.
As a last resort, we can utilize
our GTT Inventory Approach or Performance Record Worksheets. Although they are
not IRS-compliant under the new rule clarifications, they may pass muster with
the IRS. As a last resort, it’s certainly better than no attachment at all. We
cannot guarantee anything, but we are confident the IRS will accept them.
The most important thing is these
worksheets can provide accurate reporting. It’s doubtful the IRS would assess
penalties if there were no taxes due under these circumstances.
Futures traders are not affected by this rule change
Futures traders need not worry about this IRS rule change,
as they are still allowed to use the summary reporting format. Form 1099s for
futures report “aggregate profit or loss” on line 11. Taxpayers simply report
that summary amount on Form 6781 (IRC Section 1256 Contracts).
But securities are different
Form 1099s for securities only list each sale, plus total
proceeds. Most brokers also attach “Supplemental Information” – listing
summaries of stock option proceeds and purchases, plus securities purchases
(either line-by-line or in summary form).
The problem for both taxpayers
and the IRS is that these securities Form 1099s do not report gains and losses.
Taxpayers are responsible for calculating their own capital gains and losses.
This can be a very difficult job, especially when they are hyperactively trading
and/or using complex tax treatment on new instruments. Learn more about complex
tax treatment on new products at www.greencompany.com/EducationCenter/InTheMediaSFO.shtml.
So why has the IRS updated the Schedule D reporting rules
now?
Online trading has proliferated over the past decade, and
the IRS is starting to catch up with traders in tax exams. The IRS has probably
determined that many traders are making significant errors in their tax
reporting.
The IRS may have further realized
that by allowing traders to summarize their trades and skip the line-by-line
attachments, they may have enabled a breakdown in reporting and compliance. By
getting tougher on existing rules, it could improve compliance and accuracy.
It’s our
experience after working with thousands of traders that many are lost when it
comes to accounting, and some have admitted guessing at their gains and losses.
Certainly, summarizing trades is an easy way out.
Our firm has used the summary
approach, but we do have accurate gain-and-loss accounting; we only choose to
say details available on request because it is easier for filing purposes. It
does not mean, “We will figure out the details later on.”
Is the IRS acting reasonably here?
Our firm never advocated cutting corners on trade
accounting, and if these new IRS rules force traders to do a proper accounting
with their filings, that’s a good thing in our view.
The IRS
knows there are good trade-accounting programs available at a reasonable cost,
such as our GTT TradeLog, and it’s now much easier for active online traders to
use programs to calculate their gains and losses correctly.
The IRS has
accommodated traders by issuing the clarification allowing IRS-compliant
attachments, rather than being forced to manually copy trading results onto
Schedule D-1.
Congress
has given the IRS substantial powers to issue tax forms, so a challenge to the
IRS’s legal right to impose these changes isn’t likely to be successful in
court. Plus, you want to avoid looking like a “tax protester” to the IRS (or
your state’s tax authorities).
The IRS can’t count on its automated matching program
Previously, the IRS was hoping to count on its automated
program to match Form 1099 filings with tax return filings.
That program works very well for
matching Schedule B results, including interest and dividend income, as well as
futures gains and losses (since it’s one summary number).
But the IRS matching program has
not worked well for matching capital gains and losses in securities.
It’s a structural problem. The
program can only match securities proceeds, but not option proceeds. It cannot
match purchases or capital gains and losses, either. This information is simply
not listed on a Form 1099 (it’s only in Supplemental Information).
Therefore, the IRS 1099 matching
program has no means to reconcile a securities Form 1099 to a tax return.
The IRS needs other means for
ensuring compliance, and this seems to justify this new line-by-line reporting
initiative.
This all makes sense and seems
fair, in our opinion.
There is a simple solution with GTT TradeLog
Most traders have the opportunity to download their
thousands of online trades into good trade-accounting software programs.
Barron’s, other trader media, and
thousands of satisfied clients say that the best program for hyperactive
traders is GTT TradeLog (from our company). Read reviews and learn more about
our program at www.greencompany.com/Traders/Software.shtml.
GTT TradeLog has another
excellent feature: You can import the program results into Intuit’s Lacerte
(used by professionals, including our firm) or TurboTax. This import allows you
to use Schedule D-1 rather than a GTT TradeLog IRS-compliant attachment.
Doing so allows you to e-file
your tax return, since you have Schedule D-1. Attachments are not allowed with
e-filing.
Otherwise, it’s fine to attach
the GTT TradeLog report and paper file. Most business traders paper file
anyway, since they have other large footnotes to attach.
See the Update section at the
bottom. On Jan. 11, 2006, leading tax research publisher RIA (in their
Newsstand section) observed the “ IRS has not formally addressed the question
of reporting summary Schedule D totals on electronically filed returns.
Presumably, return preparers who e-file can continue to report in the same
fashion they have used, and IRS has accepted, in prior years.” See our
discussion in the Update section.
Online traders have it easier than full service clients
Note that online traders may have an edge in dealing with
the line-by-line reporting rules.
Online trading activity is
available for downloads into GTT TradeLog, whereas full-service firms often
don’t make trades available for download.
Full-service firms do provide
their clients with excellent “Realized Gain or Loss reports,” but these reports
are generally not IRS-compliant. That means you can’t attach those reports to
your tax return and you also can’t import the trades into Schedule D-1.
You are stuck having to manually
enter trades to your tax return. This manual process often leads to higher tax
preparation fees and errors (in translation).
Don’t expect full-service firms
to generate IRS-compliant reports anytime soon. To date, most brokerage firm
compliance departments prohibit them from giving tax advice – just read their
many disclaimers. This means they can’t generate Schedule D reports, as that
would include tax advice.
Again, remember there is complex
tax treatment for many new instruments, and it’s hard to know if a client has
wash sales outside of their one brokerage account. Why should a broker go on
the hook for a client tax-wise, when they don’t see the full picture?
Again, the best solution is a
good software program such as GTT TradeLog. It’s sanctioned by GTT, a leading
firm in tax advice for traders, and GTT professionals review the results for
our clients to make sure they reconcile to Form 1099s and are otherwise
correct.
Don’t panic, we still offer traders a last resort solution that should work
Many active investors and business traders may not be able to
use GTT TradeLog or another acceptable solution (with line-by-line reporting)
in a reasonable manner.
That can
mean either it’s simply impossible, or it is possible but very time-consuming,
costly and not 100-percent accurate.
Perhaps
there is another approach that is 100-percent accurate, but it’s not
IRS-compliant – that is, it’s not line-by-line reporting.
GTT has
provided a good solution in the past, and it may work well for the future, too.
It’s an
annual global accounting that is 100-percent accurate with mark-to-market
accounting, but it’s not line-by-line reporting. For the cash method, it’s also
good, except it does not report wash sales. Other means are used to back into
wash sales.
The GTT
Inventory Approach and Performance Record worksheet templates and formulas
continue to be a very handy solution.
It’s now
your last resort and it should not be your first resort.
It’s sort
of like counting the forest instead of each of the trees – the summary method
vs. the line-by-line reporting method.
The big
question is will the IRS accept these GTT accounting worksheets in lieu of
line-by-line reporting going forward?
We think they will accept them
under the right facts and circumstances on a case-by-case basis. Please consult
with us about it first. You probably need to have an excellent reason for using
this last-resort method.
So first
try to use GTT TradeLog or a similar line-by-line reporting solution. If that
fails, turn to the GTT worksheets as a last resort.
You should
definitely attach the GTT worksheets to your return and fully explain in a
footnote both why and how you used the worksheets for accurate reporting. State
your reason for using this method.
Summarize the GTT worksheet
results on Schedule D and also reconcile the worksheet to the Form 1099.
You can
find the GTT worksheets and formulas in the GTT Guides, which are available at www.greencompany.com/Traders/Guides.shtml.
There is no
guarantee that these worksheets will satisfy the IRS going forward. We never
had a problem using them in the past.
An argument can be made that for
mark-to-market securities traders (with IRC 475), the GTT worksheets can be as
accurate as GTT TradeLog – or even more accurate. Remember, thousands of trades
can cause an error in counting trees, but counting the forest overall and
reconciling it to the Form 1099 and brokerage statements is 100-percent
accurate. In the eyes of a CPA auditor, for a performance record, this
worksheet approach is the most reliable.
Stay tuned, we expect more IRS guidance soon
This IRS rule update is very new, their clarification is
informal and there has already been great public outcry for more reversal.
The IRS backtracked
once already with the clarification, allowing IRS-compliant reports rather than
forcing everyone to use their new Schedule D-1.
Will the
IRS backtrack some more? In our view, don’t count on it. What they request
seems necessary and fair. Otherwise, too many traders will continue to cut
corners and guess at their trading gains and losses. That’s not acceptable.
Again,
don’t count on brokers to provide a solution anytime soon, either. They can’t
give tax advice, and they don’t want this extra burden anyway.
What should you do about prior tax returns filed with
summary reporting?
Will the IRS force taxpayers to file amended tax returns to
include line-by-line reporting?
We highly doubt there will be any
need to file amended returns if you reported your gains and losses correctly.
Conversely, if you guessed at the
summary reporting, you should calculate the correct gains and losses and amend
those returns right away – before the IRS comes after you. That will probably
prevent any penalties for under-reporting your taxes.
In our
view, the IRS is primarily trying to steer industry practice towards change on
future filings, starting with 2005 tax returns.
Bottom line
The IRS wants to see your detailed and accurate trading gains and losses for
securities attached to your tax return. They will no longer accept the summary
method with “details available on request.” Don’t test their will here; it
could lead to higher penalties if you under-report your gains. There are many
simple low-cost solutions such as GTT TradeLog, so this change in compliance is
no skin off your back. Curry favor from the IRS on this compliance change and
then be aggressive on business tax deductions – that’s where the real savings
are.
