The 2011 Form 1040, Schedule D: Practitioner Issues
By Art Auerbach, CPA
To understand why we have the new Form 1040, Schedule D for 2011, some background information is required.
Several years ago, the U.S. Senate Finance Committee ordered a study to determine the main causes of the tax gap. One of the reasons identified was improper reporting of capital gains and losses on Schedule D of Form 1040. Schedule D on Forms 1120, 1120S and 1065 was not that much of an issue because those forms all have balance sheets attached; thus, cost basis and selling prices generally were reported correctly. Form 1041 is in abeyance at this time because fewer of those forms are filed. Two problems were identified: Not reporting the correct selling price and not reporting the correct basis for items sold.
The U.S. government used a two-pronged approach to tackle these issues. One was legislative, requiring Congressional action, and the other administrative, requiring only action by the U.S. Internal Revenue Service (IRS).
The first action was the redesign of Form 1099-B, which required the selling broker-dealer to include the selling price of securities on this form. The taxpayer and practitioner community adjusted to this and reconciled line items on the Schedule D to agree with the 1099-B. Any differences in filings were included on IRS notices in the document matching programs.
Second, Congress enacted legislation that required broker-dealers to include the cost basis of the items sold on the 1099-B, with a delayed effective start date to allow the broker-dealer community to adjust and gather the necessary information.
Finally, we now come to tax year 2011, with returns to be filed in 2012, when the delayed start date has expired and full implementation of the cost basis rules are to begin. The first part of the new program was to redesign the Form 1099-B with new instructions for the cost basis columns. This form and the accompanying instructions are available on the IRS website. The IRS redesigned Schedule D and added the new Form 8949 to support it. Both were issued in draft form on April 22, 2011. Draft instructions have been issued for both forms.
New boxes have been added for reporting date of acquisition (Box 1b), cost or other basis (Box 3), amount of loss disallowed due to wash sale (Box 5), whether the property sold is a noncovered security (Box 6) and whether the loss is short-term or long-term (Box 8). Brokers are required to complete Boxes 1b, 3, 5 and 8 when reporting sales of securities unless Box 6 is checked. Other boxes on this form have been moved and renumbered. Tax preparers are advised to review this form prior to the beginning of busy season.
There are new rules for:
- How many forms must be filed for each transaction
- Short sales of securities
- Transfer statements
- Issuer returns
- Use of transfer taxes and option premiums in determining gross proceeds
- Basis reporting
The instructions for basis reporting detail identification of securities, average basis method for stock sold, how to determine adjusted basis, initial basis of the securities sold and much more.
The real question: How does this form translate to the filings of the tax preparer community for the 2011 Form 1040 and the information that will be necessary to correctly complete a return? Remember, now that we have preparer registration, the IRS can use the preparer number to identify those who are noncompliant. Intentional disregard of forms and instructions is cause for paid preparer penalties.
The VSCPA has prepared sample letters to send to clients and brokers detailing the new reporting requirements. Both letters are available in easily-edited form here (DOC).
Schedule D-1 has been discontinued and is not available for the 1040 series of forms. Each section now has three lines that each relate to Form 8949.
Form 8949 begins with instruction that multiple Forms 8949 may have to be attached to a single 1040. Only one of the following boxes can be checked per Form 8949:
- Box A. Short term gains and losses (Part I or long term Part II), where Form 1099-B, Box 3, shows basis.
- Box B. Short term gains and losses (Part I or long term Part II), where Form 1099-B, Box 3, does not show any basis.
- Box C. Short term gains and losses (Part I or long term Part II), Form 1099-B was not received.
Remember to fill out only one of these boxes on each Form 8949.
The IRS recently released draft instructions to Schedule D and Form 8949 that allow practitioners to report transactions on an attached statement rather than reporting each transaction on a separate line of Form 8949. The attachment must contain all the same information as Form 8949 and in a similar format. Practitioners must enter the combined totals from all attached statements on a Form 8949 with the appropriate box checked. For returns with more than one attachment, report the totals from each attachment on a separate line.
For e-filed returns where transactions are not included in the electronic short-term or long-term capital gain (or loss) records, Form 8949 or a statement with the same information must be attached to Form 8453.
In addition, Column B calls for a code. These codes can be found on pages D10–D11 of the draft instructions (PDF). This establishes a very specific document-matching program related to Schedule D filings.
Several specific issues will affect the practitioner community:
- For many, this new reporting requirement may not be a problem. If your client only traded publicly-traded securities within one brokerage account with one broker-dealer, you would only have to verify with the client whether the basis reporting by the broker-dealer is correct. Remember, specific identification has time limits and writings must be timely to be useful. So if the broker uses average cost or some other method, your only recourse will be to get an amended Form 1099-B. You will not be able or permitted to attach schedules to Form 1040 if you do not agree with the Form 1099-B your client receives.
- There is a question as to whether practitioners will be able to write “see attached” on attached broker data to the 1040 or whether the IRS will require completion of Form 8949. With the adoption of the modernized e-file program, it is possible — although not certain — that PDF copies of support documents may be used, especially if you are e-filing the return.
- It is clear that if the client sells property acquired from a decedent, Box C on Form 8949 will have to be checked. Sales of partnership interests or any other property will not require completion of the 1099-B. For 2010 deaths, Form 8939 will be required to establish basis.
- Separate Forms 8949 will be required for wash sales and short sales.
- Without instructions, it is not clear how option trading is to be shown on Form 8949.
- Is it also unclear what substantiation will be required to be attached to the schedule D if Box C on the 8949 is checked.
- The IRS has begun taking to court practitioners who misstate basis sufficient to warrant the fraud penalty, so it appears that roughly coming up with basis will no longer be appropriate. This will require more work hours for increased billings.
Knowing all of this, what will you require from the client to be able to comfortably sign the return as a paid preparer? The VSCPA and the American Institute of CPAs (AICPA) are both monitoring this issue. Questions or concerns? Contact VSCPA Government Affairs Director Emily Walker at firstname.lastname@example.org.