Well fellow taxpayers, it’s February. That wonderful time of year when clients drop off their tax packages and head for Vail. Well some head to Vail, the others just head back to work.

By now, all of you should have received the annual love notes from your employer (W-2), your stockbrokers (1099s) and, for those of you who are self-employed in a unincorporated form, customers (1099s). If you’re like our clients, you faithfully bundle up these “love notes,” stuff them in an envelope, shoebox or other container, and bring the whole bundle to your CPA to prepare your tax return for 2002. Also, like our clients, we bet you hate bad surprises. That’s why we will use this article to help set your expectations for this and future years.

The first thing we always look at is the 1099-B that your broker sends you. This form is sent to the IRS and tells them the dollar value of the stock you sold this year. We use this as the minimum amount we make sure is reported on your tax return. Anything less and you may get a notice from the IRS. Depending on the broker, this may be all we need to prepare your return. Many brokers these days are including not only the proceeds from the sale of stocks, but also the cost of the stock you sold.

Unfortunately, we don’t always get the cost information from the brokers. That’s when we rely on you to give us the cost of your stocks or mutual funds. When you can do that, it makes the job easier on us and less expensive to you. But how do you determine the right cost basis to give us? Here are a few rules:

• If we are talking about mutual funds, about the only valuation the IRS accepts is average cost. This means you take the cost of all your purchases of mutual fund shares, including dividend reinvestments, and divide that total by your total number of shares on the sale date. You can either throw all shares into one pot and compute the average cost of all shares or you can use the double-category method. Under the double-category method, you add up the cost for all shares held for a year or longer and divide the result by the number of shares owned. You do the same thing for shares held for less than a year. Whichever method you choose, make sure you include all dividend reinvestments.


• If we are talking about stocks, the discussion gets a little more complicated. There are two methods you can use to determine the basis of your stock, but you must also meet certain requirements.


• If you want to use the cost of certain “lots” of stock you have bought in the past, you can do so. However, you must make sure you told your broker to specifically identify the lot sold on the transaction confirmation.


• Assuming you didn’t specifically identify the “lot” sold, then you’re pretty much stuck with the First In – First Out method. This could be good or bad. For example, if you’ve been buying Exxon-Mobil for the last thirty years, it’s a safe bet that the FIFO method would work against you because the basis of those first shares will likely be low. On the other hand, if you bought Worldcom at its highest price and sold it just before the announcement of accounting irregularities, your higher basis will work well for you.

Regardless of which method you can use, make sure you tell us the dates of purchases of stock as well as the sale date. We need this to properly report the sales to the IRS.

Some people love certain stock and that can work against them. Say Julia is a loyal Microsoft employee with stock at a high basis. Looking at minimizing her tax, she decides to sell just enough to realize a $3,000 loss (the maximum amount that can be taken against regular income). Two days later, she buys the stock back. It’s a great idea, but what Julia has just done is engage in a “wash” sale. A wash sale is one made just to take a loss, but still retain ownership of stock, by selling then buying the stock back.

The law, unfortunately, won’t allow Julia, or you, to take the loss. Instead, Julia’s basis will be the total cash cost of the stock after the second purchase. What Julia should have done is wait 31 days and then buy the stock back. While she would have taken a higher risk of the stock going up before she bought it back, she would also have been able to take the loss.

These are just a few of the many rules surrounding the purchase and sale of securities from a tax viewpoint. Sometimes these rules are straightforward; sometimes they’re not. If you have any questions, contact us so we can set up an appointment to help you avoid any April 15 surprises. Be sure to have all the pertinent information with you when you visit. Eventually, we will need it in preparing your return anyway. We look forward to talking with you.

Have a great February!