2014 is the first year that certain new IRS cost-basis reporting rules apply to municipal bonds and other fixed-income securities. The changes to 1099 forms and how they impact investors’ tax returns are dramatic as well as confusing.
In past years, brokerage firms were simply required to report payments to investors, such as interest, proceeds of sales and redemption transactions. The new rules require the reporting of cost basis on these transactions and, in most cases, the adjustments to those cost figures.
Adjusted cost
The major changes this year are the requirements to report the adjusted cost basis on bonds that were issued below par (OID), the amortization of premiums if bonds are purchased above par and the need to identify the market discount portion of any bonds sold after January 1, 2014.
These new rules have substantially increased the volume of information presented on the forms, so investors will find that their 1099 form will contain many more pages than in the past.
The new required information will compel taxpayers to more accurately identify their gains and losses and, in certain cases, interest earned. In many instances, this more detailed accounting will increase tax revenues for the IRS via the amortization of premiums paid and the identification of a market discount gain (which is taxed as ordinary income and not a capital gain).
Some updates expected
These new requirements have put a strain on the industry, as programmers have been working overtime to reconfigure systems to accommodate these new rules. In many cases, these programs have not functioned as expected, or were designed based on flawed understanding of the new rules and their effects. Several tax preparers have informed us that many well-known tax preparation software products, used by both individuals and CPA firms, are not operating correctly in applying these new rules (particularly in regard to market discounts). The software companies are in the process of programming updates to be released soon so their software will accurately process tax returns in accordance with the new rules.
Our recommendation
Many firms that sent out their 1099s early tell us their forms will need to be followed by corrected versions, so we suggest holding off until later in March to prepare your return. This will give brokerage firms as well as tax software firms time to fix any errors and issue any updates to the forms and software to avoid having to file an amended return. We also recommend investors consult with their tax advisor to explain the effects, if any, that these changes will have on their personal situation.