For tax year 2011, it's all over but the crying, and the crying starts now as America races toward the April 17 filing deadline for federal, and most state, income tax returns. But advisors can lower clients' stress (as well as their own) by understanding the newest tax forms and terms.
You can start by warning your clients that their Form 1099-Bs could arrive later than usual from their brokers. This venerable form was expanded to accommodate new cost-basis reporting in 2011. With brokers still scrambling to finalize their systems updates, it is widely anticipated that many will request extensions beyond the traditional February 15 deadline for mailing the 1099-B form.
"Advisors should educate clients about what will be different on the 1099-B," says Fidelity Institutional Wealth Services Senior Vice-President Joe Kurtzer. New boxes on the form show a security's acquisition date, its cost basis, whether it was held for a short term or long term, and the amount of disallowed loss if the transaction was a wash sale.
But brokers only need furnish the additional data for so-called "covered securities," a category that for 2011 is limited to equities purchased in 2011. As the cost-basis reporting changes continue, more securities will be covered, Kurtzer says.
Cost-Basis Reporting: The Client's Perspective
Taxpayers will encounter a new form in 2011, the Form 8949, which they will complete with information from the 1099. Form 8949 reports details for the client's securities transactions, and it replaces the retired Schedule D-1. If the basis shown on the 1099 is not correct-which could be true for many valid reasons-a taxpayer must enter code "B" in column (b) of the form and use the correct figure to calculate gain or loss.
Brokers' 1099s are only required to show wash sales involving identical securities (those with the same CUSIP number) within a single account, says Susan Hartman, a senior tax and estate planning consultant in Raymond James' corporate office. Nevertheless, taxpayers remain responsible for properly reporting wash sales caused by transactions in other accounts, such as a trade made by a client's spouse or a trade a client has made at another institution, Hartman says.
Clients may require multiple 8949s because transactions with basis reported on the 1099 must be listed on a separate 8949 from transactions without broker-reported basis. "This will make it very easy for the [IRS] to highlight differences between the client's tax return and the broker's Form 1099-B," and thus identify potential audit items, says Mark Luscombe, the principal federal tax analyst at CCH, a Wolters Kluwer business.
Tell It All, Brother (What's Overseas, Anyway)
Beginning this tax-filing season, many clients will have to bare their foreign holdings on a new IRS schedule born of FATCA (the Foreign Account Tax Compliance Act). When required, Form 8938 is due with the client's tax return, including extensions.
Taxpayers use the form to reveal information about their "specified foreign financial assets." This new IRS term includes foreign hedge funds and mutual funds as well as interests in private foreign entities, but not U.S.-based funds that invest internationally or foreign securities held in a brokerage account with a U.S. address, according to CPA Stuart D. Lyons, a principal in the tax division of New England accounting firm Baker Newman Noyes.
Joint filers living in the U.S. must file the form if the value of these assets topped either $150,000 anytime during 2011 or $100,000 at year-end. Different reporting thresholds apply to other marital and residency statuses. The form is not required for clients who don't have to file a federal return.
Determining whether a client's assets fall within the rules can be tricky, especially with real estate. "If it's fee simple real estate held directly by an individual, it's not reportable," Lyons believes, "although I've seen seminars which disagree with that."
Real estate owned through certain foreign corporations may or may not be reportable. Lyons says, "If the client made a one-time election on IRS Form 8832 to disregard the foreign entity, the client wouldn't report the holding because in the IRS' eyes the client owns real estate directly." Without this election, the interest in the foreign entity is reportable on the 8938.
Feds Are Serious
Besides imposing stiff penalties for noncompliance with the FATCA reporting rules, the IRS forces the taxpayer to reveal precisely on Form 8938 where on his tax return these assets' income is reported. Or he can check a box affirming that no income is reported for a particular asset. Goodbye, gray.
Tax preparers, meanwhile, need good records to protect themselves, says Lyons. If they can't document that they asked clients about their foreign financial assets or if files show that they did not follow up with a client who failed to respond to the question, the preparers could be held responsible for any failure-to-file penalties the IRS assesses the client, Lyons says.
If the client simply says they don't have any, that by itself may not be good enough if the preparer knows the client frequently travels or does business overseas, according to CCH's Luscombe. "You may have to inquire further and be sure that information you have doesn't lead to another conclusion," he says, pointing to IRS Circular 230, Section 10.22, which requires due diligence in determining the correctness of clients' statements.
Note that Form 8938 does not replace or satisfy foreign bank account reporting requirements, or FBAR. It is an additional filing, Luscombe says.
The Business Owner's Pension
Business owners can still alter the numbers for their 2011 returns by judiciously using deductions for bonus depreciation and first-year expensing under Section 179.
Similarly, sponsors of defined benefit plans can still make a contribution for themselves that's deductible against 2011 income. Your outlook for interest rates could sway how much they put in, according to actuary Stan Goldfarb, managing consultant at Horizon Actuarial Services LLC, in Silver Spring, Maryland.
How much they should put in depends on what they think the future interest rates will look like. If you think interest rates will go up (which is likely since they are now near zero), that would mean their future deductible contributions could go down. In the worst case, the plan could become fully funded, and they could make no further deductible contributions (although a fully funded plan is certainly good from an actuarial standpoint).
This leads to two possible courses of action now for those anticipating a sharp rise in money rates, Goldfarb says. One is to contribute the minimum that satisfies the plan's statutory-funding requirement for 2011, to lower the odds of the plan becoming fully funded. This may be particularly appealing if he expects income tax rates to climb.
The second strategy is opposite: Ramp up the 2011 contribution to get deductions now, before the opportunity evaporates.
Numerous variables affect future contributions, Goldfarb cautions, so an advisor should render different advice for different clients.
Practical Matters
Watch www.irs.gov for last-minute developments and take care when mailing returns. IRS addresses have changed for some, particularly in the Southeast.
Finally, there is an April 17 federal filing deadline (followed by most states) this year owing to the Washington, D.C., Emancipation Day holiday on Monday, April 16. It gives Americans everywhere a one-day reprieve. If that's insufficient, filing an extension buys time until October 15.