Using Zero Basis For Non-Covered Securities
The law says that preparers must rely on reports from custodians when reporting portfolio gains and losses on “covered” securities. When a security isn’t covered, the custodian will typically place an asterisk next to the item on the report and use what basis was provided to them or a zero. For most folks, few securities have zero basis. They may not know what the basis is, but it is usually not zero.
In a common scenario, the preparer first sees the zero basis when the tax reports arrive. They do not have the time to research it. The tax preparation agreement states the preparer is relying on the information provided. If they point out the issue, they ask the client to get a basis for them. The client doesn’t have a clue or thinks they can’t get a basis. When the client expresses a much greater sense of urgency to get the taxes filed than to do any digging, the preparer says, “No problem. We can always amend when you find it.” No one ever researches the basis and the clients pay taxes on an inflated gain.
We’ve made a lot of new clients very happy by doing some digging. Yes, sometimes the work is maddening, but sometimes it is simple.
Large Cap Gain Distributions
When we see large capital gain distributions from mutual funds, it is often another sign of a lack of awareness about portfolio taxation and construction. By the nature of how they are managed, some funds are far more likely to kick out capital gain distributions than others. There may be an asset location decision to be made about what types of holdings to use in the various types of accounts.
There is also an attention to detail angle here. Were the funds that paid the large distributions bought recently? What would the tax have been had the fund been sold prior to the record date? Was a chance to lessen the tax bite ignored? Did anyone even look?
Contributions To Traditional Or Roth IRAs
Deciding not to contribute to an IRA is one thing. Failing to contribute because one erroneously thinks they are prohibited from doing so is another.
Every taxpayer with earned income is eligible to contribute to an IRA of some sort. The issue is only whether they can get a deduction or not. The rules about this are a bit messy but worth attention.