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Reflections on Prior Tax Seasons

Today is April 16th, the day after tax day. For most people, this day is just another day, just like April 17th, 18th, 19th, etc… But for me, April 16th is when I breathe a bit easier. I coordinate the free tax assistance site on the MU campus, and I support several other free tax prep sites around the state. So April 16th represents the walk down from the summit of April 15th. So on this special day, I decided to reflect on some lessons my tax clients taught me from prior tax seasons.

First, when you sell something, it is very important to know how much you paid for it.

The financial services industry has made it incredibly simple and cheap to buy stocks, bonds, and other financial instruments. You can go online and buy securities with the aid of a discount broker, or you can walk into a brick and mortar store and sit down with a financial advisor. It is also relatively easy to sell securities. The problem comes with connecting the two transactions at tax time.

Years ago I had a client who had sold some shares of stock that his father had bought him in the 1950s. Not only were the initial shares bought several decades ago, the dividends from the stock had been faithfully reinvested every quarter so that the client had doubled the number of shares in his stock. Of the two transactions, the sales price was easy. His broker had sent him a trade confirmation that listed the date sold and the proceeds of the sale. The trouble began when I asked him, “So what did you pay for the stock?” The client looked at me and said, “I have no idea. My father bought it for me when I was a boy.” I then had to explain that if he didn’t have the cost basis on the return, the IRS would most likely tax him on all of the gross proceeds from the sale. He went home and spent several days reconstructing the past. Luckily, he was able to piece together the history of purchases and reinvested dividends, and we were able to enter in a cost basis for his shares.

Fortunately, Congress and former President Bush helped fix this problem. The Emergency Economic Stabilization Act of 2008 requires financial companies to start tracking cost basis information on January 1, 2011. They must deliver this information to the IRS at the end of every year with your 1099s. Also, transferring accounts between financial institutions will not cause a problem as cost basis information will now be transferred as well.

While this is great news for taxpayers who will sell stocks that will be bought after January 1, 2011, this law will not help you if you already have stocks. You will still need to track and be aware of your cost basis in stocks, i.e. what you paid for them. This is especially important for taxpayers who have been gifted stock. We have seen college students come to the tax site who have sold some stock their grandparents had given them. Unfortunately, when the grandparents gifted the shares of stocks, they also passed along their cost basis. The main exception to this rule is when securities are received through an inheritance; generally, the cost basis is “stepped up” to the fair market value on the date of death.

Second, before you put money into a ‘special’ account, be sure you know how to get the money out.

We have so many different ‘special’ accounts that Congress has written laws for: Health Savings Accounts (HSA), Flexible Spending Accounts (FSA), Roth Individual Retirement Accounts (Roth IRA), Traditional IRA, Educational Savings Accounts (ESA), and the list goes on. Each special account offers favored tax treatment and limitations on the use of the funds. Before you place your money in an account with limitations, be sure to fully understand what you’re agreeing to. Can you take the money out if you are disabled? Can you take the money out if you lose your job or want to buy a house? Can creditors come after the money? What happens to the funds after you die? All of these questions should be answered before you fund these accounts. The worst time to ask is after you have pulled the money out. Also, do not be afraid to ask a tax expert in addition to your financial planner.

If you would like to email me with comments or questions, feel free to do so at ZumwaltA@missouri.edu

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