The fact that capital gains and losses are misunderstood by many Americans is not surprising, mainly because of the modifications to the way these gains have been taxed over the past thirty years.
Recently, a couple came into a tax office with a not-so-friendly letter from the IRS regarding their self-prepared return. They had sold a variety of stocks when the market was down, and because the taxpayer knew that they hadn't made any profit on the sale, they didn't think they had to report it to the IRS.
Besides the fact that it isn't wise to ignore any type of income on your tax return, the problem with this stemmed from the way the brokerage firm reported the sales to the IRS. Most stocks are reported on a form called a 1099-B, which has information for each stock transaction during the year.
This can be a large report, especially for self-employed professional day traders and those that enjoy playing the stock market, even if just as a hobby. The information required on a 1099-B is the name of the stock, number of shares, date of sale and the total sale price.
New regulations require brokers to report the cost basis and the date of acquisition (which determines short or long-term status) when that information is available.
However, sometimes information might not be available (due to the age of the stock and/or the number of agencies it has been transferred to during the stockholder's ownership term). If that's the case, it will be left blank on the 1099-B.
This means the IRS only knows that you sold the stock for the amount reported. In this situation, the taxpayers sold over $75,000 in stocks. Since the original purchase price was over $100,000, the taxpayers knew they were not profiting from the transaction.
The couple failed to report this on their tax return and eventually received a letter from the IRS inquiring why they had not reported the $75,000 as income.
This is a common error for infrequent sellers of stock who when preparing their taxes. While it might seem logical that if you aren't making a profit on a sale of stocks it wouldn't be of any interest to the IRS, this line of thinking can backfire.
We amended the couple's return to include the Schedule D and a Form 8949 to report the sale and the cost basis. This actually resulted in a refund for the taxpayers.
What you don't understand about capital gains and losses can cost you in a big way. Let me simplify this for you even more--get to a trusted tax pro who can handle this for you while you run your business.
The simplest tax errors--including errors of omission--can be the most costly.