Best Way to Avoid Cardiac Moments? Accurate and Timely Trade Accounting

Put yourself for a moment in the shoes of one Anna E. Charlton, an adjunct law professor at Rutgers University who, along with her law professor husband Gary Francione, operated the Rutgers Animal Rights Law Clinic/Center from 1990 to 2000.

Put yourself for a moment in the shoes of one Anna E. Charlton, an adjunct law professor at Rutgers University who, along with her law professor husband Gary Francione, operated the Rutgers Animal Rights Law Clinic/Center from 1990 to 2000.

Follow Charlton to her mailbox one cold January day in 2006, where she discovers a certified letter from the Internal Revenue Service. Take a deep breath as she opens it and receives the news that she owes Uncle Sam $34.7 million, including interest and penalties.

How’s that for a cardiac moment?

In all likelihood, Charlton saw it coming. After all, you don’t come up $27.6 million short in back taxes without at least a twinge of anticipation.

But the Tax Court ruling last May on Charlton’s appeal once again reminds us of the importance of accurate and timely trade accounting if you want to keep your trading career – heck, any career – on the rails.

Your best insurance against cardiac moments? A Traders Accounting tax professional to guide you through the often-complex maze of trader taxation.

At the center of the eye-popping assessment was a $27.6 million tax deficiency on her 2002 federal income tax return – a return that Charlton claimed she filed jointly with her husband, but which the IRS says it never received.

Representing herself, Charlton claimed that the IRS erroneously overtaxed her by nailing her for capital gains on certain stock sales reported to the IRS on Forms 1099-B without subtracting her cost basis in those holdings from the gross sale proceeds. Unfortunately, the professor subsequently failed to produce said basis figures in those sold stocks.

When repeated IRS attempts to contact Charlton proved unsuccessful and she failed to appear at her Tax Court trial in Philadelphia on Jan. 22, 2007, the court granted the IRS motion to dismiss her appeal.

The Beauty of Basis

The curious thing about this case – in addition to the petitioner’s non-responsiveness (see also, the lawyer who represents herself…) – is that Charlton might well have saved herself a small fortune if she’d only produced her cost bases for the trades in question.

It is not uncommon for the IRS to over-assess when it comes to trading gains. That’s because, although stockbrokers are required to report gross sales prices to the feds on Form 1099-B, they do not report your cost basis in the stock; that responsibility falls to you when you prepare your tax return. If you fail to provide the cost basis data on your return, the IRS may treat the entire gross sales price as capital gain and tax accordingly.

When this happens, the snafu generally can be resolved simply by producing documentation of your basis in the stock(s) in question to the IRS, usually by obtaining the purchase records from your broker.

It gets trickier however. If you broker charges you to conduct trades, you may subtract his or her fees from your gain. Some brokerage firms record gross gains and losses, meaning they haven’t subtracted their expenses, while others record net gains and losses from which their fees have already been subtracted.

Be sure to read carefully the Form 1099 from your broker at year’s end, and always use net gains and losses to calculate your taxes.

The Stakes Get Higher

This year, the IRS is poised to revive its random audit program, which is expected to continue on an annual basis indefinitely. Beginning in October, the IRS will randomly select 13,000 of the anticipated 136 million 2006 income tax returns from various income categories for a closer inspection, in hopes of closing the estimated $290 billion “tax gap” between taxes owed and taxes paid each year.

Of particular interest to Uncle Sam are the self-employed, who the IRS views as taking the most liberties with the tax code. Part of the case they would like to support with random audits is that some scofflaws inflate the cost basis on their trades in an effort to lower their capital gains exposure, thereby ducking billions in taxes.

As a result, it has become more important than ever to tighten up your trade log and faithfully reconcile your appropriate forms: Schedule D (Capital Gains and Losses); Form 4797 (Sales of Business Property) for those using the mark-to-market accounting method; or Form 6781 (Gains and Losses from Section 1256 Contracts and Saddles) for forex and futures traders.

Audit-proof returns don’t happen magically on April 14th – they are the result of 12 months of meticulous trade accounting that leaves little room for interpretation – or avarice – on the part of the taxman. But it takes time to master the art of trade accounting.

That’s where Traders Accounting comes in. As traders and accountants ourselves, we know the most efficient routes through the trader tax landscape better than anyone. Our expertise can save you time and money. And should a cardiac moment ever occur, we’ll be there to advise you every step of the way to a tax-smart solution.