Mutual Funds and Cost Basis Reporting

With each sale or exchange of mutual fund shares, you may realize a capital gain or loss that must be reported to the IRS.  To calculate gains and losses, you need to determine which shares were sold and the cost basis of those shares.

The sales proceeds minus the cost basis of the shares is your gain or loss.

The IRS permits the following methods of accounting for mutual fund cost basis:

1. First-In, First-Out (FIFO) Method

The FIFO method is the most common way of computing a basis. If you do not specify that another method is being used, the IRS will presume you are using the FIFO method.  As the name implies, the oldest shares available (first-in) are those considered sold first (first-out).

2. Specific Identification Method

The specific identification method allows you to choose which shares you are selling, thereby giving you more control over whether you will generate a gain or loss by the transaction. To use this method, you must specify to the mutual fund at the time of sale the particular shares to be sold. Your gain or loss will vary, depending on which shares you choose.

3. Average Cost – Single and Double Category

You may elect to calculate the cost basis of your mutual fund shares using an average price. There are some special requirements if you wish to do so. The IRS requires you to elect this method by stating so on your tax return and by using the method consistently for all your accounts in the same fund. The choice is effective until you get permission from the IRS to revoke it. These methods may be appealing for shareholders who redeem shares infrequently.

The single category method averages all shares owned at the time of sale.

In determining the holding period, the IRS considers the shares sold to be those shares acquired first (i.e., first-in, first-out).

The double category method requires you to divide all shares owned at the time of sale into two categories (long- and short-term) and calculate an average cost for each category. Shares held one year or less are short-term. Shares held longer than one year are long-term.

Similar to the specific identification method, you may specify to the fund at the time of sale from which category you wish to sell shares. If no specification is made, you must first charge the shares sold against the long-term category and then any remaining shares sold against the short-term category.

Wash Sale Rule

If you sell shares at a loss and purchase shares in the same fund within 30 days before or after the sale, the IRS considers the purchase to have “washed” all or a portion of your loss. The IRS designed this rule to discourage investors from selling securities solely for the purpose of generating a tax loss. A wash sale is indicated on your statement.

In the case of a wash sale, two important adjustments must be made. All or a portion of the loss must be deferred and added back to the basis, and the holding period of the purchased shares must be changed to account for the deferral. Your statement already reflects the adjusted cost basis and allowable loss. You need not make any further adjustments.

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The HST and you!

If approved, effective July 1st, 2010, the Province of Ontario will combine the 8% Ontario sales tax and the 5% GST into a single 13% value-added sales tax (HST) that would be federally administered by the Canada Revenue Agency (CRA).  

 As part of the proposed sales tax reform, cash payments would be provided to Ontario tax filers, in each of June and December 2010, and June 2011.

ADDITIONAL POINT-OF-SALE REBATES (EXEMPTIONS)

In addition to the point-of-sale rebates of the provincial component of the HST proposed in the 2009 Budget, the government intends to provide further targeted sales tax relief for consumers. Additional point-of-sale rebates from the eight per cent provincial component of the HST are proposed for the following:

  • Print newspapers that contain news, editorials, feature stories or other information of interest to the general public, and that are published at regular intervals, typically on a daily, weekly or monthly basis, but not flyers, inserts, magazines, periodicals and shoppers.
  • Qualifying prepared food and beverages that are ready for immediate consumption and are sold for a total price (for all qualifying items purchased, excluding HST), of not more than $4.00. Qualifying items would include:
    • food or beverages heated for consumption;
    • salads;
    • sandwiches and similar products;
    • platters of cheese, cold cuts, fruit or vegetables and other arrangements of prepared food;
    • cakes, muffins, pies, pastries, tarts, cookies, doughnuts, brownies, croissants with sweetened filling or coating, or similar products where they are not prepackaged for sale to consumers and are sold as single servings in quantities of less than six;
    • ice cream, ice milk, sherbet, frozen yoghurt or frozen pudding, non-dairy substitutes for any of the foregoing, or any product that contains any of the foregoing, when hand-scooped or machine dispensed and sold in single servings;
    • other food items that are excluded from zero-rated GST/HST treatment as basic groceries solely by virtue of the types of sales made at the establishment where they are sold, such as the sale of a bagel or a plain croissant in a restaurant;
    • non-carbonated beverages, when dispensed at the place they are sold; or
    • when sold with a qualifying food item listed above: other beverages except if the cans, bottles or other primary containers in which they are sold contain a quantity exceeding a single serving; cakes, muffins, pies, pastries, tarts, cookies, doughnuts, brownies, croissants with sweetened filling or coating, or similar products where they are pre-packaged for sale to consumers in quantities of less than six items each of which is a single serving; ice cream, ice milk, sherbet, frozen yoghurt or frozen pudding, non-dairy substitutes for any of the foregoing, or any product that contains any of the foregoing, when packaged and sold in single servings; or other snack foods, such as chips, salted nuts, popcorn, candies, fruit bars, granola bars, etc.
  • Wine, spirits, beer, malt liquor or other alcoholic beverages would not be a qualifying beverage for the purpose of the point-of-sale rebate of the Ontario component of the HST.

DETAILS ON POINT-OF-SALE REBATES (EXEMPTIONS)

The 2009 Budget proposed to provide targeted relief for consumers on the provincial component of the HST on many items important to Ontario families by providing point-of-sale rebates for books, children’s clothing, children’s footwear, children’s car seats and car booster seats, diapers and feminine hygiene products.

The following information provides additional details for consumers and retailers:

  • Books, including:
    • a printed book or an update of a printed book,
    • an audio book (i.e., all or substantially all of which is a spoken reading of a printed book),
    • a bound or unbound printed version of a scripture of any religion,
    • a printed book and a read-only medium (e.g., CD-ROM) whose content is related and integrated with the book’s content and when sold together as a single package,
    • a printed book and a read-only medium and/or a right to access a website when sold together as a single package, and if specifically designed for students enrolled in a qualifying course, such as educational courses of elementary or secondary schools.
  • Children’s clothing designed for babies,, girls and boys up to and including girls’ Canada Standard Size 16 and boys’ Canada Standard Size 20, or clothing designated for girls and boys in sizes small, medium or large if the clothing does not have a designated Canada Standard Size. Children’s clothing eligible for the exemption would not include costumes or clothing like sports protective equipment. These are the rules that exist for current PST exemption, and are similar to other provinces with these exemptions.
  • Children’s footwear designed for babies and girls and boys up to and including girls’ size 6 and boys’ size 6, including footwear without a numerical size that is designated for girls or boys in size small, medium or large. Children’s footwear eligible for the exemption would not include skates, rollerblades, ski-boots, footwear that has cleats, or similar footwear. These are similar to conditions that exist in other provinces that have a similar exemption.
  • Children’s car seats and car booster seats that are restraint systems or booster cushions that conform with Transport Canada’s safety requirements for Standards 213, 213.1, 213.2 and 213.5, as described under the federal Motor Vehicle Safety Act.
  • Diapers, including cloth and disposable diapers designed for babies and children, and diaper inserts and liners, rubber pants and training pants. Incontinence products would be zero-rated under HST, in accordance with current GST rules.
  • Feminine hygiene products, including sanitary napkins, tampons, sanitary belts or other products marked exclusively for purposes similar to the purposes for which sanitary napkins, tampons and sanitary belts are marketed.

ELIMINATING HIDDEN TAX

Replacing the provincial sales tax would help eliminate the hidden sales tax that many products carry. Currently the PST is charged on various business costs throughout the production of an item. This hidden tax is ultimately added into the cost the consumer pays at the cash register.

Under the proposed HST, most taxes paid on business inputs would be refunded to the business — savings that can be passed on to consumers in the form of lower prices.

How it is intended to impact businesses in Ontario:

Benefits for Business

Increased Competitiveness = Greater Investment, More Jobs

  • The HST and cuts to business taxes will cut Ontario’s marginal effective tax rate on new investment in half.
  • Ontario will join more than 140 countries and four other provinces that already have a value-added sales tax like the HST – because it is modern, efficient and necessary to compete in today’s changing world.
  • Report: Changes Mean More Jobs For Ontario

Cuts to Business Taxes

Ontario will be providing $4.5 billion in tax relief over three years, including Corporate Income Tax (CIT) cuts starting July 1, 2010:

  • The CIT rate will be lowered from 14% to 12% then further reduced to 10% over the next three years
  • The CIT rate for manufacturing and processing will be lowered from 12% to 10%
  • The small business CIT rate will be cut from 5.5% to 4.5%
  • The small business deduction surtax will be eliminated
  • Fewer small and medium-sized businesses will have to pay the Corporate Minimum Tax, and the rate will be cut from 4% to 2.7% in 2010.

This is in addition to the existing plan to eliminate the capital tax . Capital tax was already eliminated for firms primarily engaged in manufacturing and resource activities in 2007.  For all other businesses, the capital tax rate will be cut by 33% on January 1, 2010 and then completely eliminated on July 1, 2010.

Reduced Business Costs

  • Most businesses will receive input tax credits (ITC’s) for sales tax they pay on many of their business purchases and capital investments, providing significant savings.
  • The HST is eliminating cascading layers of PST–embedded tax hidden in the purchase price, making inputs cheaper.
  • Businesses also save from the reduction of embedded tax in supplier prices.

Lower Compliance Costs

  • Businesses will save over $500 million a year in administrative and compliance costs alone.
  • Administration of a single tax instead of two means one set of forms, one payment and one point of contact for audits, appeals and taxpayer services.

IRS and healthcare?!?

The already busy (read: crabby) IRS and it’s agents already try to catch tax cheats and under the proposed health care legislation, they would get another assignment: checking to see whether Americans have health insurance. The legislation would require most Americans to have health insurance and to prove it on their federal tax returns.  Those who don’t would pay a penalty to the IRS.

Good thing that IRS agents get to carry guns, unlike their Canadian counterparts…

That’s one of several key duties the IRS would assume under the bills that have been approved by the House of Representatives and Senate and will be merged by negotiators from both chambers.

The IRS also would distribute as much as $140 billion a year in new government subsidies to help small employers and as many as 19 million lower-income people buy coverage.

In addition, the IRS would collect hundreds of billions of dollars in new fees on employers, drug companies and device makers, according to the non-partisan Congressional Budget Office.

Some critics of the health bill question whether the IRS, which has struggled in recent years with budget problems, staffing shortages and outdated computer systems, will be up to the job of enforcing the mandate and efficiently handling the subsidies.

The CBO estimated the IRS would need $5 billion to $10 billion in the first decade to cover the costs of its expanded role. The IRS’ annual budget is currently $11.5 billion.

Neither the House nor Senate bill includes funding for the IRS, but money could be added by House and Senate negotiators.

The IRS already has trouble meeting its primary duty: collecting taxes. By the IRS’s own estimates, it failed to collect about $290 billion in taxes in 2005, the latest year for which data are available.

In one of the biggest examples of using the tax code to achieve a social goal, Congress shifted much of its effort to help the poor in the 1990s from direct spending to the Earned Income Tax Credit, an IRS-run program that pays rebates to low-income working people to offset taxes.

In 2005, more than 22 million people claimed the credit, resulting in more than $40 billion in payments, a Treasury Department inspector general found last year. The audit found $11.4 billion in improper payments in 2005 — about 28 cents of every dollar paid out.

Under the health care legislation, the IRS would determine who qualifies for the insurance subsidies.  Those subsidies would apply to people with incomes up to four times the federal poverty level, which is $43,320 for an individual and $88,200 for a family of four.  The government would pay insurance companies to help individuals buy policies on the new exchanges.  The exchanges, a central feature in both bills, would be a sort of marketplace where small businesses and individuals who don’t get employer-sponsored coverage could shop for health plans.

To meet the mandate, Americans would have to provide proof of insurance coverage with their annual tax returns. The mandate would begin in 2013 under the House bill; 2014 in the Senate bill.

The penalty in the Senate bill for not having coverage would start in 2014 at $95 or 0.5% of an individual’s income, whichever is greater. It would rise to $750 or 2% of annual income in 2016, up to the cost of the cheapest health plans. The House bill penalty would be up to 2.5% of an individual’s income up to the cost of the average health plan.

In 2007, Massachusetts became the first state to enact a health insurance mandate and lowered the percentage of uninsured residents from 7% to 4%.  State residents there were required to report their health insurance status on a special form they attach to state income tax returns. Insurers provide statements to policyholders confirming coverage and report that data to the state Department of Revenue.

The state tax agency did not get extra staff or money for enforcement and has not had serious difficulties gathering the information, spokesman Robert Bliss said.  In 2008, more than 96% of tax filers provided proof of coverage. Only 1.3% of filers, or about 45,000 residents, were assessed a no-coverage penalty of up to $1,068.  The “vast majority” of Massachusetts residents who pay the penalty are self-reported, Bliss said.

Bliss said the fact that the department had 18 months to get ready for the state’s insurance mandate was “enormously important” in making sure it was ready to handle the assignment. That bodes well for the IRS, which would have three to four years to get ready under the bills.

Under the current versions of the health care bills, the IRS would oversee:

  • Subsidies for low-income people purchasing health insurance through newly created state exchanges.
  • Small-business tax credits to provide insurance to employees,
  • Enforcement of mandate that all U.S. citizens and legal residents have insurance.
  • Penalties on employers for not providing affordable coverage if any of their employees get subsidies under the new insurance exchanges.
  • A tax on insurers that provide high-cost “Cadillac” insurance benefits.
  • Penalties for improper distributions from Health Savings Accounts, which would increase under the legislation.
  • Contributions to Flexible Savings Accounts, which would be limited.
  • New requirements for non-profit hospitals to prove their charitable missions, such as doing a “community needs assessment” once every three years.
  • Taxes on pharmaceutical companies, medical device companies and health insurance providers.

Here they come… IRS Builds New International Tax Group

The IRS has started putting together a new group to focus on international tax issues, including offshore bank accounts used to evade taxes.

An IRS unit that deals with large corporations and large partnerships has posted job openings for several positions in a new group that will “focus on examinations involving the complicated business arrangements and entities controlled by the high-wealth taxpayer segment,” according to IRS spokesman Frank Keith.

It shows the agency is “taking this very seriously,” says Roy Black, an attorney at Black, Srebnick, Kornspan & Stumpf.  The IRS looks to be assembling a “more sophisticated” group of examiners for the group, judging from the job postings, Black adds.

The group was formed to follow on a pledge by IRS Commissioner Doug Shulman to beef up international tax compliance, partly through a crackdown on people who use offshore accounts to evade taxes. President Obama’s 2010 budget earmarked extra IRS funds for this purpose.

IRS spokesman Keith said it would “be premature at this time to discuss further specifics” of the group that’s being formed.

 

I think the IRS should open up more than one phone line for international entities and actually have their officers be patient and understanding that those who are calling from say, Canada, may not understand the IRS way of operating and may need some tender love and care.  As it is, they come across on this line, from Pennsylvania, as being pompous, arrogant know-it-alls, unwilling to take a few minutes to explain anything to the callers.

At least that is my impression in the dozens of times I have called this line and spoke to a Mr. Jones, Mr. Smith or Agent 345678.

Is it too much to ask for some customer service too… Not everyone calling is a criminal!

IRS Qualified Intermediary (QI) – Know Your Client Rules

Logo of the Internal Revenue Service
Logo of the Internal Revenue Service (Photo credit: Wikipedia)

List of Approved Know-Your-Client Rules

Revenue Procedure 2000-12 states that the IRS will not enter into a qualified intermediary (QI) withholding agreement that provides for the use of documentary evidence obtained under a country’s know-your-customer rules if it has not received the know-your-customer practices and procedures for opening accounts and responses to 18 specific questions listed in the revenue procedure.This document lists those countries that have submitted know-your-customer rules and those rules have been approved.The QI agreement contains an attachment that lists the specific types of know-your-customer documentary evidence for each country that is sufficient for purposes of the QI.  The IRS is working together with the organizations that have submitted acceptable know-your-customer rules to develop standardized attachments.  The attachments can be seen here as soon as they are available.

If a country is on the approved list, entities and branches located in that country may submit their QI applications. Once a specific attachment has been developed for a particular country, the IRS will associate the attachment with the QI agreement it sends for signature. A QI may suggest amendments to the attachment, but departures from the standardized attachment may delay processing of an application.

To determine whether the know-your-customer rules that have been submitted to the IRS cover a particular QI applicant, the applicant should look to the specific country attachment. For example, in some countries, different rules apply to banks and brokers. A QI applicant that is a bank or a broker should verify that the know-your-customer rules that have been submitted cover all the rules applicable to that applicant.

For a list of countries, follow this URL: http://www.irs.gov/businesses/international/article/0,,id=96618,00.html

CRA Tax Question: T5008. Divorce. Court Order.

In the process of managing the processing of 2 million tax slips for my employer, the world’s largest transfer agent, the following question came across my desk:

A husband and wife divorced during the year and the husband did not make his child support payments as required by court order.  As a result, family court here in Canada passed a judgement stating that any stock he held be removed from his name and either cashed in so those funds could be given to his wife, or the stock be transferred to his wife so that she may cash them in as she needs them.

So here is the question:

Who gets the T5008?  Him or her?

Note:  Traders or dealers in securities have to file a T5008 information return to report purchases of securities as principal for their own account, and sales of securities they make as an agent or nominee, for any vendor.

Issuers of securities and their agents or nominees use this (T5008) information return to report redemptions, acquisitions, or cancellations of securities.

Might this be considered a deemed disposition?

Deemed dispositions

You do not have to report deemed dispositions on a T5008 slip, in certain circumstances, the Income Tax Act considers that a property has been disposed of, even though no real compensation in the form of money or other consideration has been received.

Some examples of when a deemed disposition may occur are:

  • transfers of property to a trust;
  • gifts of property (that is, the name of the beneficial owner of the property is changed);
  • the owner dies; or
  • the owner ceases to be a resident of Canada.

In this guide, “sale” generally refers to a transaction where the ownership of property is transferred from one person or entity to another for a sum of money or other consideration. In the case of a deemed disposition, ownership of the property is not transferred for money or other consideration. In addition, a deemed disposition is not a purchase, redemption or cancellation of a security. Consequently, a deemed disposition is not considered for the purposes of Income Tax Regulation 230 and a T5008 slip is not required.

Answer to follow…

In-TAX-icating

In-TAX-icating.

Definition:

a: To excite or stupefy by taxation to the point where physical and mental control is markedly diminished

b: to excite or elate to the point of enthusiasm or frenzy… about taxation.

Passionate about Taxation.  Passionate about helping you!