Even thoughindividual investors receive separate account statements frombrokerages that correctly show their gains and losses, manyindividual investors rely on the 1099-Bs to tell them how much taxthey owe on profits and losses. (Photo: Shutterstock)

(Bloomberg) –Brokerage firms are sending tax statements to clients and the IRS withinformation that differs from the taxes investors ultimately owe, leading some filersto appear to owe tax on profits they never made.

The federal tax code contains two sets of IRS rules — one thatdefines what information on taxable gains and losses thatbrokerages must report to their clients and the IRS, and anotherthat defines how individual taxpayers report those gains and losseson their returns.

Those conflicting rules mean that the brokerage statements —known as 1099-Bs — don't always reflect all of an investor'saccounts or original costs. It's caused some investors toinadvertently draw the attention of government auditors.

That the statements can cause problems for unwary investors “isa dirty little secret,” said Robert Green, an accountant and thechief executive officer of GreenTraderTax, an accounting andconsulting firm in Ridgefield, Connecticut. “Brokers don't wantthis publicized.”

Edward Zollars, a certified public accountant, said his firm,Thomas, Zollars & Lynch in Phoenix, had a client who'dexercised $135,000 in stock options granted for $39,000. Theclient's recent statement, from E*Trade, showed those figures butanother one as well: a $96,000 “realized gain,” or the differencebetween the two figures.

Taxes withheld

While the statement made it look like the client owed ordinarytaxes of around $35,000 on that gain, he didn't. The statementdidn't reflect that the client's employer had already withheld taxwhen the options were exercised. E*Trade didn't respond to requestsfor comment.

“You can get in trouble just following the 1099,” Zollars said,adding that it can create tax-season “nightmares.”

In most cases, brokerages are simply following IRS rules — whichin this case predate, and weren't changed by, the 2017 federal taxoverhaul.

But nine clients of accountant Mark Fichtenbaum this yearreceived 1099-B forms from online broker and wealth manager TDAmeritrade with incorrect values for their investments in optionstied to the S&P 500 stock index.

Mark-to-market

Under an accounting system known as mark-to-market, thestatements are supposed to reflect values as of the last businessday of the year, usually Dec. 31; instead, they showed thereflected values on the last day the options traded.

Due to the stock market's volatility last December, thedifferent dates made the investors look to the IRS like they'd mademore millions more in taxable profits than they actually had.

In an April 3 letter to one client, TD Ameritrade said thatGainsKeeper, the trade-accounting software company it uses toprepare the statements, deploys its own methodology to track thevalues.“GainsKeeper has informed us that they use their methodologyconsistently,” TD Ameritrade said in the letter, adding that it“cannot amend” the document. “Unfortunately, this is whatoccurred.”

The letter counseled that under special IRS rules for thecontracts, the customers would get the tax back in the followingyear, when the amounts reversed.

Looking for 'reality'

“So we're going to give the government $1 million for tax onphantom gains and get it back the next year? Seriously?” saidFichtenbaum, counsel to Twenty-First Securities Corp., a brokerageand financial services firm in New York. He provided some of hisclients' statements for review.

Had GainsKeeper used that same methodology on all open S&P500 contracts as of Dec. 31, it would have distorted clients' gainsby $6 billion, he said. “I am not looking for perfection, justreality.”

Rebecca Niiya, a TD Ameritrade spokeswoman, said the brokeragewas merely following the rules. Stevie Conlon, a tax and regulatorycounsel for the Wolters Kluwer's unit that oversees GainsKeeper,said that due to murkiness in IRS rules on computing values forassets like options contracts, the firm relies on separate rules inestates and gift tax laws. “There's no explicit guidance that tellsus how to do it,” she said, adding that another broker “could comeup with a different price.”

Even though individual investors receive separate accountstatements from brokerages that correctly show their gains andlosses, many individual investors rely on the 1099-Bs to tell themhow much tax they owe on profits and losses in stocks, commodities,regulated futures contracts and options, among other securities, aswell as on barter transactions.

Finding cheaters

The IRS in theory matches the statements to federal returns toroot out cheaters. But even though a copy goes to the IRS, “youcan't rely on the 1099-B for your return,” said Muhammad Akram, anaccountant and the founder of Akram & Associates in Cary, NorthCarolina, which caters to small hedge funds.

Since 2011, the statements must track and disclose an investor'scost basis, or amount paid, for an asset bought that year or later— a requirement that prohibited the earlier practice ofself-reporting profits.

Brokers have to send the previous tax year's statements by Jan.31, but routinely issue corrected statements without warning,sometimes more than once, after they receive details ondistributions from mutual funds, real-estate investment trusts andother assets.

Smaller brokerages are more likely to issue statements thatmisreport basis or dates, Akram said, because they invest less inthe technology required to generate the reports and often don't usethird-party software to tally values. But even Wall Streetbrokerages have inconsistencies, especially with reporting dividendincome, he said.

Complex holdings

“It's systemic,” said Akram.

The statements can be a particularly unreliable tax guide forinvestors with complex assets like futures, options and exercisedstock options, accountants say.

Also left in the dark are investors who have multiple accountsat a single brokerage, or have portfolios across multiple wealthmanagers, and taxpayers who've inherited portfolios, said CharlesSarowitz, an accountant and founder of Sarowitz Milito & Co. inBrooklyn, New York.

Statements also can't detail instances across multiple brokerageaccounts in which investors sell securities at a loss and purchasethe same asset or one “substantially identical” before or after 30days, known as a wash sale.

And for investors in master-limited partnerships, common in theoil and gas industry, “there's never a correct basis” in thebrokerage statements because the partnerships typically issue finalperformance data weeks after the brokerage issues the 1099-B,Sarowitz said.

Software solution

Big hedge funds routinely use third-party trade software fromfirms like TradeLog to reconcile brokerage statements and tradinglogs “because they know” the statements “are screwed up,” Greensaid. But individual investors and smaller funds typicallydon't.

So what's an investor to do?

An IRS spokesman said that an investor could ask his or herbrokerage for a corrected statement — something Fichtenbaum saidhad worked for only one of his many clients with mis-datedoptions.

And while taxpayers can enter adjustments onto their returns,that pits the statements against those entries and createssomething he said no one wants: “a good chance somebody at the IRSis going to audit the return.”

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