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BASIS CHEATING: A $29 BILLION PROBLEM?

January 24, 2005

Last week a Winston Knauss was spanked in Tax Court for inflating the cost basis of assets he sold to falsely reduce his taxable gain. While Mr. Knauss was penalized for basis fraud, a study published today by Tax Analysts says basis cheating may cost the IRS $29 billion in revenues annually.

The New York Times has picked up the story, which may make basis cheating part of this year's tax reform debate.

The study notes the obvious solution for basis cheating in stocks and securities: requiring brokerage houses to report the cost of stock sold to the IRS. Under current law, only the sales price of stocks is reported; this makes the IRS aware that stock has been sold, but the IRS gets no information on the amount of gain or loss.

The study also suggests other measures to reduce basis cheating, including

-require stock sales to be reported using average cost of the securities, eliminating fifo or specific identification reporting.
-Impose strict recordkeeping requirements to track stock basis, with a zero-basis rule if documentation isn't maintained.
-Eliminate other tax rules that can make basis determination complicated, such as Sec. 1031 for like kind exchanges.

ESTATE TAX REPEAL AND BASIS ISSUES

If the current version of estate tax repeal remains in place, another complication to basis tracking looms. Under current estate tax rules, the basis of all assets, including stocks and bonds, is adjusted to the date of death fair market value. If the current version of the estate tax repeal becomes permanent, taxpayers will be able to increase basis at death by up to $1.3 million ($3 million for spousal property). Since the "increase" has to to be based on initial basis, there is much more potential for confusion and error than the current system, which wipes the slate clean and assigns all estate property current fair market value.

As difficult as it can be to get information from a living person about the basis of stock purchased long ago, it's even harder to get it from the dead.

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