The Reconciliation Trifecta: Workflow Efficiency, Wash Sale Reporting Accuracy and Cost Basis Compliance

Guest Contributor: George Michaels, CEO, G2 FinTech

Ah…new rules, new regulations. They are often times met with a mixed and not always favorable reaction. For one thing, they aren’t always easy to write. Just ask the folks over at the SEC and CFTC. In early January of this year, we learned that both regulating bodies have already missed over 140 deadlines in their task to compose all of the new Dodd-Frank rules.  Perhaps more importantly, complying with new requirements can be equally daunting, often exposing shaky information systems workflows or introducing inefficiencies.  Case in point:  the Emergency Economic Stabilization Act of 2008 (EESA 2008) and its requirement that Brokers now include cost basis and holding period information as part of the 1099(b)s they generate for their clients. Let’s take a closer look at this.

Legacy approach for calculating wash sales

The first year of the three-year EESA 2008 rollout has just come to a close, and according to the new reporting requirements, the cost basis on the current version of 1099(b)s now must include adjustments for wash sales. Accurately calculating wash sales is no easy feat, however, in some cases, Brokers make this already complex task more challenging.  This happens when they adopt an approach to tax analysis that requires gains and losses to be recalculated before the firm’s wash sale adjustments can be determined. The only way for wash sales data to be accurate is if the gains and losses calculated by the wash sale system first match the gains and losses from the Broker’s system. This simply isn’t always the case, and that spells trouble, let alone redundancies in workflow. Inaccurate reporting to the IRS could potentially lead to painful audits, hefty fines and fewer clients. Incorrect data on wash sale disallowed and re-allowed losses can result in over or underpaying taxes and an undesirable impact on the investor’s bottom line. When firms do not properly reconcile before generating their wash sale results, they open themselves up to the IRS pain-points cited above as well as unhappy clients / investors.

A Better Way – avoiding / eliminating reconciliation issues related to wash sales reporting

Well, how are reconciliation issues avoidable? How can compliance with cost basis reporting be made easier, while also having the means to determine ways to optimize profit and loss with your wash sales calculations? Arguably, the most challenging aspect of accurately determining gains and losses is the complex task of determining lot retirement— identifying which shares are retired every time a stock is sold. A Broker’s system already addresses this, and among other things, accounts for more complex transactions, such as when a series of purchases overtime has been made (as with dollar cost averaging) and/or when a sequence of sales over time has been executed.  What’s new for Brokers is the wash sale engine component and how it’s integrated into their workflow process. In the case of wash sale reporting, there is a better way:  a streamlined workflow process that feeds existing tax lot retirement data directly into the wash sale system, avoiding the addition of a costly, time-consuming and error-prone reconciliation step that comes along with the act of recalculating gains and losses.

In order to truly know your tax liabilities, wash sale calculators need to be fed accurate lot retirement data in order to properly identify disallowed and re-allowed losses. Otherwise, you are looking at inaccurate information flows both into and out of the system – a dilemma that could raise problems with auditors. The IRS recently announced that it audited more millionaires in 2011 than the previous year—four percent more to be exact.  In 2010, eight percent of millionaire earners were audited and the number jumped to 12 percent in 2011. This begs the question:  will increased audit pressure on millionaires force hedge funds to re-examine the accuracy of their tax analyses and K-1s? Perhaps now, more than ever before, compliance—accurate, efficient compliance—should be the utmost priority.

About Maureen Lowe

President and Founder of Financial Technologies Forum, LLC. Editor-In-Chief of FTF News. Entrepreneur, Jersey Girl that recently returned to Jersey, Loves to Bake, Married to a Kiwi, First Time Mom
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