NEW YORK (CNNfn) - It's bad enough that stock gains within an individual retirement account are taxed as ordinary income when they are withdrawn, but it really hurts when those same gains are erroneously taxed twice -- once when the stock is distributed from the IRA, and again when the shares are eventually sold from a regular brokerage account. |
Broker errors are causing IRA owners to pay needless additional tax on stock distributions. It's a costly mistake and one that is rarely caught or corrected.
If an IRA owner takes a distribution from his account in stock, he or she will pay ordinary income tax on the value of the stock on the date of the distribution. There are no capital gains recognized inside an IRA.
Let's say you buy $2,000 worth of a certain stock inside your IRA. The stock remains in the IRA and grows in value to $20,000. You now want to withdraw the stock, but you do not want to sell it.
So you transfer it to a regular taxable brokerage account with the same broker. It's really just a book entry from your IRA account to your regular (non-IRA) taxable brokerage account, but it is treated as an IRA withdrawal for Internal Revenue Service tax purposes.
When the stock is distributed from the IRA, there will be a tax on $20,000 of IRA distributions. It does not matter that you did not actually sell the stock, but merely transferred it to your taxable brokerage account. It's still a taxable distribution. Assuming that there are no non-deductible IRA contributions, the entire $20,000 will be taxed at ordinary income tax rates.
The new basis for figuring gain or loss on any subsequent sale is now $20,000. The holding period for long-term capital gain begins on the day after the IRA distribution, not on the day the stock was originally purchased within the IRA. You cannot tack on the period the stock was held inside the IRA. To qualify as a long-term capital gain, the stock must be held for more than one year from the day after the date of the IRA distribution.
When you eventually sell that stock from your taxable brokerage account, you will need to know the basis and holding period for figuring gain or loss, the same as if it were purchased that day. If you or your accountant are relying on the broker's information, you'll end up paying tax twice, and maybe at the wrong rates. Brokers are carrying over the original cost and purchase date information from the IRA account to the regular brokerage account. The basis and holding period will be incorrect.
David Zalles, a CPA in Lafayette Hill, Pa., has had clients who have experienced this problem with many of the biggest name brokers.
"The brokers have not programmed their computers to recognize stock distributions from IRAs, and to adjust basis when that occurs," Zalles said. "Once I realized what happened to these clients, I made it a point to check the accuracy of the cost information transferred."
Zalles requires a purchase slip or a brokerage statement for the month of purchase of all stocks, and mutual fund histories for all sales of mutual funds in order to verify the basis. In addition, he gets copies of documentation of IRA distributions of stock, which he keeps in his clients' permanent tax files for future reference.
There are several things you can do to make sure that you are not overpaying your federal and state taxes every time you sell a stock that was distributed from your IRA.
· Buy slips: Don't rely on the broker statement if there is even the slightest doubt that the stock purchase may have originated from your IRA. Instead, find the original buy slip. If the stock was originally purchased within an IRA, with a present or any former broker, the buy slip would show that, and you would know not to use that value.
· 1099-R Forms: When stock is distributed from your IRA, you will receive a 1099-R form showing the fair market value of the stock on the date of the distribution. This is the amount that you will use to establish basis of the stock when it is eventually sold. Save this form as you would any buy slip for a stock you purchase. In effect, this is the buy slip for the stock.
· Broker Statements: Keep your broker statement for the month that includes the distribution of the stock from your IRA. Also keep the broker statement for your regular taxable broker account, which shows the transfer-in of the stock so you can trace the transaction.
· Amended returns: If you ever sold stock that was distributed from your IRA, then there is a good chance that you have overpaid your taxes for those prior years. You should immediately file amended tax returns (both federal and state) and claim refunds for all tax years still open under the statute of limitations, which is 3 years from the filing date (including extensions).
· Your own records: In the end, you are responsible for your own tax return. You must make sure to maintain accurate records and do not rely on the broker. Go back and correct your own records to show a basis adjustment on the date of the distribution of any stock that was distributed from your IRA. You can then inform your broker to correct his computer records. Hopefully they will understand the situation and comply immediately with your request.
-- Ed Slott, a CPA from Rockville Centre, N.Y., is a national expert on IRA distribution planning. He is also author of the newsletter Ed Slott's IRA Advisor.