IRSMedic

Were you issued an IRS CP 2000 for stock sales or or mutual funds?

The IRS has new enhanced stock sales reporting. But this does not help taxpayers who purchased stock prior to 2011 --- as the the IRS only mandates that brokerage houses report cost basis on the sale of stock and mutual funds purchased after 2011. While this change helps millions of taxpayers who sold stock that they purchased after 2011 avoid the dreaded CP2000 letter, this does not help people who sold stock purchased before 2011 and have had recent gains.

What is a CP2000?

A CP 2000 is a type of audit (although technically not a field or corr audit). It is a little bit different, but the results, if things go bad, especially when it comes to stock sales can be real bad.
The CP 2000 is a letter the IRS sends that proposes to increase your taxes and this increase is... "based on a comparison of the income, payments, credits, and deductions reported on your tax return with information on these items reported to us by employers, banks, businesses, and other payers. The CP 2000 also reflects any corrections we made to your original return when we processed it."

What is the big deal about CP2000 stock sales, and mutual funds?

A CP 2000 "audit" letter on the sale of stocks or mutual funds causes thousands of Americans each year to overpay their taxes. The IRS issues a Form CP2000 stating that shares of stock were sold and provides the taxpayer with an estimate of the taxes owed. If no action is taken, the IRS assumes that there is no cost basis and that the stock or mutual funds were purchased for nothing!
Say you sold $50,000 worth of technology mutual fund in 2012 that you purchased in 2000 that you believe you paid $100,000 for, if you were issued a CP 2000 and don’t have the actual cost basis, it is very likely that the IRS assumed that you purchased the mutual fund for nothing! Someone in this circumstance is owed a capital loss and potentially lots of tax deductions and should not pay taxes on money not earned.
Another common situation is the IRS issues a CP 2000 for stock sold in 2012 and the taxpayer does not know the cost basis because the stock sold was purchased many years ago. Let’s pretend this taxpayer had a brokerage account at Merrill Lynch, DLJ, UBS, or Morgan Stanley and in 2005, they transferred or ACAT their account to Scottrade, e-trade or AmeriTrade to take advantage of $7 trades. In this transfer they sent over stock and mutual funds. Good luck finding the cost basis from accounts that were purged from brokerage house records. Its an excruciating process that rarely end with success. Though it is likely that stock held for many years has appreciated greatly, the tax liability should not be based on the entire sale, only the gain.

This is what the IRS assumes with a CP2000 --- all your stocks were purchased for zero!

The way the IRS calculates gains, it assumes the taxpayer has a zero basis. That is, someone was kind enough to just hand over a bunch of valuable securities for no consideration (the IRS sure has some sunshine assumptions about society, doesn't it?).
The way to fix this is by getting the cost basis information. Your tax liability will go down dramatically. If you do not have a cost basis, or you are involved in mark-to-market accounting on mutual funds or PFICs, this is where things get more complicated.
A tax attorney can assist with uncovering the cost basis or provide evidence to a reasonable estimate to the satisfaction of the IRS. There are proven ways to discover cost basis. But they are complicated and need a hyper-organized approach
Too many times, we see taxpayers get overwhelmed by the paperwork required and they get overwhelmed by a CP2000, and then try to ignore it. While we are always able to undo the damage of a CP2000, it is always quicker and cheaper for us to deal with the issue when it first appears.