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<< The way the IRS handles this seems strange to me. All they know is your proceeds from sales. Wouldn't you think that thousands of people a year lie about what they paid for a security to lower their taxes? What can the IRS do about this except hope to catch them thru their random audits? Anyone with any insight on how the IRS looks at your Schedule D?

It would seem to me that the IRS would require the brokerage firm to send your cost basis as well. If you disagreed, then you would need to submit notes on why it is different. Anyone wanna tell me why the IRS does it this way? >>

Short answer: because that's the way they do it.

Long answer:

The broker who sells the stock may not be the broker through whom you purchased the stock and may be without the first clue as to its basis. (Judging from the posts on this board, there are a lot of purchasers who are without the first clue also.) Unless you want to get into a situation where the IRS gets a record of every investment you make (and wouldn't we all love that), there's not really a better way to handle it.

Do people cheat? Of course they do. Ignoring computer matching of information returns, many of IRS's full-scale audits of individuals are conducted because of the DIF score on the return (sorry, I don't remember what the abbreviation means). Some are selected for other reasons, e.g. a letter from a spurned lover or jealous neighbor (moral: if you're going to cheat on your taxes, keep your mouth shut) or special emphasis on a problem industry, but DIF accounts for a lot of them.

DIF scores are based in large part on data gathered during the Taxpayer Compliance Measurement Program (TCMP), also known as the audit from Hell. Returns are randomly selected, and you have to prove EVERYTHING that's on it. TCMP's are extremely burdensome on and expensive for both the taxpayer and the IRS, but they yield a wealth of information. The requriement for SSN's for dependents is a direct product of a TCMP. The first year it was in effect, millions of dependents disappeared from returns. Must have been a banner year for the funeral industry.

The last TCMP was, I believe, for tax year 1988 and is woefully out of date. Getting back to your point, widespread individual ownership of stocks is a relatively recent phenomenon. I doubt that this was much of a blip during the last TCMP. It could be a huge one in the next, if Congress ever allows another one.

Phil Marti
Tax Preparer

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