Don't Blindly Trust Your 1099
Almost everyone who subscribes to this blog, is an investor. As such it’s likely you receive a 1099 from your brokerage. After one client’s experience with TD Ameritrade, it’s worth thinking about how much faith we put in these to be accurate.
A little tax law background to this story: Sec. 1256 Contracts are a type of option or futures contract that has a unique tax treatment.
Unlike most positions which don’t experience a taxable event until either expiration or sale, Sec. 1256 Contracts are marked to market at year’s end, and unrealized gains/losses are counted as if they had been realized. Of which 60% is treated as LTCG and 40% as ordinary income.
In my client’s case, his 1099 reported to the IRS that he generated 130k in profits during the year, with an aggregate unrealized loss of 7k heading in to 2024. In total, the IRS was told that his taxable income from trading was around 123k.
My client came to me saying the 1099 was wrong and that he lost money. Typically I don’t tend to believe this sort of story. However in order not to leave a bad taste in a potential client’s mouth, I decided a simple reconciliation would flush the truth out. After reconciling his account balances, much to my surprise I found that my client was right. The math wasn’t mathing, and to get the bottom of it, we’d have to go line by line and look at every trade and see why.
In the end what it boiled down to was a few small transactions and one major transaction. A Dec 29 23 short option on which my client had a 137k loss. In reviewing the 1099-COMP transaction list, this transaction was not found. TD Claimed that the transaction was not realized during 2023 and thus not included.
Whether or not the loss was realized or unrealized is debatable. In my opinion, as of Dec 29 2023 he had accrued a loss which he was contractually obligated to fulfill and his custodian was holding funds to fulfill that obligation. Thereby for tax purposes the transaction would meet the requirements for realization even for a cash taxpayer (because the money was constructively paid).
However even if I’m wrong, it’s a moot point, since as we mentioned earlier unrealized gain/loss is marked to market for Sec. 1256 contracts and treated as if it had been realized. How multiple TD reps wouldn’t have been able to understand that boggles the mind.
So whether or not the transaction settled or not, the transaction should have been included in his 2023 1099. Either as a transaction in his realized gain/loss as of December 31, or one in his unrealized gain/loss as of December 31. Yet TD somehow didn’t include it in either category (I suspect due to the Schwab integration). Had it not been for outside intervention, my client would have had a major tax problem!
I share this horror story as a lesson to investors. If you think your 1099 is wrong, don’t ignore your feelings. You can check by reconciling your account balance to your 1099 P&L. If a large discrepancy exists, pull a CSV of your transactions and compare them to your 1099. Pay special attention to transactions at the start and end of the year, along with wash transactions.
The morale of the story: we often work hard reading over financial statements to try and find alpha, but maybe alpha can be found by looking at our own financial statements.
Capital Gains Advisory is a tax advisory business based out of Duluth, GA. Steve Harrison is the owner of Capital Gains Advisory and offers investment advisory services as a representative of D. L. Fields Advisory Group, a state registered investment advisor. If you need help navigating the tax consequences of an investing strategy please visit our website at https://cg-advisory.net