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The Tax Cuts and Jobs Act adopted by the Senate (Senate Tax Bill) included a provision that would generally require taxpayers selling, gifting or otherwise disposing of securities in which the taxpayer holds multiple positions to determine cost basis on a first-in, first-out (FIFO) basis, effective for dispositions on or after January 1, 2018 (Mandatory FIFO). An exception would apply to mutual funds, exchange-traded funds (ETFs) and other regulated investment companies (RICs), which could continue to use the specific lot identification method currently available to all taxpayers. Holders of RIC shares could also continue to apply average cost as currently permitted. Conforming amendments would include a rule generally restricting a broker’s basis reporting method to FIFO.
The staff of the Joint Committee on Taxation (JCT) has estimated that Mandatory FIFO would raise $2.4 billion of additional tax revenue over ten years. The tax bill passed by the House of Representatives did not include a Mandatory FIFO provision.
Issues and Concerns:
Conflicts with purposes of tax reform. As articulated in the GOP Tax Reform Framework released in September, tax reform seeks to establish a “simpler, fairer” tax code “built for growth.” If passed into law, the Mandatory FIFO provision of the Senate Finance Tax Bill would do the opposite: stymy economic growth by creating new barriers to efficient capital formation, needlessly complicate the tax lives of millions of American investors and unfairly favor registered investment funds over individual investors and other taxpayers. The Mandatory FIFO provision:
- Stymies economic growth by interfering with efficient capital formation. Capital markets serve to promote economic growth by allocating capital, and do so most effectively when investor decision-making is minimally affected by taxes. Mandatory FIFO would aggravate the existing “lock-in” effect that inhibits taxpayers holding successful investments from selling, and would introduce a new “lock-out” effect that would deter holders of winning investments from buying more. As an example, Mandatory FIFO would incentivize an owner of a successful position in Stock X to invest in new Stock Y over buying more Stock X, even if Stock X is judged the superior investment, because the later sale of the acquired X shares would trigger greater tax liability than selling Y at equivalent economic gain. By increasing the influence of taxes on investment decisions, Mandatory FIFO would interfere with market efficiency and inhibit economic growth.
- Increases role of taxes in financial planning. Mandatory FIFO would eliminate investor choice, increase investor taxes and elevate the importance of tax considerations in financial planning for millions of American investors. Under Mandatory FIFO, conscientious investors would be forced to spend more time thinking about and planning for investment tax effects than they do today, changing what and when they buy and sell, and where they hold different investments.
- Unfairly favors registered funds over direct securities ownership and private vehicles. In an eleventh-hour amendment, the Senate Finance Tax Bill was modified to provide an exemption from Mandatory FIFO for mutual funds, ETFs and other RICs. While in some respects a step in the right direction, this change raises fairness issues and creates concerns about potential distortive effects on investor behavior of this differentiated treatment. All taxpayers, not just registered funds, should maintain freedom of choice in designating the tax lots of securities they sell.
Burdensome and expensive to administer. Since 2011, brokers have been required to report to customers and to the IRS the cost basis and holding period of securities sold. When introduced, this requirement applied prospectively to new securities positions purchased. Brokers today generally do not have purchase records for customers’ holdings acquired before 2011. Mandatory FIFO would require brokers and their customers to undertake the highly burdensome task of determining the full purchase history of each position ever acquired in any security the customer sells. The cost in time in money required to research old purchase information would, for many investors, not be trivial, increasing the “lock-in” effect of adopting Mandatory FIFO. Securities for which the owner holds positions acquired prior to 2011 would be increasingly frozen in place.
Disadvantages older investors. Because older investors are more likely to hold securities positions acquired before 2011, the increased administrative burden and resulting added “lock-in” effect of Mandatory FIFO would fall disproportionately on the elderly. Requiring older Americans to spend more time looking through shoe boxes whenever they need to sell stock is surely not among the objectives of tax reform.
Disadvantages smaller investors. To coordinate with the broker reporting requirements, Mandatory FIFO is expected to be implemented on an account-by-account basis. By maintaining multiple accounts and/or carefully managing their transactions in related securities, wealthy investors could potentially achieve greater control over their capital gain taxes than would be available to smaller investors without the means to qualify for multiple account relationships or without access to sophisticated tax management. While registered funds could continue to utilize specific lot identification, investors in fund shares would no longer be permitted to do so.
Cannot possibly be implemented by January 1, 2018. If Mandatory FIFO is enacted, the proposed effective date of January 1, 2018 is completely unrealistic. The major upgrades to broker recordkeeping and reporting systems that would be required cannot possibly be completed by the end of 2017. If Mandatory FIFO must become the law of the land, the effective date needs to be moved forward at least one year to provide a reasonable timeframe for implementation.
Contributes almost nothing to paying for tax reform. JCT has scored Mandatory FIFO as raising $2.4 billion of new tax revenue over ten years. This minute contribution to the $1.5 trillion estimated cost of paying for tax reform does not begin to justify the distortive effects of Mandatory FIFO on investor behavior and the resulting harm to market efficiency and economic growth, the adverse effects on tax system equity and the substantial cost to implement and administer this proposed tax change.
The Mandatory FIFO provision of the Senate Tax Bill is bad policy and should not be enacted. It should be struck by the House and Senate conferees. Contact Congress Now.