An IRS tax audit versus my tax reports from Charles Schwab

A couple of times over the years I have had someone from the IRS either call or send me a message stating that I had forgotten to include some tax form related to my stock trading or that I needed to be more specific about this trade or that one.

I received a letter from “Tax-Payer's Hell." It said something like, “Come on in and see us, we would like to talk to you about your most recent tax return; and, be sure to bring all of your supporting documents with you.”

I called the local IRS office and made an appointment to see Mrs. So and So.

Since I’m not a tax cheat, I knew that all I really needed to do was to go to my tax files for that year and dig out all of my receipts, income statements and figure out how to present the information relating to 350 to 400 stock trading transactions for the same period in some sort of understandable format.

I have a friend

This time I had an ace in the hole. Charles Schwab & Co. had just started creating a year-end report that included profit and loss for each trading transaction that had gone over their desk that year. There was a little gap that wasn’t too difficult to fill, relating to a couple of trades that had been opened in late in the year and and closed early in the next year.

I gathered up all of my income documents, deduction statements, including charitable donations (I’m a tither at church), trade confirmations and Schwab’s report and headed for my appointment with the IRS. I had visions of standing before some sort an inquest, having to answer tough questions about why those blue jeans were worth $2.00 as a donation ad infinitum.

The inquisition

When I got to the IRS office I was ushered into a large cubicle with a couple of computers and a book or two, but much sparser than I had envisioned. After a couple of niceties we proceeded to get down to the business of auditing my return.

We went through the process of finding out if I was really who I said I was, whether I had made “x” amount of income and whether or not I really had “x” amount of dependants and deductions. That all went pretty well.

The moment of truth arrived. I could see Mrs. So and So scrolling down her computer screen to the area that covers other income. I pulled out a large stack of trade confirmations and handed them to her. I could see her thinking that this was going to take a while. The next thing I did brought a hint of a smile to her face. I asked her if she minded if I used Schwab’s profit and loss report to help keep us on track. Then she did the unexpected; her smile got bigger and she grabbed it from me.

The auditor then looked over the report for five or ten minutes and told me that I had made a trade that should have been treated as a wash sale and that I had made a little more than a thousand dollars more that I had reported. At that point, I had visions of having to do my tax return all over again, at least having to resubmit some sort of alternate version of it and having to pay an attendant penalty.

The surprising verdict

She grabbed her calculator, did a couple of quick calculations and smiled again. She then said, "You’ll be glad to hear that your error was within our allowable limits."

Then I heard what may have been almost as satisfying as, “You have a son and your wife is doing fine.” I can still hear her say, “Mr. Diamond, there is no change in your taxes.” A couple of weeks later I received an official letter from the IRS stating the same thing. I treasure that letter.

You had better believe that I have used the information provided by that Schwab year-end report to record the profit and loss from my trading activities involving stocks and derivatives on every tax return since.