Shortly after Alan Clark was born, his father bought him some shares in The Dreyfus Fund.
The elder Clark put the investment on auto-pilot, merely reinvesting dividends and capital gains.
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The only thing he didn’t do was keep good records.
Now, some 35 years later, Alan Clark is one of many long-time investors whose personal history with a mutual fund exceeds the records of the fund company itself. Most fund groups keep records for 10 to 20 years. Without paperwork showing what they paid for shares, these investors fear selling their funds, because it could generate a huge tax bill and a spanking from Uncle Sam if that bill is not based on reliable numbers.
Worse yet, investors who haven’t kept their investment history have almost nowhere to turn for help.
Demographics and the surge in mutual fund ownership in the past decade dictate this dilemma will mount as investors let the paperwork slide and the years pile up. The problem is heightened by funds changing recordkeepers and data providers, by mergers and by a lack of consensus about just how long a fund company should maintain account information.
But while this story should spur you to keep better files, it is really about what to do when your records and recollections are not quite up to Internal Revenue Service standards.
Four years ago, unhappy with lagging performance, Clark sought help. But Dreyfus records were insufficient.
“When it came time to researching this, they lost interest in helping me,” recalls Clark, a cost analyst with a consulting firm. “They didn’t have records that old, and if they did, it was going to be a lot of work to find them and help me.”
Clark endured continuing below-average returns but put off his paperwork nightmare. Now the Pacific Palisades, Calif., resident needs his birth gift for a down payment on a home.
Investors pay taxes on their fund’s annual capital gains and dividends distributions. When you sell a fund, however, you capture “unrealized gains” or long-term appreciation of stocks in the fund. (Say, for instance, Dreyfus Fund held a stock for Clark’s 35 years; that stock buoyed the fund but never generated a tax bill. Clark owes taxes on those gains when he sells.)
Reinvested dividends–or any addition to holdings at varied prices–complicate matters by changing average cost per share.
Many funds now put average share cost on their statements, albeit with the same problem you face on your own: Their records may not go back far enough. If average-cost accounting began in, say, 1992, some funds treat that as the time you first invested. That’s misleading. On older holdings, therefore, the estimate of your cost could be way off.
The IRS doesn’t expect perfection, but rather a good-faith effort to establish your true cost. A guess just won’t cut it.
“You must be able to tell us, if we ask, how you came up with the number used as your cost for the fund shares,” says Stanley Boris, an IRS spokesman. “If we can establish a lower cost basis for your shares, you will owe more money on the sale of those shares and there might be penalties to pay.”
The IRS, however, won’t say what qualifies as a good-faith effort. Chances are, however, it won’t come up with records much better than your own attempt to reconstruct history.
So, if you have incomplete purchase records and expect someday to sell the fund, you should:
– Call the fund. You will need to be persistent and/or pay a nominal charge to access records in a dusty microfiche room, but get as much history as possible. If you aren’t selling now, get the numbers anyway; they are harder to retrieve as time passes.
– Call your broker/planner. If an adviser sold you the fund, his or her firm may have your data. In fact, the advisory firm–and not the fund company–may be the only one with you on file.
– Call anyone else familiar with the investment. Clark, for instance, got information from his mother narrowing down when shares were purchased and estimating the amount invested.
– Get your pencil. Armed with an idea of the amount and time of the initial investment, you can make an estimate that satisfies the IRS, typically the fund’s lowest price at the time.
Clark, for instance, will use the lowest price during the 13 months after his birth. He can get that price data either from Dreyfus, newspaper archives or in some fund-tracking databases. This lowest-price method hikes the tax bill slightly from the actual cost, but shows the good faith the IRS is looking for.
Next, ask the fund for a history of dividend/capital gains distributions. It won’t be easy, but with a starting point, you can do the math and reconstruct your investment history.
“Use the practical resources you can muster and the worst that can happen is that you end up in a negotiating situation if the IRS audits you,” says Cathy Heron, vice president and senior counsel at the Investment Company Institute. “That’s not great, but it’s better than living with a fund you want to sell.
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“Consider any extra taxes the cost of poor recordkeeping. At least that way, you won’t let it happen again.”
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Charles A. Jaffe is mutual funds columnist at The Boston Globe. He can be reached by e-mail at [email protected] or at The Boston Globe, Box 2378, Boston, Mass. 02107-2378.