Inaccurate tax reporting by broker-dealers could force brokerage clients to seek damages, as highlighted in an ongoing lawsuit against UBS Financial Services in New Jersey District Court, and could force brokers to seek protection by forcing their clients to sign liability waivers in connection with their tax reporting.
That's according to Mayer Brown tax transaction and consulting partners Jared Goldberger and Mark Leeds in a recent client alert which outlines that if the lawsuit is successful, it could have wide implications for how brokerage clients respond to lapses in tax reporting and how brokers protect themselves from liability going forward.
But even though the specific case involves an individual who purchased taxable municipal securities through a broker, its implications aren't limited to a particular security or investment and could impact how all brokers comply with their tax reporting obligations, Goldberger said.
"It's really unusual for an individual to take its broker to court over inaccurate tax reporting," Leeds said. "Most people just 'swim upstream' against the Form 1099, report correctly and beg and plead with the broker to correct the reporting mistakes," he added. "Even if there was a good faith error by the broker, nobody would have reasonably foreseen a lawsuit over something like this."
If the lawsuit succeeds, then brokers may take the extra step to protect themselves in ways not widely seen as of now.
"Brokers should consider whether account documentation should have a waiver of liability," Goldberger said. "If you want to open your account at any brokerage, you should understand when you open the account, that there's a possibility that the tax reporting won't be perfect but that the brokerage itself is not going to be liable for damages if they make mistakes."
The mistake arose when sometime before 2014, Richard Goodman and "similarly situated individuals" purchased a significant number of taxable municipal bonds at a premium, issued by the states of Texas and Michigan and held in a brokerage account controlled by UBS Financial Services.
When bonds are purchased at a premium, "U.S. tax law permits the taxpayer to amortize the premium over the remaining life of the bond," the Mayer Brown alert said. Treasury regulations say that unless a client states in writing otherwise, the broker must report the amount of any amortizable bond premiums allocable to a stated interest payment, thus reducing the taxpayer's taxable income.
Goodman claims that UBS violated policies set out in the Form 1099 guide as the forms he received included only the interest amount without the amortizable bond premium, which forced him to overstate his income tax obligations for 2015-2018.
UBS eventually provided Goodman with the corrected forms, revealing that the original forms overstated Goodman's income by $200,868.34 during those four years, the documents said.
Goodman brought contract and tort claims against UBS and the firm filed a motion to dismiss, which was denied but the court found it appropriate to allow the parties to proceed to discovery. The claim could still be thrown out in a future motion for summary judgment made by the broker.
"The Goodman opinion highlights the need to carefully review existing client/customer documentation to see what, if anything, is agreed or promised to clients, customers, or payees in terms of information reporting," the alert said. "At the very least, taxpayers should consider whether such documentation should contain an acknowledgment by the client/customer/payee that the broker is not liable for inadvertent tax reporting errors."
"This case is a valuable reminder of the complexities associated with tax reporting," said Michael Decker, senior vice president for research and public policy at the Bond Dealers of America. "Dealers should and do take care to ensure that reporting is accurate and complete."
