The Risk of Filing Taxes Early

Changes in Law Could Cause Late Revisions to 1099 Forms; An Extension for Wachovia

Investors shouldn't be in a rush to file their 2006 tax returns. Those who do may have to amend them later this year.

Major financial-services companies are struggling to avoid what some fear could be an unusually severe recurrence of a problem that has bedeviled investors the past three years.

The issue is 1099 forms, those statements that banks, brokerage houses and mutual funds send out to account holders around the end of January. Since 2004, millions of taxpayers have received revised 1099 forms -- typically in late February, March and even April -- restating information, such as dividends, that was reported on their initial 1099s.

This year, some financial executives worry that things may get even worse, thanks in part to a recent tax-law change. Seeking to minimize the problem, a few firms have asked the Internal Revenue Service for more time to mail out their 1099 forms to investors.

Among the firms that have received extensions from the IRS are Wachovia Securities, a unit of Wachovia Corp., and Morgan Stanley. A Wachovia spokeswoman says the company plans two waves of 1099 mailings to investors in February and is counseling clients to sit tight.

"My advice would be to delay filing as long as possible" this year because of the 1099 issue, says Julia Flenner, a first vice president at Wachovia Securities in Richmond, Va.

Morgan Stanley recently wrote clients to say it had received a 30-day filing extension from the IRS. The company made the request "in anticipation that tax-law changes will significantly increase the number of mutual funds that will be late in supplying their tax information," says Ted Jahn, executive director of client reporting in Morgan Stanley's Global Wealth Management Group. Morgan Stanley will use only about one week of that 30-day extension, Mr. Jahn says, which "will give us enough time to capture the majority of this late tax information."

This move "should substantially reduce the number of corrected 1099s we need to send" -- but it "won't eliminate them entirely," he says.

Morgan Stanley told clients about the delayed mailing via an insert in their December statements. The company said it will begin mailing 1099 statements on Feb. 5 and will complete the mailing by Feb. 9.

The firm cited a law enacted last year that included a change in how tax-exempt interest income is reported to customers for 2006. Two new boxes have been added to the IRS's Form 1099-INT, for reporting interest payments. (The 1099 form for dividends is called Form 1099-DIV.) One of them, box 8, includes tax-exempt bond interest, tax-exempt interest dividends from mutual funds, tax-free unit-investment-trust interest and accrued interest received on the sale of a municipal bond. The other new one, box 9, shows tax-exempt interest that is subject to the alternative minimum tax.

Paradoxically, the origins of the 1099 tempest date to a 2003 tax law designed to help investors. Part of that law slashed the top tax rate on most -- but not all -- dividends to 15%, effective retroactively to the start of 2003. Previously, dividends had been subject to tax as ordinary income, which meant at federal rates as high as 38.6%.

Early in 2004, investors began to notice a sharp increase in the number of revised 1099 forms. Before the 2003 law was enacted, the percentage of revised 1099 forms sent out typically was only about 5% to 8% a year, says Patricia McClanahan, vice president and director of tax policy at the Securities Industry and Financial Markets Association, or SIFMA.

In 2004, that percentage jumped to 14.3%, Ms. McClanahan says. In 2005, it fell to 11.7% -- but then bounced back up again last year to 13.2%. SIFMA, a trade group formed recently by the merger of the Securities Industry Association and Bond Market Association, represents about 650 securities firms, banks and asset managers.

Industry leaders have long tried to persuade the IRS to allow them more time to send out 1099s to customers. They say the IRS has refused to grant an industry-wide extension because many taxpayers like to file their returns in February and collect their refunds early.

Instead, the IRS said it would consider requests by individual firms for extensions. Previously, some firms that received those extensions chose not to use them out of fear that their clients wanted the information more quickly.

So what should you do if you file your return this year and later receive a revised 1099 form?

In some cases, the answer is nothing. Many corrections are so small it probably isn't worthwhile to amend your original return. That is especially the case if it winds up that you are entitled only to a small additional refund -- and you have to pay a tax preparer an additional amount to figure out how much.

If the correction is large enough, it may well be worth the time and effort to revise your return. Moreover, if the revised information means you owe more tax, you should consider fixing your return before the mid-April deadline. Otherwise, you could face interest charges and possible penalties as well.

Some investors have received multiple 1099 revisions from the same investment firm, says Stephen W. DeFilippis, owner of West Suburban Income Tax Service in Wheaton, Ill. He typically tells investors to wait at least until late March to file since it is likely that most 1099 revisions will have been sent out by that time. (To be sure, some revised forms have been sent out even later than March in past years.)

Some taxpayers go even further: They estimate and pay what they owe by the April deadline and file for an automatic six-month extension. "It's typically smarter to file for an extension than to have to file an amended return," says Mr. DeFilippis, who is an enrolled agent and thus licensed to represent taxpayers before the IRS.

A SENATE PANEL plans to focus on a new whistleblower law.

The Senate Finance Committee plans a "roundtable discussion" on Feb. 5 about the law, which authorizes the IRS to pay higher rewards to informants in certain types of cases. Sen. Chuck Grassley, an Iowa Republican, recently asked Treasury Secretary Henry Paulson for details on how the whistleblower program will be run and who will be placed in charge of it. IRS officials have said that most of the tips it receives from informants don't justify a reward.

Since the late 1960s, the IRS has paid rewards on less than 8% of all informants' claims.

HEAVY READING: Congressional staffers summarize recent tax laws.

Check out the Web site of Congress's Joint Committee on Taxation (www.house.gov/jct) for a handy "general explanation" by the committee's staff of tax legislation passed in the 109th Congress, which covers the years 2005 and 2006.

The JCT publication totals more than 800 pages.

BRIEFS: The total number of estate-tax returns filed in 2005 with a gross estate of $1.5 million or more was 39,481, the IRS Statistics of Income Division says. Of those returns, only 18,431 were taxable....Who's news: Mark Prater is named deputy staff director for the Republican staff on the Senate Finance Committee. He retains the title of chief tax counsel, which he has held for 13 years. As deputy staff director, Mr. Prater succeeds Ted Totman, who has retired.

• Email Tom Herman at taxreport@wsj.com

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