Finalized on Oct. 12, 2010, the new cost basis reporting regulations implement key provisions of the Emergency Economic Stabilization Act of 2008 that apply to institutions that issue IRS Form 1099-B (Proceeds from Broker and Barter Exchange Transactions). 

The regulations place the burden of reporting on brokers, custodians and transfer agents who, upon transferring securities out of clients’ accounts, must now provide receiving institutions with cost basis information within 15 days of the transfer.  This burden is seen as a blessing by trust companies, accountants and the like who have traditionally had to track down this type of information when securities were received from a prior custodian. 

For the past year, brokers have been preparing for the challenges posed by the proposed regulations that were issued on Dec. 17, 2009.  Brokers have always been required to report on Form 1099-B the trade date, sale price and description of the security sold.  Internal Revenue Code Section 6045 will now require Forms 1099-B to include:

• the adjusted cost basis for securities sold,
• the gain or loss on the security sold,
• whether the resulting gain or loss is long-term or short-term,
• the date of acquisition,
• wash sale loss disallowed, and
• if the security is covered (that is, based on the security type and acquired after the effective dates listed below).

Effective Dates

The IRS will phase in application of the regulations over three years; cost basis reporting will be required based on the security type and acquisition date:

1. corporate stock acquired on or after Jan. 1, 2011,
2. securities purchased through regulated investment companies (mutual funds) and dividend reinvestment plan (DRIP) shares acquired on or after Jan. 1, 2012, and;
3. all other specified securities (including bonds and other options) acquired on or after Jan. 1, 2013.

The official deadline for reporting with the IRS using new Form 1099-B isn’t until 2012, but to meet the reporting requirements, brokers have been working hard to capture cost basis information beginning Jan. 1, 2011. 

All securities will be considered “covered” if they’re acquired after the effective dates listed above.  While brokers aren’t required to report cost basis on non-covered securities, taxpayers are responsible for reporting cost basis on both covered and non-covered securities to the IRS on their tax returns when securities are sold.

Required Reporting Information

Computing the adjusted cost basis on securities sold under the regulations will be a cumbersome undertaking.  Adjusted cost basis, of course, reflects the original value of the security (typically the purchase price) and any adjustments due to wash sales, stock splits and other corporate actions.

Complicating matters further is the requirement that brokers allow their investors to select which inventory methodology to follow.  Shares of the same security in an investor’s account are often acquired at different times and at different prices, referred to as “tax lots.”  As a result of the new cost basis regulations, when those tax lots are sold or transferred, investors must identify the order of their disposal. 

Unless an investor chooses otherwise, under the final regulations, his account will default to the first in-first out (FIFO) methodology.  Often, the FIFO method doesn’t provide the most tax-efficient result, presenting an array of new complexities.

A more tax-efficient methodology is specific identification, which allows the account owner to designate which lots to dispose of at sale.  The most common method, highest in-first out, will dispose of the highest cost lots that will minimize the account owner’s taxable gain.

Luck Favors the Prepared

Through the new regulations, the IRS will be able to increase revenue without raising taxes, which is rarely a popular move.  Indeed, The Joint Committee on Taxation estimates that the IRS stands to gain $6.67 billion in additional tax revenue over the next decade under the new cost basis reporting requirements. 

As the regulations are implemented over the next three years, the clarity that trust administrators and accountants will have is seen as a positive consequence of the regulations.  For brokers, the regulations have been and will continue to be a burden, costing time, technology and money, to meet the timeline the IRS has set.  Stay tuned for how well firms are prepared to meet the IRS’ requirements.

This article includes views expressed by representatives of Fiduciary Trust Company International, as of the date indicated, and it is intended to provide general information only on the financial topics it addresses. It is not intended to provide specific legal advice or market predictions. You should consult your personal financial, legal or tax advisor(s) regarding your specific circumstances in determining whether the contents of, or opinions expressed herein are appropriate for you or relevant to any investment, tax or estate planning decisions that you make.

IRS Circular 230 Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.