Press Coverage

IRS Guidance on Cost Basis Coming Soon

December 10, 2009

The Internal Revenue Service is close to issuing its long-awaited guidance on the cost basis reporting law passed late last year.

The IRS plans to issue the guidance in "upcoming weeks," writes Nayyera Haq, a spokeswoman for the Department of Treasury, in an e-mail to Ignites. She declined to comment further on the nature of the guidance or its exact timing.

Haq's message comes after Josh Odintz, acting tax counsel in the Treasury office for tax policy, said Dec. 4 that IRS cost basis guidance was expected in the "next few weeks."

In February, the IRS posed 36 questions to the industry about cost basis reporting that will help the agency draft its guidance. The IRS asked very specific questions, such as the scope of the wash sales exception and whether a customer, after a sale, "may identify or change the identification of specific stock sold and, if so, for what period of time or by what deadline," according to the agency notice. The IRS invited the public to comment.

Once the guidance is released, the IRS will hold a comment period, which will then be followed by the final guidance. Odintz, who was speaking at a Practicing Law Institute conference, said the final regulations are expected to be introduced this summer. He encouraged practitioners to offer their comments on the proposed rules once they are out, according to press reports.

H.R. 1424 was adopted in late 2008 and imposes new reporting requirements for broker-dealers and fund firms. The law requires that firms provide cost basis information to customers and the IRS when securities are sold.

Cost basis - which is the original price of an asset - is used to calculate capital gains or losses for tax purposes. There are several different methods to calculate cost basis, and investors can choose whichever method gives them the best tax treatment.

The IRS has been expected to issue guidance for months. In November, rumors began to circulate, again, that the government agency was close to producing something soon. "We were really hoping to have the proposed regulations out before now, because it will take a year, at minimum, [for firms] to get the systems and software ready," says Stevie Conlon, tax director at GainsKeeper, which provides automated tax-based services to institutional and individual investors.

The compliance date for brokers is Jan. 1, 2011, while fund groups have until Jan. 1, 2012. Just because the IRS says the guidance will be out in the next few weeks doesn't actually mean it will be, Conlon says. There will also be a delay, likely three to six months, between the proposed guidance and the final version, she says.

"I'm not holding my breath, but I'm hopeful it will come out in the next couple weeks," says Cameron Routh, Scivantage's SVP of strategic products. Scivantage provides Web-based front- and middle-office technology to the financial services industry.

Routh hopes the IRS produces the final guidance this spring, which will give brokerages more time to comply with it.

While the compliance date may seem distant for fund firms, most agree that annually reporting the adjusted cost basis for mutual funds to shareholders and the Internal Revenue Service will require massive upgrades to recordkeeping and accounting systems.

Deanna Flores, a principal in KPMG's Washington national tax office, says it's difficult to predict whether the IRS will issue guidance in a few weeks.

"Six months following the issuance of final regulations doesn't appear to be enough time to implement and fully test the cost basis functionality required for 2011," Flores says.

"The earlier we get those regs, the better we will be," Routh adds. "I hope everything is resolved by spring."

Despite the looming compliance dates, firms still deciding on how to comply do have choices. They can build their own cost-basis system, as Fidelity and Charles Schwab have done. But firms that go this route may underestimate the task. A cost-basis platform takes time - from two to three years - to build from scratch, Routh says. The only firms that could undertake such a task would be those with the required functionality already on their systems and the investment to build it out, he says. "And it would be expensive," he says.

Another option for firms is to outsource cost basis to a handful of players available in the sector. This includes GainsKeeper, a unit of Wolters Kluwer; Maxit, which is owned by Scivantage; SunGard's Cost Basis Reporting Engine; and BroadRidge's Tax Lot Engine and Aspire Portfolio Accounting. Thomson Reuters also has Cost Basis Plus, a Web-based product.

Morgan Stanley Investment Management will rely on the capabilities of a vendor to manage reporting requirements, a spokeswoman says. MSIM has chosen the vendor but the spokeswoman declined to disclose its name.

Lastly, firms can try building their own service and outsource part of it. A Celent study, released in October, found that many financial services firms have yet to begin implementing a solution or even allocating a budget to address the issue. Only 12% of those questioned had a solution in place. When asked about their compliance plans, 12% said they plan to build their own while 8% said they plan to buy (outsource) and 16% said they expect to use a combination of build and buy. However, 29% said they weren't sure how they would comply.

While GainsKeeper's Conlon says firms will need about a year to comply with the rule, others have different timelines. Firms using SunGard's cost basis engine can be done in as little as four months, with most cases averaging four to eight months, says Jen Valdez, SunGard's SVP in product management. "It's not a lengthy process," Valdez says. "We do an integration and we implement the cost basis solution."

However, Valdez cautions that the time needed will differ for each firm.

Scivantage's Routh thinks six months will be the average time needed to implement any changes. "It's a pretty complex system to get up and running," he says.