Press Coverage

IRS Issues Long-Awaited Cost Basis Guidance

December 18, 2009

By Luisa Beltran

The Internal Revenue Service has finally issued its long-awaited guidance on cost basis reporting this week.

"Basis Reporting by Securities Brokers and Basis Determination for Stock," a sprawling 141-page document, is available to download via the Federal Register. The guidance provides more clarification on several issues, including a new Form 1099-B — used to report the year's gross proceeds from fund share sales — that will be used for calendar year 2011.

While most in the fund industry were waiting for IRS clarity on several issues, the guidance is important for what it didn't say, says Stevie Conlon, tax director at GainsKeeper, which provides automated tax-based services to institutional and individual investors. Many broker-dealers and fund firms had hoped the IRS would delay the effective date for the cost basis rule.

However, the IRS remained silent on any delay.

"The industry is concerned that we won't have time to get all the work done," Conlon says.

The new reporting standards were adopted in late 2008 and require firms, including mutual fund advisors and broker-dealers, to provide cost basis information to customers and the IRS when securities are sold. While fund groups have until Jan. 1, 2012, the compliance date for brokers is Jan. 1, 2011.

The standards were part of the Emergency Economic Stabilization Act, which was passed in 2008 and is intended to improve compliance with tax laws and raise revenues to fund the Troubled Asset Relief Program (TARP).

Cameron Routh, Scivantages SVP of strategic products, says it will be difficult for firms to meet the current timetable for compliance. "This will cause a lot of problems for many folks that have been waiting for the regs to be issued," says Routh. Scivantage provides Web-based front- and middle-office technology to the financial services industry.

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. Both the fund industry and brokers have been waiting for months for the IRS to issue guidance on the law.

Interested parties have until Feb. 8 to comment on the guidance, and the IRS is scheduled to hold a public hearing Feb. 17 to discuss the regulation. Conlon expects the IRS will likely take several months to issue final guidance. That could mean brokers will have roughly six months to comply with the Jan. 1, 2011, deadline.

"There's not enough time to prepare the operations systems and software," says Conlon.

Also, Conlon says firms cannot rely on the proposed guidance. Only a final version will help protect firms from penalties, she says. "This is like a draft of a playbook. The team needs to know what the final playbook is," she says.

Sean Cunniff, research director in the brokerage and wealth management practice at TowerGroup, says he never expected the IRS to issue a delay. Even if the agency did provide one, Cunniff is not sure more firms would comply any faster. Some firms have done much due diligence and have spent millions upgrading their systems. However, there are still firms that are unsure what to do. "I have had several conversations with firms still deciding whether to build or buy," he says.

The IRS, on its website, also put a draft version of Form 1099-B, which will affect broker-dealers and mutual fund firms. The form includes a new box for long- and short-term gains. The form is expected to be used for calendar year 2011 sales and provided to investors in early 2012. "This gives the level of detail of information that brokers or mutual funds will have to provide to customers," Conlon says.

The IRS is requiring brokers to provide corrected 1099 forms to investors if a transfer of a security occurs. Also, if an issuer provides a return that concerns a corporate organizational action after the broker has reported the sale, the broker has to issue a corrected 1099, the proposed guidance says. "As a customer relations matter, this won't go over very well with brokers," Conlon says.

The IRS did take a hard line on wash sales. The agency isn't providing exceptions for wash sales resulting in de minimis adjustments or wash sales triggered by scheduled periodic investments, such as an employee stock purchase plan. Wash sales affect more than just sophisticated investors; they also include regular investors as well, Conlon says. A wash sale occurs when a security is sold at a loss and then shortly thereafter the same stock is purchased. The idea is to claim the loss on the sale as a deduction, but repurchase the security in the hopes it will appreciate in value. Deductions from wash sales are disallowed if the stock is repurchased within 30 days of the sale.

Fund firms did get some leeway when computing average basis, which is used to determine gains or losses. Taxpayers currently can use the double-category or single-category method. The IRS, with its proposed guidance, has eliminated the double category bucket, which divides stock by the holding period and averages long-term shares separately from short-term shares. In contrast, the single category method requires users to average all shares together regardless of their holding period. The IRS did ask for comments on whether the double category bucket should stay.

"That was always cumbersome," Conlon says. "No one uses [the double category].

John Lehner, president and CEO of Eagle Investment Systems, says some firms are hoping that there will be latitude regarding enforcement of penalties for those that fail to comply. "It is not uncommon to get revised 1099 forms, or for firms to restate or corporate actions to be unwound," he says. "At the end of the day, it will be interesting who will be held accountable by the government for the accuracy of the information when the underlying pieces are in movement."