Cost Basis Reporting Regulations: A Snapshot of Phase III Fixed Income and Options Requirements

The Internal Revenue Service (IRS) released the final cost basis reporting regulations for Phase 3 on April 18, 2013, addressing specific requirements for fixed income, options and single stock futures. The final rules outline the phases for implementation of reporting requirements for debt instruments and transfers. Although the IRS relaxed some of the areas of Phase 3 regulation, the majority of the newly covered securities remains complex and requires superior tax expertise.

The final regulations state that debt instruments that provide for single fixed/alternate payment schedules, for which a yield and maturity can be determined, require basis reporting if acquired on or after January 1, 2014. More complex debt instruments that do not have a fixed yield and a fixed maturity date require basis reporting if acquired on or after January 1, 2016. In addition, the final regulations require basis reporting to options granted or acquired on or after January 1, 2014.

One of the major adjustments was to the handling of transfers―the transfer reporting for options, securities future contracts and less complex debt instruments is applicable on or after January 1, 2015. For the more complex debt instruments, transfer reporting applies to transfers occurring on or after January 1, 2017.

An overview of the points of interest is given below. It provides the main areas that are estimated to require systems development.

Fixed Income Points of Interest from the Regulations:

  • •   Brokers are required to report information using the default assumptions provided in the statute and regulations
  • •   Upon written notification by a customer, a broker must take into account the customer elections for basis reporting – purposes:
      • –   the election to accrue market discount using a constant yield (not revocable)
      • –   the election to recognize market discount in income currently
      • –   the election to amortize bond premium on taxable debt
      • –   the election to treat all interest as OID
      • –   the spot rate election for interest accruals with respect to a covered debt instrument denominated in a currency other than the U.S. dollar
  • •  Transfer statements should include information needed for a receiving broker to compute adjustments in a manner consistent with the transferor broker, including payment terms, and assumptions used by the transferor broker as well as any taxpayer elections that were supported by the transferor broker

Options Points of Interest from the Regulations:

  • •   Transferring broker of an OTC option is required to provide detailed information to the receiving broker that will sufficiently describe the option
  • •   1256 options are exempt from transfer statement reporting
  • •   Future contracts become covered from January 1, 2014 onwards

Exemptions for Fixed Income/Options Basis Reporting:

  • •   REMIC securities, collateralized bonds and pools of debt instruments
  • •   Short term debt instruments
  • •   Compensatory options are not covered. Brokers are not permitted to adjust basis to account for the exercise of a compensatory option that is granted or acquired on or after January 1, 2014
  • •   An option issued as part of a unit is not covered until Jan 1, 2016
  • •   Options on foreign currencies or options on commodities

Cost basis data is extremely powerful and will continue to impact various functions throughout an organization. As firms continue to face upcoming regulation deadlines, they must recognize the need to move beyond compliance by streamlining operations and portfolio reporting, ultimately delivering exceptional client service. For a more detailed summary of the final regulations, please refer to KPMG’s latest brief: “What’s New in Tax”.

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