Further to our recent blog post, IRPAC Commentary Evaluates IRS Cost Basis Reporting Regulations, various industry organizations are raising their concerns to the Internal Revenue Service (IRS) following the release of the Final Regulations for Basis Reporting by Securities Brokers and Basis Determination for Debt Instruments and Options. These mandates have added another layer of complexity into the cost basis landscape and institutions have taken advantage of the opportunity to outline the critical issues they foresee with the rules as they currently stand during the open comment period.
In an August 22 letter, The Financial Information Forum (FIF), in which Scivantage is an active member, referenced that there are many issues to be addressed in regards to cost basis reporting regulations and focused on the rules that will become effective January 1, 2014. The organization has identified several requirements it believes will “either inflict hardship on taxpayers or place an undue burden on brokers that must be addressed immediately” and highlights that the requirements for transfer statements is unworkable in its current form.
Support of Multiple Accrual Methods and Holder Elections
The FIF takes immediate issue with the Regulation’s preamble, in which the IRS states that “support for customer debt instrument elections would be beneficial to taxpayers and would not impose an undue burden on brokers.”
The FIF says that supporting multiple accrual methods and building necessary systems to support holder elections puts a heavy burden on brokers that was not suggested in the proposed regulations, and that the relative infrequency with which customers may elect out of the defaults fails to reduce the complexity of implementing support of these elections in brokerage systems. Further, the FIF asserts that the IRS has provided little guidance regarding the manner of elections, the application of elections to transferred securities, the revocation of elections or the relationships and dependencies between and among elections.
The FIF recommends the following points to improve this section of the requirements:
- – Holder elections on an account-by-account basis, meaning that a client making an election would be required to designate the account(s) to which the election(s) would apply
- – Clarifying that elections made on an instrument-by-instrument basis be treated as made with a single CUSIP, rather than tax lot or individual note
- – When identifying and resolving any potential conflicts, the taxpayer provide the original tax year of the election with any election provided to the broker
- – That a broker not be penalized for inaccurate reporting when they rely on a written election provided by a client to alter their method of accrual or income reporting from the default requirement
Assumption of Election to Amortize Bond Premium, No Assumption for Accrual of Market Discount Using Constant Yield
With respect to the assumption to amortize bond premium, the FIF supports the decision requiring brokers to apply this election by default. However, the FIF is surprised that the IRS chose not to require brokers to make a similar assumption with respect to the accrual of market discount using constant yield. In its letter to the IRS, the FIF said: “In light of the tax benefit of this election to clients, we would prefer that this election also be assumed.”
Revocations of Elections
Additionally, the organization has also raised a red flag on requirements related to transfer statements. The FIF says that although the regulations do address the requirement to use the constant yield method to amortize acquisition premium when the customer makes the election under 1.1272-3, they don’t outline what happens to the accrual of acquisition premium when the holder revokes this election. In its recommendation, the FIF writes that supporting the election will be more manageable for all parties involved if the accruals of acquisition premium are calculated using a constant yield method after a revocation of an election under 1.1272-3.
Members of FIF also highlighted the below recommendations for the IRS to consider:
- – Although there was some internal disagreement about the issue of wash sale adjustments, FIF recommended that the IRS provide clarity in regards to if the amount and holding period adjustment should be transferred as separate values
- – The IRS should allow brokers to adjust the basis of shares acquired through the exercise of compensatory options permissively; the new 1099-B indicator should be added to allow the broker to provide a clear indication to the client and the IRS that basis has been adjusted, and in the event a taxpayer chooses to transfer shares away from the broker that originally executed the exercise of a compensatory option, the delivering broker will provide unadjusted basis only on the transfer letter for the shares
In closing the letter, the FIF notes there are several issues that need to be addressed for the cost basis reporting rules scheduled to go into effect starting in January 2013, such as transfer of basis for 1256 options, and is looking forward to discussing those specifics with the IRS once the immediate requirements are addressed.
It is clear that the industry is demanding clarity from the IRS and the final regulations have only further complicated the regulatory environment. It will no longer be feasible to manually compile, process, and distribute this data with the added requirements, especially since fixed income instruments ultimately have more taxable events than equities, potentially creating a significant increase in the volume of transaction processing. Firms need to automate the process in advance of the first wave from the final regulations in order to avoid costly mistakes. By engaging with an experienced partner and leveraging a trusted platform with proven success, such as Scivantage Maxit®, broker-dealers, mutual funds, custodians and prime brokers can achieve cost basis reporting compliance, while increasing efficiencies and reducing operational costs.