Cost Basis Reporting Regulations
The Emergency Economic Stabilization Act of 2008 includes reporting requirements for financial institutions. Under the revised IRS regulations, which began with the 2011 tax year, financial institutions must report to the Internal Revenue Service on clients' Forms 1099-B not only gross proceeds, but also the cost basis for covered securities sold, and whether the related gain or loss is long-term or short-term.
In addition, the legislation created a number of regulations surrounding many other organizational actions such as what is reportable to the IRS, how specific tax lots are chosen for disposition, and how accounts and individual securities are transferred - just to name a few. The following information goes into more detail on these and many other regulatory changes that affect you.
- Calculating Cost Basis
- Covered/Noncovered Securities
- Tax Lot Relief Methods
- Closing Lot Information by Settlement Date
- Account Transfer Changes
- Corporate Action Reporting Changes
- Wash Sale Reporting Changes
- Short Sale Reporting Changes
- S Corporation Reporting Changes
- Changes to Tax Packages and Tax Forms
Calculating Cost Basis
Cost basis is the original value of a security for tax purposes - usually the purchase price. The cost basis for a security may also be adjusted for stock splits, nondividend distributions (return of capital), and other corporate actions. This value is used to determine the capital gain or loss, which is equal to the difference between the asset's cost basis and the sale price of the closing transaction.
The cost basis reporting requirements to the IRS apply only to the disposition of covered securities that occur on or after their effective date. A covered security is the type of security purchased or acquired on or after its effective date as determined by Congress and the IRS. The legislation is rolling out in three phases and started in 2011. The effective dates of covered securities are:
- Equity securities acquired on or after January 1, 2011
- Mutual fund and dividend reinvestment plan (DRIP) shares acquired on or after January 1, 2012.
- Simple debt securities such as fixed-rate bonds, original issue discount (OID) bonds, and zero coupon bonds, options, rights, and warrants acquired on or after January 1, 2014
- More complex debt instruments acquired on or after January 1, 2016
The new default elections for debt securities included in the IRS regulations pertain to the treatment of bond premium amortization, market discount accrual, and original issue discount accretion. For simple bonds purchased on or after January 1, 2014, it will be assumed the client has made the following elections:
- Current amortization of taxable bond premiums
- Deferred inclusion of market discount as income to the date of sale or redemption
- Computation of market discount accruals under the straight line method for bonds acquired between 1/1/2014 and 12/31/2014 and the “constant yield method” for bonds acquired on or after 1/1/2015
If, after consulting with a tax advisor, your client wants to change these default election methods, it will require a written request. Note: Election and/or default methods for debt securities purchased prior to December 31, 2013 will not change.
Remember that transactions involving assets purchased and held prior to these effective dates, or noncovered securities will continue to be reported as they have been in the past, meaning only gross proceeds will be reported by Wells Fargo Clearing Services, LLC. Wells Fargo Clearing Services, LLC will NOT report cost basis information to the IRS on noncovered security sales. It remains the clients' responsibility to report noncovered security transactions along with the proper cost basis on tax returns to the IRS.
Tax Lot Relief Methods
Selecting a tax lot relief method is a way of setting a default for determining the selection of which lots of a security will be liquidated first in a given transaction. In addition to selecting which lot of a security will be sold, it also identifies its associated cost basis and holding period which are used in computing the gain or loss and whether or not it is long-term or short-term.
When using specific tax strategies, clients need to be aware of the tax consequences of their trading activity throughout the entire year. There may be benefits to using a different tax lot relief method in different accounts or in the sale of some specific covered positions. As in the past, clients can choose a specific tax lot to close even if they have set a specific tax lot relief method as a default and instruct their financial professional to execute the closing transaction using the "versus purchase" method. Clients should consult with their tax advisors to determine the best tax lot relief method for their needs.
- Default Tax Lot Relief Method
The IRS requires that all firms establish a default tax lot relief method to determine cost basis on all accounts in the event a client does not determine a specific tax lot relief method. Consistent with current federal income tax regulations, Wells Fargo Clearing Services, LLC is using the default tax lot relief method of First In First Out (FIFO).
- Available Tax Lot Relief Methods
Wells Fargo Clearing Services, LLC now offers a number of tax lot relief methods available to assist clients with their tax strategies. Contact your financial professional for the tax lot relief method that would best serve your needs.
Closing Lot Information by Settlement Date
Once a specific tax lot has been sold, federal tax regulations prohibit the firm or the client from changing that selection after the settlement date. Federal tax regulations mandate the enforcement of this deadline so cost-basis information reported by the firm on a Form 1099-B for a covered security can be matched to the cost-basis information reported by taxpayers on their federal income tax returns.
Wells Fargo Clearing Services, LLC does not provide legal or tax advice. Although this information is not intended to replace discussions with your tax advisor, it may help you understand the tax implications to your investment plan effectively going forward.
Account Transfer Changes
In the event of an account transfer to another financial institution, the delivering firm must provide accurate cost basis information on a transfer statement to the receiving firm for all covered securities including partial transfers, free deliveries and physical transfers. This information must be provided within 15 calendar days of the account transfer. If the lots are noncovered, the delivering firm is not required to send the receiving firm this cost basis information if they identify the security as noncovered on the transfer statement
Corporate Action Reporting Changes
Financial institutions are required to adjust cost basis of covered securities based on issuer corporate action reporting. IRS regulations require issuing corporations to provide shareholders with the applicable tax consequences necessary to adjust cost basis information, or post that information on their web site in lieu of notifying each shareholder directly.
Shares received in a corporate action event where tax information was not provided by the issuer will result in tax lots without a cost basis. Subsequent sales of those tax lots will result in financial institutions reporting a gain equal to the full amount of the proceeds (i.e., the cost basis information will equal zero.)
Foreign corporations that are not subject to U.S. tax laws are not obligated to provide U.S. tax implications on their corporate actions. Therefore, the inability to determine cost basis in new shares, rights, warrants, etc. will occur most often in those circumstances.
Wash Sale Reporting Changes
When a stock is sold at a loss, the IRS allows the loss to offset capital gains you might have. Excess losses may be used to offset ordinary income up to $3,000. The exception to this is a "wash sale." If the same or substantially identical stock is purchased 30 days before or after the sale, the Federal tax code does not allow current recognition of that loss. This prevents you from selling the stock, taking the deduction and then buying it back within the wash sale time frame to capture any future gains. The wash sale rule can also be triggered by multiple purchases on the same day if one of those tax lots is sold within 30 days for a loss.
For securities with the same CUSIP number, financial institutions are required to monitor and report wash sales that occur in the same account. They are not required to track replacement shares if there are substantially "identical" but have different CUSIP numbers, purchased at another institution or even purchased in another account at the same institution. You are required to monitor wash sales across all accounts - including across institutions or among spousal and other accounts - and comply with the requirements regarding wash sale positions.
Short Sale Reporting Changes
Prior to the revised regulations, short sale transactions were reported to the IRS in the year the position was opened. As of 2011, short sale transactions are now being reported in the year that the position is closed.
S Corporation Reporting Changes
S Corporations now receive consolidated year-end 1099-B forms which will be reported to the IRS.
Tax Packages and Tax Form Changes
IRS Schedule D of the Form 1040 has been reformatted and the new IRS Form 8949 has been added. This new form includes a column to report adjustments to cost basis information we have provided as well as codes to explain the reason for the adjustment. You should consult with your tax advisor regarding any adjustments, such as where the issuing corporation has not provided tax consequences of a corporate action.
Changes in the IRS forms have prompted Wells Fargo Clearing Services, LLC to make enhancements to the supporting documentation provided to you. For example, the Realized Gain/Loss information in your year-end tax package has been reformatted to more closely align with IRS Form 8949 which provides the information that flows through to the new IRS Form 1040 Schedule D.