Small Business Taxes & ManagementTM--Copyright 2012, A/N Group, Inc.
Cost Basis Reporting Overview and FAQs
The IRS has published an overview along with some frequently asked questions about the new basis reporting rules. We've edited the IRS material to remove rules that apply only to brokers and references to infrequently encountered situations. Basis reporting for stocks is required for 2011. (To see the full text go to www.irs.gov/taxpros/article/0,,id=237099,00.html.) You'll have to show the basis reported by the broker on Form 8949. Your broker is only required to report basis for stocks acquired in 2011. (Most brokers have been reporting basis for some years.)
The law now requires that every broker required to file a return with the IRS reporting gross proceeds from the sale of a covered security additionally report a customer’s adjusted basis in the security and whether any gain or loss on the sale is classified as short-term or long-term. Brokers must follow customers’ instructions and elections when determining adjusted basis. When a broker transfers securities to another new broker before their sale, the transferring broker must furnish to the receiving broker a statement containing sufficient information about the transferred securities for the receiving broker to determine the customer’s adjusted basis and whether any gain or loss is short-term or long-term when the transferred security is eventually sold. Finally, the law requires issuers of securities to file a return with the IRS and furnish a statement to holders of the securities after taking a corporate action that affects the basis of the security to explain the corporate action and its quantitative effect upon the basis of the security.
Securities Subject to Reporting
The types of securities covered by the legislation (“specified securities”) include stock in a corporation, notes, bonds, debentures and other evidence of indebtedness, commodities, commodity contracts or derivatives, and any other financial instrument for which the Secretary determines reporting adjusted basis is appropriate. A security is a “covered security” and therefore subject to the basis reporting requirements if it is acquired after its corresponding applicable date. For stock in a corporation, the applicable date is January 1, 2011 unless the stock is in a mutual fund or is acquired in connection with a dividend reinvestment plan (DRP), in which case the applicable date is January 1, 2012. For any other specified security, the applicable date is January 1, 2013, or a later date determined by the Secretary of the Treasury. Brokers therefore are not required to report basis for any securities acquired before 2011.
If a customer sells less than his or her entire position of a security in an account, a broker must report a customer’s adjusted basis in the security (other than mutual fund or DRP stock) using the first-in, first-out (FIFO) method, unless the customer provides the broker an adequate and timely identification of the shares or units the customer wants to sell. A broker must report the adjusted basis of mutual fund or DRP stock (for which a customer may average the basis of the stock) in accordance with the broker’s default method unless the customer notifies the broker that the customer elects a different permitted method.
The rules change how taxpayers determine the average basis of mutual fund stock and permit taxpayers to average stock held in a DRP. Starting in 2012, taxpayers who elect to average the basis of mutual fund shares will compute separate averages for fund shares held in different accounts. Taxpayers also will be permitted to average the basis of mutual fund shares in one account but not average them in another account. Further, unless the fund or broker holding the fund shares elects otherwise, taxpayers will compute a separate average for fund shares in an account that are covered securities and a separate average for fund shares in an account that are not covered securities.
Taxpayers also may average the basis of stock held in a DRP and acquired on or after January 1, 2011. Averaging only applies to DRP stock held in plans for which the written plan documents require that at least 10 percent of every dividend paid is reinvested in identical stock.
Other Broker Reporting Provisions
Wash Sales-– The amendments require brokers to adjust basis to reflect wash sales but only if the acquired securities are identical (instead of substantially identical) to the sold securities. Further, the amendments only require brokers to report wash sales when the purchase and sale transactions occur in the same account.
S Corporations-– Brokers have not previously been required to report the gross proceeds from the sale of securities owned by S corporations or C corporations. The amendments now require that brokers report sales of covered securities that S corporations acquire on or after January 1, 2012.
Short Sales-– Previously, brokers reported the gross proceeds of short sales for the year in which a short sale is entered into. The amendments now require that brokers report short sales for the year in which the short sale is closed.
Time for Furnishing Statements-– The amendments extend the due date for brokers to report securities sales to customers on Form 1099-B from January 31 to February 15 of the year following the calendar year in which a security is sold. This later due date also applies to Form 1099-S, and, when reporting payments to attorneys or substitute payments by brokers in lieu of dividends or interest, Form 1099-MISC. The later due date also applies to other statements that must be furnished by January 31 if furnished with one of these three statements in a consolidated reporting statement.
The law provides that an issuer of a specified security must file a new information return with the IRS to describe any organizational action it takes that affects the basis of the security (such as a stock split or merger) within 45 days after the date of the organizational action (unless the action takes place in December, in which case the return must be filed by January 15 of the following year). The return must describe the organizational action and its quantitative effect on the basis of the security. Additionally, the issuer must furnish a copy of the return to each holder of the security by January 15 of the year following the action. These requirements first apply to organizational actions on or after January 1, 2011, that affect the basis of stock in a corporation other than a mutual fund.
Frequently Asked Questions
When are returns due? The Act gives brokers until February 15 of the year following the sale of a security to furnish Form 1099-B to their customers.
Who qualifies as a broker? The Act did not change the definition of a broker that must report the sale of securities. The regulations continue to define a “broker” as any U.S. or foreign person that, in the ordinary course of a trade or business, stands ready to effect sales to be made by others.
What are “specified securities”? The term “specified securities” connotes the various types of securities which, if acquired after their respective effective dates, are subject to the basis reporting requirements of the Act. Specified securities include stock in a corporation, notes, bonds, debentures and other evidence of indebtedness, commodities, commodity contracts or derivatives, and any other financial instrument for which the Secretary determines reporting adjusted basis is appropriate.
What are “covered securities”? The term “covered security” refers to specified securities which are acquired after their applicable effective date. Covered securities are therefore those securities subject to the basis reporting requirements. Because the regulations stipulate that a specified security is only covered if it is received for cash, certain stock acquired through other transactions is not covered. Stock granted by an employer is not covered because it is not acquired for cash. Conversely, stock acquired by the exercise of rights distributed by an issuer is a covered security because it is acquired for cash. The regulations further treat a security acquired by stock dividend, stock split, reorganization, redemption, stock conversion, recapitalization, corporate division, or other similar action as if it were acquired for cash and, therefore, as a covered security if the basis of the new security is determined from the basis of a covered security.
What will brokers have to report? The regulations instruct brokers to report basis as the total amount of cash paid by a customer or credited against a customer’s account when securities are acquired, adjusted for commissions and fees from the purchase of the security and other events in the account such as a stock split.
When do these reporting requirements go into effect? For stock in a corporation, the applicable date is January 1, 2011 except for shares of a mutual fund and stock held in a dividend reinvestment plan (DRP), in which case the applicable date is January 1, 2012. For any other specified security, the applicable date is January 1, 2013 or a later date determined by the Secretary of the Treasury.
How is basis to be calculated on wash sales? Although taxpayers must comply with the wash sale rules of Code section 1091 for sales of securities that are substantially similar to securities acquired within 30 days of a sale, brokers are only required to report wash sales when the securities have the same CUSIP number. Further, brokers are only required to report wash sales when the purchase and sale transactions occur in the same account. Taxpayers must still comply with the wash sale rules whether the transactions occur in the same or different accounts.
Are securities acquired by businesses covered? It depends. Securities acquired by S corporations or partnerships are covered securities if bought after the applicable date. However, securities acquired by S corporations in 2011 are not covered. Securities acquired by C corporations are never covered.
In the case of a short sale, at what point is reporting required? For short sales opened on or after January 1, 2011, brokers must report the sale for the year in which the short sale is closed. Previously, brokers reported the sale for the year in which the short sale was opened.
Is transfer reporting ever required for short sales? Yes. A transfer statement is required if a customer who has entered into a short sale at a broker borrows securities from another broker and delivers the borrowed securities to the first broker to satisfy the obligation to the first broker. What are the new reporting obligations imposed on issuers of securities? An issuer of a specified security must file a new information return with the IRS that describes any organizational action it takes that affects the basis of the security (such as a stock split or merger) within 45 days after the date of the organizational action (unless the action takes place in December, in which case the return must be filed by January 15 of the following year). The return must identify the issuer and security affected by the action, provide information and a detailed description of the action, and explain the quantitative effect on the basis of the security. Additionally, the issuer must furnish a copy of the return to each holder of the security by January 15 of the year following the action. These requirements apply to corporations (except for mutual funds) for organizational actions on or after January 1, 2011, that affect the basis of the corporation’s stock. Mutual funds must report all organizational actions taken on or after January 1, 2012, that affect the basis of the fund’s stock.
If securities affected by an organizational action are held by someone other than the holder, to whom must the issuer report the action? When securities are held as nominee by someone other than the holder of record, such as a broker or custodian, the issuer is required to furnish the issuer statements to the nominee listed on its books, unless the nominee is the issuer itself or the issuer’s agent.
Is there an alternative to mailing the issuer statements to each holder or nominee? Yes. The regulations waive the requirement to file the issuer return with the IRS and furnish issuer statements to holders and nominees if the issuer (1) posts the return in a readily accessible format to a section of its primary public website dedicated to the sole purpose of reporting organizational actions; (2) posts the return by the same due date for reporting the action to the IRS; and (3) keeps the return accessible to the public for ten years on its website or the primary public website of any successor organization.
Must an S corporation report organizational actions to shareholders even though it furnishes them a Schedule K-1 each year? No. Although S corporations are not exempt from the reporting requirements concerning organizational actions, the regulations consider an S corporation to satisfy its reporting obligations if the organizational action’s effects are reflected on a Schedule K-1 for each applicable shareholder, the K-1s are timely filed with the IRS, and copies of the K-1s are timely furnished to all applicable shareholders.
How must a broker determine basis when a sale includes securities acquired on different days or at different prices? What if the acquisition date is unknown for some shares? If a customer acquires securities on different days or at different prices and sells less than the entire position in an account, a broker must report the sale consistently with the customer’s identification of the security to be sold if the customer provides the broker an adequate and timely identification. If the customer does not provide an adequate and timely identification when selling securities other than mutual fund or DRP stock, the broker must first report the sale of any shares or units in the account for which the broker does not know the acquisition or purchase date followed by the earliest shares or units purchased or acquired, whether covered securities or noncovered securities. For mutual fund or DRP stock (for which a customer may average the basis of the stock), a broker must report adjusted basis in accordance with its default method unless the customer notifies the broker that the customer elects a different permitted method.
Must brokers use the average basis method to determine basis? The regulations permit taxpayers to average the basis of identical shares of mutual fund or DRP stock. Brokers must use the average basis method when determining basis for this stock if a customer elects the method and notifies the broker of the election. Brokers may also choose the average basis method as its default method when determining basis for mutual fund and DRP stock unless a customer elects another permitted method.
What qualifies as “identical” shares of stock? Shares of stock are identical when they have the same Committee on Uniform Security Identification Procedures (CUSIP) number or other security identifier that the IRS may designate in later published guidance. For purposes of averaging the basis of identical stock, stock acquired in connection with a DRP is not identical to stock with the same CUSIP number that is not in a DRP.
42. If the DRP’s plan documents do not require that at least 10% of every dividend paid be reinvested in identical stock, may the taxpayer use the average basis method for stock held in the plan? No. If the plan documents do not provide for the reinvestment of at least 10 % of every dividend in identical stock, the plan is not a DRP for purposes of the average basis method. 43. Will a plan still qualify as a DRP if the issuer of the securities has never paid dividends or if it suspends dividends? Yes. The regulations provide that a stock may be held in a DRP even if the issuer has never paid dividends or the issuer has suspended dividends. Can a taxpayer who has been using the double category method of determining average basis for mutual fund stock continue to do so? No. The regulations provide a transition rule for taxpayers using the double category method for mutual fund shares. On April 1, 2011, the basis of stock for which the average basis method has been elected is computed by averaging the basis of all identical stock in an account regardless of the holding period.
How and when is the average basis method elected? Starting in 2012, a customer elects the average basis method by notifying his or her broker of the election in writing. A taxpayer may make a written average basis election electronically. The regulations provide that a customer may elect the average basis method at any time. The election takes effect for sales that occur after the election.
When is a taxpayer permitted to revoke an average basis election or change from the average basis method? A taxpayer may revoke an average basis election by the earlier of one year from the date of making the election or the first sale or other disposition of the stock following the election. After a revocation, the taxpayer’s stock basis is the basis before averaging. However, a taxpayer may change from the average basis method to another permissible method prospectively. The regulations do not limit the number of times or the frequency at which a taxpayer can change his or her basis determination method. Following a change, the taxpayer’s stock basis remains the same as the basis immediately before the change.
If a taxpayer owns shares of the same mutual fund in different accounts, can he or she make an average basis election for only some of the accounts? Yes, but only after December 31, 2011. Prior to 2012, the regulations require that an average basis election apply to all shares of a particular mutual fund in all accounts in which a taxpayer holds the fund. Starting in 2012, a taxpayer may elect to average basis for a particular mutual fund in one account but not in another account.
Can taxpayers average the basis of different lots of identical stock purchased on the same day? Yes. Taxpayers must calculate the average of the basis of multiple lots of identical stock purchased at separate times on the same day if the stock is purchased in a single trade order and the broker executing the trade provides a single confirmation reporting the aggregate total cost or average cost per share. However, a taxpayer is permitted to calculate basis by actual cost per share if he or she informs the broker in writing of this intent.
When must taxpayers elect specific identification as their lot selection method? Taxpayers must identify stock sold by the earlier of the settlement date or the time for settlement under SEC regulations.
Can a taxpayer use a standing order to specify a lot selection method? Yes. A broker may permit a taxpayer to identify lots to be sold by a standing order.
Is there any specific way that a taxpayer must communicate a lot selection? No. In order to enable the greatest flexibility to taxpayers, there is no specific method designated by the regulations for communicating a lot selection.
How is specific identification achieved in an estate or trust? A trustee of a trust or executor of an estate satisfies the specific identification requirements if he specifies the stock in writing in the books and records of the estate or trust. If the stock is distributed, the trustee or executor must identify the stock in writing to each distributee.
Can gifted or inherited securities be covered? Yes. If gifted or inherited securities were covered in the account of the donor or decedent, they remain covered upon receipt by the donee or heir. Covered securities transferred by gift or inheritance must be accompanied by a transfer statement that indicates that the gifted or inherited securities are covered securities. In the case of inherited securities, the transfer statement must also report the date of death and the stepped-up basis as of the date of death or as reported to the broker by the authorized representative of the estate. In the case of gifted securities, the transfer statement must include the donor’s adjusted basis, the donor’s original acquisition date, the date of the gift, and the fair market value of the gift on that date. The transferor is only required to compute the fair market value of the securities on the date of the gift if the value is readily ascertainable at the time of the transfer.
Copyright 2012 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. Articles in this publication are not intended to be used, and cannot be used, for the purpose of avoiding accuracy-related penalties that may be imposed on a taxpayer. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536
--Last Update 02/06/12