Cost-Basis Burdens Looming
New reporting rules present operational, technology hurdles
November 17, 2008
Under the recently passed economic bailout bill, brokerages, mutual fund companies, issuers and their transfer agents will face new cost-basis reporting requirements that are likely to pose substantial administrative and technological challenges. Software and service providers are adapting quickly to the mandate, accommodating firms who have until 2011 before they must begin reporting customers' cost basis when selling certain products.
Depository Trust & Clearing Corp. (DTCC) last week said it has bolstered AccuBasis, an online cost-basis reporting service used by 35 brokers, banks, transfer agents and issuers including Aflac, Walt Disney Co., Johnson Controls and First American Stock Transfer. Last month, Eagle Investment Systems, a unit of Bank of New York Mellon Corp., announced that its investment accounting solution now supports the new reporting requirement, while Wolters Kluwer Financial Services has rolled out enhanced tax reporting functionality for short sales on its GainsKeeper platform.
Although some of the largest brokers, mutual funds and transfer agents offer cost-basis accounting as part of their customer service functions, they have only been required to report to the Internal Revenue Service the gross proceeds of their clients' stock and mutual fund sales on 1099 forms. That means that the IRS has relied largely on investors to come up with their own cost-basis numbers. Those shareholders, in turn, often obtain that data--or the information needed to calculate it--by calling up the corporate issuer or its transfer agent, the mutual fund complex or their broker-dealer. Such requests can take days and there's no guarantee the data will be accurate.
"The burden of disclosure and accuracy will now be placed on the brokerage firms and mutual funds, which have to report the cost basis for the accounts as well as whether the sales are short-term gains--for holdings of a year or less--or long-term gains," explained David Eich, president of Armen Computing, an Inman, S.C.-based accounting firm and software provider catering to active traders. "Short-term gains are taxed at higher ordinary income tax rates while long-term gains are taxed at lower capital gains tax rates."
Broker-dealers, mutual funds and others that provide the IRS and investors with inaccurate 1099s will be fined $100 for each form, with an annual cap of $350,000. If an error is deemed intentional, the penalties are even higher.
The reporting requirements were included in the Oct. 3 Emergency Economic Stabilization Act as a revenue-generating provision. However, the IRS, which projects it can take in an extra $7 billion in taxes over the next decade with more efficient cost-basis reporting, has yet to come up with specific compliance rules for financial firms. Given the complexities of computing adjusted cost basis, meeting the impending deadline could be problematic and costly. Estimates range from $100,000 to over $1 million, depending on the size of the firm, the types of products traded and its current practices.
Tiered Approach
"Brokerage and mutual fund systems must capture adequate information for any stock acquired during calendar year 2011," said Stevie Conlon, tax director of Minneapolis-based Wolters Kluwers' GainsKeeper unit. If they do not, "it would be impossible to compute the adjusted basis needed for information returns due in 2012."
Due to the varying methodologies used for different instruments, the IRS is taking a three-tiered approach to cost-basis reporting. Stocks acquired after Jan. 1, 2011 fall under the legislation, as do mutual fund shares and dividend reinvestment plans purchased in 2012. Beginning in 2013, debt instruments, options and other securities are included.
