PHOENIX -- Mandated cost-basis reporting has arrived and while most dealer-brokers and financial advisors have been preparing for this eventuality for almost four years, 2011 marks the first year they'll have to actually figure out how to do it.
A byproduct of the Emergency Economic Stabilization Act of 2008, better known as the Wall Street bailout bill, mandatory cost-basis reporting takes effect this year for any equities acquired on or after Jan. 1.
Eventually, the requirement will extend to mutual funds, dividend reinvestment (DRIP) plans and private placements (January 2012) and debt securities, options and private placements (January 2013).
Failing to provide accurate, adjusted cost-basis data to the IRS and clients on their Form 1099-B can result in penalties up to $350,000 a year for broker-dealers and up to $5,000 for individual investors who willfully disregard the new law.
"This is not a new tax law, but a new reporting requirement," Bob Linville, director of product management at Broadridge Financial Solutions, told attendees Tuesday during an educational session at the OneVoice 2011: FSI Broker Dealer Conference. "Now brokers are involved in gathering and capturing all that information and reporting those losses and gains."
"In that sense, it's a big change and brokers are involved in many ways," he added.
While cost-basis data, which will be used by the IRS for taxing capital gains, is readily available in most broker-dealer computer systems, extracting that data in an efficient fashion and then delivering it a manageable form to investors on their 1099-B forms poses the real challenge.
Further complicating matters is the fact that investors will now have the option of choosing which lot or lots of equities they will designate to formulate that cost basis. Historically, brokers have used "average cost" as the method for determining the cost basis for investor transactions. Now, for example, investors can opt for "last in, first out" or "specific identification" as their preferred methods for determining the adjusted cost basis for their transactions.
While it's still early in the game, Linville said scrambling to develop the internal data-collecting applications needed to the calculations and determine basis. Early examples of how this new requirement is impacting advisors is found with stock gifts to family members were investors almost assuredly have a particular lot in mind to gift in order to reduce tax liability.
"In the past year since the regulations have been finalized, the brokerage community has put lot of energy into how to use their existing automated system that were not intended to be used for all kinds of assets to transfer basis," he said. "There's still a big challenge there."
To simplify the process and alleviate some of the inherent challenges of transferring investor cost-basis information between firms, a significant portion of the broker-dealer community are now participating in the Cost Basis Reporting Service, an automated system that gives them the ability to transfer the data from one firm to another on any asset transfer.
Linville said before the cost-basis reporting requirement was all but assured, there were only 67 active members. Now, he says there are almost 150 participants and at least 80 of the newbies are transfer agents and, fortunately for investors and advisors, most of them are the biggest and most active firms.
It's a good start, Linville said, but it's not nearly enough to ensure smooth and relatively painless compliance for broker-dealers and their clients.
"We all know how many thousands of banks there are out there, but thus far only about 20 or so have joined CBRS," he said.