New Headache: Cost Basis Reporting Broker Responsibility in 2011

May 13, 2010

Last May, we informed you about the changes in reporting as a result of the Emergency Economic Stabilization Act of 2008, which would be in effect January 1, 2011. The start date is now drawing near and it could have a major effect on your reporting of equity (stock) transactions. The new requirements place the responsibility for cost basis reporting for all equities in the hands of your broker. The form 1099-B will change to include the new information for adjusted cost basis.

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. Formerly the IRS relied largely on investors to come up with their own cost-basis numbers.

Shareholders often obtained the information needed to calculate cost basis from the corporate issuer or its transfer agent, the mutual fund complex or the broker-dealer - with varying results of time and accuracy. As of January 1, 2011 that will change.

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.

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.

In addition, the legislation set start dates for all mutual funds and dividend reinvestment plans (DRiP) shares acquired on or after January 1, 2012. Other specified securities types, such as debt issues, options, private placements acquired will begin on or after January 1, 2013.

Brokers are required to provide cost basis information to the counterparty receiving an investor's account. The share positions can move independently of the cost basis infor­mation. Under current industry practice, the cost basis information must be sent to the receiving counterparty within 15 days after the actual share positions have been moved.

The penalties for inaccurate reporting can be very steep, especially for those intermediaries that report inac­curate cost basis for a high number of investor/shareholder accounts. 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.

As we approach the January 1, 1011 deadline, we will share additional information on this new reporting responsibility.

For more information, please contact your Perelson Weiner partner.

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