Author: William H. Byrnes & Benjamin S. Terner

Why is this Topic Important to Wealth Managers? Provides wealth managers with information relating to client transactions and reporting to the Internal Revenue Service beginning next year.

The Energy Improvement and Extension Act of 2008 created new laws requiring most regulated securities transactions occurring after December 31, 2010 to be subject to cost basis reporting by securities brokers to the IRS. [1] Currently, brokers are required to report the gross proceeds from the sale of a security on Form 1099. [2] The new law will add reporting of client’s adjusted basis of the security, and whether the gain is a short or long-term.  [3] Mutual fund cost basis reporting is to start a year after regulated securities reporting, and options and debt contracts are to follow a year after mutual funds.  The reports are to be filed on a Form 1099-B, Proceeds from Broker and Barter Exchange. [4]

Why is it important to know that the IRS will be receiving information about the values of securities of clients?

Generally, gain determination for the sale or exchange of a capital asset is the sales price minus what the asset was acquired for, or the cost basis. [5]

Until now, gain determination, which directly effects tax liability, has largely been a task for accountants.  The new law fundamentally changes how gains will be calculated by the Treasury;  going forward, it will have all the information it needs to calculate tax liabilities for taxpayers from transactions occurring on capital markets. [6]

Now, under Form 1099 reporting by brokers—“basis, sales price, and type of gain, the IRS can track” what was paid for the stock, what the stock was sold for, and whether the gain is short term or long term. [7] There is now little room for error for individuals purchasing securities to correctly report gains from transactions on stocks.  If the IRS receives information from the broker that does not match information on the client’s tax return, “the mismatch should trigger an IRS inquiry.” [8]

The effort is part of the Federal initiative of finding “innovative ways to reduce the tax gap and improve compliance.” [9] Internal Revenue Service Commissioner Shulman states the new law “will go a long way to reducing [miscalculated gains] and making things easier for investors.” [10]

Also, the requirements for reporting continue—a broker who transfers custody of a security to another broker must include an accompanying written statement with information to determine basis. [11] Moreover, once an issuer of stock takes an organizational action such as a stock split, merger, or acquisition that affects basis, an issuer must report to the Service and to each stockholder or nominee a description of any such action and the quantitative effect of that action on basis. [12]

The Commissioner relates to the issue personally, “I don’t know about you, but I have spent far too much time digging through old records, trying to find the basis for securities I sold.  I think investors…and I count myself one …will welcome getting this new, easy-to-understand information from their brokers.” [13] Others may disagree with the Commissioner but, time should tell.

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[1] Section 403 of the Energy Improvement and Extension Act of 2008, Div. B of

Pub. L. No. 110-343, 122 Stat. 3765, enacted on October 3, 2008, added sections

6045(g), 6045A, and 6045B to the Code. Section 6045(g) 6045(a); Notice 2010-67.  http://www.irs.gov/pub/irs-drop/n-10-67.pdf.  Last Accessed 11/7/2010.

[2] 26 U.S.C. § 6045.

[3] Id.

[4] See  26 U.S.C. § 6045; 26 CFR § 1.6045-1.

[5] See generally, 26 U.S.C. §§ 1001, 1011, 1012.

[6] Arden Dale.  The Wall Street Journal.

Cost Basis to Come on 1099B’s.  http://online.wsj.com/article/SB10001424052748704763904575550461405074090.html.  October 14, 2010.  Last Accessed 11/22/2010.

[7] Robert W. Wood.  “Forms 1099 For Cost Basis: What, Me Worry?”.  Forbes-The Tax Lawyer.  Oct. 20 2010.  http://blogs.forbes.com/robertwood/2010/10/20/forms-1099-for-cost-basis-what-me-worry/.  Last Accessed 11/22/2010.

[8] Robert W. Wood. Forbes-The Tax Lawyer.

[9] Internal Revenue Service Commissioner Douglas Shulman.   Prepared Address to The American Payroll Association’s and American Accounts Payable Association’s 28th Annual Congress. IR-2010-68.  May 27, 2010, Washington, D.C.

[10] Douglas Shulman.  IR-2010-68.

[11] 26 U.S.C. § 6045(g).

[12] 26 U.S.C. §  6045B.

[13] Douglas Shulman.  IR-2010-68.