Rescue law requires cost basis reporting

Under the financial-rescue law signed Oct. 3 by President Bush, brokerage firms and mutual fund companies must report their customers’ cost basis when securities are sold.

The provision was included in the Emergency Economic Stabilization Act, which allows the government to purchase bad mortgage debts from banks.

Requiring financial services firms to report the information to the Internal Revenue Service will result in better compliance with tax laws, according to the Government Accountability Office and National Taxpayer Advocate Nina Olson.

AN ADDED BURDEN

The brokerage and mutual fund industries have voiced numerous questions about how cost basis reporting would work.

“It will be something that they’ll adapt to and live with it, like they did with basic 1099 reporting,” said Stevie Conlon, tax director of GainsKeeper, a division of Wolters Kluwer Financial Services of Minneapolis. She works in the Waltham, Mass., office of the company.

Form 1099 is an income information form that financial services firms must give their customers and submit to the IRS annually.

“It’s an additional burden, but probably incremental,” Ms. Conlon said.

GainsKeeper is an automated system used by brokerage and financial services firms to provide cost basis reporting.

The Securities Industry and Financial Markets Association, which is based in New York and Washington, “has worked long and hard with Congress on the technical issues surrounding [the new law], and we believe the current cost basis package provides both the time and the parameters necessary so the industry can successfully implement the program,” SIFMA spokesman Travis Larson wrote in an e-mail.

The provision is estimated to increase tax revenue for capital gains taxes by about $7 billion through 2018.

Previously, brokerage and mutual fund companies had to report gross proceeds when clients sold stock.

Under the legislation, they will also have to report the cost basis for the securities sold as well as whether the sales are short-term gains — for holdings of a year or less — or long-term gains.

Long-term gains are taxed at capital gains tax rates, while short-term gains are taxed at higher ordinary income tax rates.

Financial firms will have to report the cost basis for stock acquired after Jan. 1, 2011. Mutual fund shares or stock eligible for a dividend reinvestment plan acquired after Jan. 1, 2012, also will have to be reported.

Other types of securities, principally debt securities and options acquired after Jan. 1, 2013, must be reported as well.

There are several difficulties that brokerage firms and mutual funds could face in reporting cost basis, Ms. Conlon said.

One such challenge is that stock splits and mergers must be taken into account.

In addition, wash sales also will have to be accounted for in a simplified form, Ms. Conlon said. Wash sales are sales of securities at a loss in one year, followed by repurchasing the same security the following year in order to claim an unrealized loss as a tax deduction.

Under tax law, such losses are disallowed, and the loss is required to be deferred.

“It’s easy to think of how it could have happened in the current market,” Ms. Conlon said of such sales. Worried investors could have sold shares in a distressed financial services firm and decided to repurchase the same stock after reading upbeat news about a possible bailout, she said.

E-mail Sara Hansard at [email protected].