Congress seeks comment on cost basis reporting

WASHINGTON — The Senate Finance Committee has taken the unusual step of asking for public comment on a legislative proposal for a bill that would require brokers and mutual funds to report the cost bases of their customers’ securities transactions. Legislation requiring cost basis reporting was first introduced last year in Congress by a bipartisan group led by Sen. Evan Bayh, D-Ind., and it was reintroduced this year (InvestmentNews, Feb. 12). A proposal issued by the Finance Committee on May 25 includes newly added sections stipulating that brokers and mutual funds would have to report cost basis information to the Internal Revenue Service no later than 45 days after a security’s sale or transfer to another financial services firm. Large tax gap The legislation would take effect for securities acquired after 2008, or 18 months after enactment. The Finance Committee is asking for public comment on the issue by June 30. Unlike regulatory agencies, Congress seldom issues legislative proposals for public comment.
“There’s general recognition that there are a lot of issues to be sorted out if this is going to work,” said Keith Lawson, senior counsel for tax law at the Investment Company Institute in Washington. The idea of making financial services firms report securities’ cost bases to the IRS and to their customers has been endorsed by the Government Accountability Office in Washington and National Taxpayer Advocate Nina Olson. It was proposed as part of President Bush’s fiscal 2008 budget proposal. As of 2001, the latest year for which calculations are available, the IRS estimated that the “tax gap” associated with underreporting capital gains was about $11 billion. The tax gap, which is estimated at $345 billion a year, is the amount of taxes owed, but not paid, to the federal government. Proponents of the plan argue that cost basis reporting not only will help increase government revenue but will help taxpayers who have trouble keeping track of their cost basis. Financial advisers like the idea, as well, because it could help them calculate their clients’ tax liability. Although accepting the likelihood that Congress will enact cost-basis-reporting legislation, perhaps as early as this year, the brokerage and mutual fund industries caution that such reporting is complicated. For instance, financial services firms may not have access to some information needed to compute cost basis accurately, Mr. Lawson said. If securities are transferred from one owner to another, firms have no way of knowing if the security was purchased or whether it was a gift. If gift taxes are paid for the transfer, the tax should be included in the cost basis of the shares, Mr. Lawson said, and firms won’t know whether the donor paid the tax. In addition, rules need to be adopted for calculating cost basis, because there are several ways to do so, he said. The industry also needs more than the 18 months allowed in the draft legislation to implement it, Mr. Lawson said. It took about two years for the industry to implement a 2005 Securities and Exchange Commission rule allowing redemption fees to combat market timing, and “that rule is a lot simpler in terms of its application,” he said. The legislative draft has “left a lot to [the Department of the Treasury] to fill in the blanks,” said William Paul, a partner with Washington law firm Covington & Burling LLP. The draft doesn’t address what firms should do if they don’t have information they are required to report, he said. Security holders can have accounts with more than one financial services firm, Mr. Paul said, which could make it difficult for firms to compute cost basis accurately. Advocates of cost basis reporting note that most large brokerage firms already use a cost-basis-reporting service operated by the Depository Trust and Clearing Corp. of New York.