Vast changes to cost basis reporting rules are set to go live in 2012. These changes will challenge - and possibly cause headaches for - advisors and their clients.

For the first time, custodians and brokers will have to report detailed cost basis information on equities acquired on or after Jan. 1, 2011 to advisors' clients (on a revised Form 1099-B), as well as to the IRS. Mandatory cost basis reporting will extend beyond equities to mutual funds, DRIPs and most ETFs acquired after Jan. 1, 2012.

If you haven't formulated a plan to deal with these developments, you shouldn't wait. The initial legislation that took effect this year will have a huge impact on the upcoming tax season. What's more, a second round of new and complex requirements are set to begin Jan. 1, 2012, and these will affect even more advisory firms.


This legislation has resulted in numerous changes in areas like cost basis default methods, specified lot decisions and other aspects of cost basis reporting and planning. Not surprisingly, there is great potential for confusion, uncertainty and mistakes in the wake of this massive shift - especially as millions of investors contend with new and unfamiliar tax forms and filing requirements over the next several months.

Expect call volume at planning firms to soar during the next few months as investors begin receiving 1099-B's that look very different from what they have received in the past. Schwab alone will send out more than 800,000 revised Form 1099-B's with cost basis information to clients of advisors, and to close to 3.2 million households overall.


Frankly, even if you have made preparations, the next few months are going to be challenging. However, there are steps you can take now to make the new rules cost basis reporting process much smoother - and even ways to take advantage of the new legislation to strengthen your client relationships and grow your business.

Here are key steps you need to take right now:

* Synch up with your custodians. Make sure you have a reconciliation process in place to ensure there are no discrepancies between your internal cost basis information in your system and the data held by your custodians. Otherwise, errors could occur that result in unintended outcomes - generating a capital gain instead of a capital loss, for example, if your share-lot information doesn't match your custodian's - and unwanted IRS attention if clients report costs basis data on their tax returns that differs from their Form 1099-B.

* Talk to clients now. Start by reaching out to clients about the revised Form 1099-B's that they'll begin receiving soon. Obviously, many clients who own individual stocks and are directly affected by changes that began in 2011 will need guidance. Say, for example, that you have provided cost basis and realized gain/loss information to those clients in the past and told them to use your data instead of what they get from their custodians. Since the IRS now considers custodians to be the authoritative sources of cost basis information, you'll want to instruct clients to pay close attention to the custodian's data and explain why.

That said, even if you offer only mutual funds and ETFs, and aren't yet affected by the legislation, you can be sure clients will be confused by the redesigned tax form. Don't just wait for these questions to roll in. Get out in front of the issue by telling clients why they will now receive cost basis information on their 1099s, and what specific information they are responsible for reporting on their tax returns.

If you report cost basis information for uncovered securities as a value-added service, for example, tell clients that they need to report that information on their returns (even through it's not being sent to the IRS). And if you work with more than one custodian (or your clients have multiple advisor relationships), let them know they may receive cost basis data in multiple formats and walk them through the differences.

Consider developing a one- or two-page summary sheet overview of the new 1099-B's impact on tax preparation and sending it to clients and their tax professionals. Your custodians may be a good resource for such materials. For example, Schwab has created a toolkit for advisors' clients that includes a guide to the new tax reporting rules, a how-to guide on reading the new 1099 and an online interactive demo that takes clients through the new form.

While you've got their attention, take the opportunity to talk about the new changes that go into effect on Jan. 1, and affect mutual funds, DRIPs and ETFs bought on or after the first of the year. In particular, the changes to the average cost method could have tax consequences for clients in 2012. Start a discussion about whether they'll want to use the average cost method or select a different approach, based on their tax situation and goals. You can then revisit the topic over the course of the year.

* Get your team ready. Cost basis reporting will differ from custodian to custodian in many cases. Therefore, you and your team need to know how each of your custodians will report cost basis data for the 2011 tax year, and understand the tax implications so that you can relay those facts accurately to clients and their CPAs. Some custodians are educating advisors in these areas through webcasts, regional meetings and conference calls. As you arm yourself with the specifics of each firm, create a grid listing each custodian's key information so that you and your team can access it quickly.

Also, start preparing staff for the second phase of legislation beginning next month. For example, you'll want to know your broker's default reporting method for fund and ETF shares, and decide if you want to use a different approach for determining gain/loss for clients' shares.

Another key issue on the horizon is fund positions with two average costs: one for shares affected by the legislation and another for shares that aren't. Currently held funds won't be covered by the legislation, but additional shares of the same funds bought after Jan. 1, will be covered - and those share lots will have to be tracked separately for cost basis purposes. Other key changes related to transfers, inherited shares and wash sales should be understood fully by the entire organization to ensure smooth client service.

* Capture new opportunities. The legislative changes also offer some sizable benefits. Chief among them: The ability to strengthen loyalty among your existing clients. By helping to guide clients through these complex new reporting rules and save them time and stress, you can enhance your value in their eyes. That, in turn, gives you an opportunity to show clients working with multiple advisors the advantages of working solely with you - and capture additional assets.

You might also be able to save time and money. Because gain/loss information will now be included on the 1099-B's issued by custodians, you may no longer need to send out annual in-house gain/loss reports to clients (depending on whether your custodian will include cost basis information on both covered and uncovered securities). That could potentially free up significant staff time and expense that you can reallocate to other, more profitable tasks.

The opportunities the new cost basis legislation offers can outweigh the challenges. Advisory firms can guide clients and CPAs through this transition with less confusion and stress - and, in doing so, showcase their own value and high-level service.

Brian Keil is director of cost basis and tax reporting for Charles Schwab.


Register or login for access to this item and much more

All Financial Planning content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access