As cost-basis reporting becomes a reality, the investment industry is facing one of the most sweeping legislations of our time. This legislation impacts most aspects of shareholder interaction, including new account openings, trading and reporting. Firms face increased expenses implementing the legislation through increases in staffing requirements for trade processing and investor education and system enhancements.
While compliance with the new regulation is daunting, through its implementation true opportunities present themselves to the industry: shareholders will have access to their cost-basis information, while funds and firms can distinguish themselves by demystifying the subject for their shareholders by providing premium cost-basis services.
An IRS analysis of the 2001 owed, but unpaid, taxes indicated a $345 billion loss, $11 billion of which was attributed to under-reporting of taxable gains. This led the Government Accountability Office to recommend more accurate cost-basis reporting through legislation. Through this new law, the IRS is expected to recoup unpaid taxes in excess of $6 billion over a 10-year period.
Today, many mutual funds and broker/dealer firms provide average cost information as a value-added service to shareholders even though there is no legal obligation to do so. There is also no requirement to report cost-basis data to the IRS. In addition, when accounts are transferred from one broker/dealer or mutual fund to another, the current law does not require the exchange of cost-basis data.
Beginning January 1, 2011, the first phase of the new IRS cost basis regulations go into effect. Mutual funds and broker/dealers must start reporting complete and accurate short-term and long-term gain/loss for redemptions of mutual fund shares acquired on or after January 1, 2012. Providing incorrect information can result in stiff penalties. Additionally, shareholders may begin choosing any of the IRS approved lot identification and basis methods (Average Cost, Specific Identification or First-In, First-Out). The 1099B and IRS electronic filing formats will be revised to support the reporting of the gain/loss data. After January 1, 2012, Broker/dealer firms and mutual funds must exchange cost-basis data for accounts transferred between them so that the receiving broker has all the information needed for complete and correct cost-basis reporting on subsequent redemptions.
Firms need to ensure that their shareholder accounting systems are fully compliant with the new regulations and support the shareholders' choice of cost-basis computation methods, the tracking and identifying of purchase lots for redemptions, and make adjustments for wash sales and sales load deferrals when determining a transactions gain or loss. Further, pre- and post-effective date acquired shares may need to be considered as separate accounts. Redemption gain/loss data must be reported on 1099Bs and IRS electronic filings of the data must be maintained for future corrections. The complexity of implementing solutions to these new regulations is high, and funds and firms must not delay any further in starting to build solutions or partnering with vendors.
To facilitate compliance with the new law, the Department of the Treasury and the IRS continue to issue guidance on the new reporting requirements and basis rules. You can influence or obtain information on the regulation from the Investment Company Institute, National Investment Company Service Association, Financial Information Forum and other similar organizations. They are actively engaged in seeking clarifications and suggesting changes on the new requirements. They also sponsor cost-basis task forces, reporting panels, working groups, webinars and round tables. The LinkedIn Cost Basis Community is another great place to gather practical information on the subject.
Shareholders could benefit from these changes by using the cost-basis data to manage their tax bills. Investor education on various tax lot relief methods will get a boost when the new law gets implemented.
Unfortunately, shareholders may ultimately bear the cost of these additional services through increase fund expenses.
Mutual funds and broker/dealer firms should view these new regulations as an opportunity, and embrace the necessary upgrades to their systems.
By providing real-time cost-basis data to shareholders through web portals and other means, firms can earn the distinction of having a strong customer focus. Further, firms can provide industry leadership, enhance customer satisfaction and create loyalty by simplifying the process for shareholders through offering and supporting advanced lot selection strategies such as "Maximize Losses-Long-Term then Short-Term" or "Maximize Losses-Short-Term or Long-Term." These allow shareholders to manage their finances to a desired tax result without having to spend the time to figure out which purchase lots need to be redeemed to meet the goal. Making all of this information available on demand via the web has the added benefit of reducing a company's servicing cost and putting control into their shareholders' hands.
With a little planning and a lot of work, fund companies and broker/dealers can get ahead of their competition and delight their clients as cost-basis reporting requirements become reality.