By Steven M. Etkind and Roger D. Lorence – The 2008 Energy Act required the Internal Revenue Service (the “IRS”) to issue rules effective January 1, 2011 specifying how broker-dealers in securities that provide Form 1099-B (information return of broker-dealers to their customers) are to include data on the recipient’s tax basis in securities sold. The IRS has issued those rules, with very little time to spare, given the enormous complexity of the rules and the IT systems changes necessary to implement this new tax reporting system.
It can be a difficult task for any taxpayer to determine their adjusted tax basis in any given lot of securities sold during the year. These difficulties are compounded in the case of securities received by gift, received from an estate, securities of issuers that have had a stock split, a stock dividend, a nontaxable merger or other acquisition, have been sold in a short sale, are foreign securities, or are securities of a mutual fund or real estate investment trust that has a DRIP (dividend reinvestment program). These difficulties did not deter Congress from requiring broker-dealers to report adjusted tax basis to customers. We briefly underline below some of the issues.
Overview of the New Rules’ Mechanics
The new reporting regime requires the issuer of a Form 1099-B to report adjusted tax basis in “stocks” disposed of during the year and any gain or loss is long-term or short-term. The final regulations define “stocks” so that, in general, all stocks of both U.S. and foreign issuers is covered.
The rules apply, generally, to securities in accounts opened at the broker-dealer on or after January 1, 2011, and to securities transferred to an account opened after that date from another account covered by the new regime. However, this is only if the receiving broker receives a statement from the transferring broker providing the tax data needed by the receiving broker to issue a Form 1099-B with respect to that security under the new regime. In general, a First In, First Out (“FIFO”) system for selecting which lots are sold in a multi-lot position is followed (that is, stocks sold are treated as the oldest held in the account) unless the account holder has instructed the broker otherwise.
Although the statute authorizes the IRS to require tax basis reporting for virtually all securities and commodities, in this first round only “stocks” are “covered securities” to which the new rules apply. Special rules are provided for reporting for stocks of regulated investment companies (mutual funds and listed closed end funds) and for stocks acquired through a company’s DRIP, as well as for stocks sold short, which now will be reported in the year the short sale closes, rather than the year the short sale is entered into (replacing this confusing rule of current law is helpful).
An important extension of the Form 1099-B regime is to account holders that are S corporations, which are treated here as a partnership (as it is under certain other tax rules) but the new regime will only apply to securities acquired by an S corporation on or after January 1, 2012.
New Types of Statements to Support the New Regime
Two types of statements will be required: (1) a statement by a transferring broker to the receiving broker with respect to an account that includes covered securities; and (2) a corporate issuer of stocks that have experienced a corporation event with respect to a covered security, such as a stock split, merger or acquisition. Category 1 statements must be furnished no more than 15 days after the transfer of the covered security.
Because of the lateness of the final regulations’ issuance, the IRS issued a notice providing that brokers will, in general, not be liable to penalties for providing the statement upon transfer of covered securities during 2011. Category 2 statements must be furnished to the nominee or certificate holder by January 15th of the year following the year in which the corporate event occurred. In lieu of the actual delivery of the statement, the issuer can make the information regarding the corporate event publicly available, in a format to be prescribed by the IRS.
Points to Be Aware of as a Customer
The new tax reporting regime has been widely reported as likely to have an extended and vexing tryout period. As a customer you will want to consider:
Beefing up internal accounting and compliance functions to make sure that you can reconcile the Forms 1099-B you receive in 2012 with the information in your own records.
The Best Way to Reconcile Errors. It is likely that there will be differences between the information in your records and the Form 1099-B from the broker, e.g., double counting of sales, understatement of tax basis, all sorts of other errors. Because so many forms will have erroneous information, you will need to include copies of the schedules in your 2011 tax returns showing the erroneous information and removing it from the information you report.
Don’t be hasty when you get your first forms. As is true of Form 1099-B presently, it is likely that you will receive both original and corrected forms.
Mark-to-Market Election. A considerable portion, but certainly not all, of the administrative burden in dealing with the new tax reporting rules goes away for active traders in securities who have made the election under Section 475(f) of the tax law to mark-to-market their securities held for trading (gain or loss on the trading account being ordinary).
If you have any questions concerning this Tax Alert or any related matters, please contact Steven M. Etkind, 212-573-8412 (setkind@sglawyers.com) or Roger D. Lorence, 212-573-8413 (rlorence@sglawyers.com). We welcome your input.
Editing by Alex Akesson
