December 13, 2010

6 Key IRS Cost-Basis Reporting Changes for Advisor-Clients: Fidelity Report

The report and two operational guides are intended to aid advisors in implementing changes

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Fidelity released a report on Monday to help advisors "understand differences between the proposed cost-basis reporting requirements and those recently finalized by the Internal Revenue Service."

"The new requirements may have significant implications for RIAs and broker-dealers, from the costs associated with operational changes to educating staff and clients," Maggie Serravalli, executive vice president of Fidelity Institutional, told AdvisorOne by e-mail.

"According to a recent poll of more than 400 advisors, 80% of respondents say that their firms will be their clients' primary source to learn about the new regulations. This means that advisors must take the time to educate themselves on the new regulations so as to best educate their clients," she added.

Serravalli noted that advisors have been working with their third party providers to "ensure that they are prepared to support the new cost basis regulations and are actively coordinating and synching up data across platforms."

The report is available through Fidelity's RIA custody business, and through National Financial, the corresponding clearing business.

Following are the six changes addressed in Fidelity's report.

  1. Clarification for when certain types of securities are considered covered.  The final regulations clarify the timing of coverage for unit investment trusts (UITs), real estate investment trusts (REITs), and exchange-traded funds (ETFs).  Generally, these three types of securities are considered shares of stock in a corporation and thus considered covered securities beginning in 2011.
  2. No requirement for brokers to offer standing instructions for client accounts.  The preamble to the final regulations clarifies that although allowable, it is not required for brokers to accept standing instructions for alternative cost-basis disposal methods (ADMs) for client accounts.
  3. Simplified requirements for average cost elections.  Beginning Jan. 1, 2011, an average cost election is no longer binding, i.e., taxpayers will no longer be required to obtain written approval from the IRS to change a client account from average cost to another depletion method.
  4. New process for broker’s reporting of cost basis for inherited securities.  The final regulations now require brokers to apply fair market value (FMV) as of the date of death to inherited securities when determining the cost basis for assets transferred from a decedent account.  This change makes the transfer process for securities much simpler than the process originally outlined in the proposed regulations.
  5. Complex rules for reporting gifted securities.  Although the industry requested simplified rules from the IRS, the final regulations continue to require brokers to capture and maintain both the carryover basis (i.e., the donor’s cost basis) and the FMV as of the date of the gift.  At the time of the sale, the broker will then evaluate which form of basis to use based on specific IRS rules for gifted securities.
  6. Penalty relief for transfers with missing cost basis.  The final regulations provide penalty relief for transferors through 2011.  Essentially, between Jan. 1, 2011 and Dec. 31, 2011, brokers who are not prepared to send cost basis with asset transfers will not incur IRS penalties.  In these situations, receiving brokers of transferred assets without cost basis may classify them as non-covered.

In addition to the report, Fidelity released a pair of operational guides to "acquaint advisors with its new technology and service enhancements implemented as a result of the new cost basis requirements," Serravalli wrote. The guides are available on Fidelity's online cost-basis resource center, which is available to RIAs at fiws.fidelity.com/costbasis, and to broker-dealers at nationalfinancial.fidelity.com/costbasis. Fidelity will release new guides periodically.

"With the addition of these two operational guides and the legislative analysis report, Fidelity has produced nearly 10 educational and best practices guides since the beginning of the year attended by nearly 2000 clients," according to Serravalli. "In the months ahead, Fidelity will continue to provide legislative and operational updates as well as additional resources for supporting the implementation of the changes."

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