From the December 2011 issue of Investment Advisor • Subscribe!

New Cost Basis Reporting Best Practices

If you haven’t already implemented these strategies, these tips can help you prepare for next year’s changes

We have almost completed our first year under the IRS’s new cost basis regulations and reporting requirements. Stocks were the first group of securities included in the new reporting requirements. Mutual funds will be covered starting next year, and coverage for other securities like bonds and options begins in 2013. Hopefully your firm has been ahead of the game with understanding these new reporting requirements. If not, or if you need a refresher course, there are already many best practices and ideas to help your firm.

First, make sure the accounting method for your clients’ accounts are coded correctly. Now that new systems for capturing trade records are in place with most custodians, you have several accounting methods to choose from, and in most cases this can be identified on the client’s new account application. Given the importance of this selection, part of your reconciliation process for confirming clients’ correct names, addresses, beneficiary information, etc., should include checking the cost basis accounting method.

One of the more confusing aspects of the new cost basis regulations is the concept of covered and uncovered securities. Even though stocks are part of the new reporting requirements for 2011, the rules only apply to stocks that were purchased and sold after January 2011. For example, 100 shares purchased in February 2011 and then sold in November 2011 would be covered. However, if the purchase date was in October 2010, then they would be considered uncovered. This is fairly straightforward, but it will likely become more confusing with the introduction of mutual funds in 2012—especially if you reinvest the dividends of your mutual funds. Perhaps you purchased a mutual fund in 2011, reinvested the quarterly dividends and then sold the entire position in August 2012. At the point of sale, the original purchase would be considered uncovered. However, the quarterly dividends reinvested during 2012 and subsequently sold would be considered covered.

Perhaps one of the more important best practices is how you communicate with your clients regarding the details of new cost basis regulations. Your clients will see the cost basis accounting method they have selected on a number of account documents. This information is provided on the trade confirmation, the account statement and the website where clients access their accounts. It is important that this information matches, but what if it doesn’t? Should your client be concerned? In some cases the answer is “yes” and in others “not really.” This goes back to the issue of whether the cost basis of a transaction is covered or uncovered.

Next year your client will receive their first Form 1099-B that will include the cost or other basis for covered securities in Box 3. If the security is uncovered, the box will be blank. Again, it could be troubling to some clients if they don’t understand why the box is filled in some cases and blank in others. Perhaps creating further confusion, the cost basis for an uncovered security might be listed on the client’s statements or performance reports. Thus an uninformed client could easily expect to see it on the 1099-B as well. Save your firm a number of unnecessary phone calls next April by creating a clear cost basis communication strategy and sharing it with your staff.

Although the new cost basis regulations have increased the workload for everyone in our industry, the IRS has estimated that over $10 billion in additional taxes will be collected as a result. The good news is that the only real challenge remaining is ensuring that your records reconcile with your custodian’s. This is just another example of how you serve all aspects of your clients’ financial needs.

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