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Financial Services Insights - Nov 2010 - New Form 1099-B Reporting Rules Start January 1, 2011

With the signing of the Emergency Economic Stabilization Act on October 3, 2008, brokers and certain other financial intermediaries will have to start reporting stock cost basis information, among other things, to investors starting in 2012 for the 2011 reporting year. Cost basis reporting requirements for DRiPs and mutual funds, as well as debt, options, and other specified securities covered under the new law, will phase in on January 1, 2012 and 2013 respectively. This new law added Code Section 6045(g), mandating brokers that are required to file returns under Code Section 6045(a) (Form 1099-B) to also report to their customers the adjusted basis in securities and whether gain or loss with respect to such security is long-term or short-term.

These provisions were included as part of the new law based on the IRS estimate that approximately $11 billion in tax revenue was being missed, attributable to investors not accurately reporting their cost basis in securities sold. The new reporting requirements now shift the responsibility of this reporting to brokers, starting with securities purchased on or after January 1, 2011. These securities will be known as covered securities. Any securities purchased before that date will be known as noncovered securities and reported in a new box, box 6, on the redesigned Form 1099-B.

Included in recently issued final regulations are provisions that require a taxpayer to adequately identify to the selling broker the specific tax lots sold. This disposition instruction must be communicated to the broker by the settlement date of the trade, typically 3 days. Acknowledging that this new rule for the identification of tax lots may be cumbersome, the IRS has added a provision in Final Regulation Section 1.1012-1(c)(8) that allows for the taxpayer to set up "standing orders" for their trades. First-In, First-Out (FIFO) is the regulation's default assumption for disposition of securities other than DRiPs and stock in RICs, which are discussed separately and will be reported based on their specified agreements.

Additional items that will be part of the new reporting regime include wash sales, changes in short sale reporting and transfers of stock. Wash sales will be reported on a simplified basis, only becoming a reportable item if the covered securities in question are in the same account and with the same CUSIP number, as opposed to substantially identical, as is the case under Section 1091. If wash sale adjustments are made by the broker, they (the brokers) are required to report the disallowed loss, the adjusted basis in the securities, and the gross proceeds. The broker must also take the amount of loss disallowed on the sale transaction into account in determining the adjusted basis of the purchased securities. It is important to note that although the broker reports the wash sales on Form 1099 on a simplified basis, the taxpayer is still required to compute their actual wash sales under Section 1091. After comments were made in conjunction with this new reporting requirement, the Service has included in the final regulations an exception for wash sale reporting for taxpayers that have a mark-to-market election under Section 475(f)(1) in effect. The taxpayer will be required to provide a statement to the broker in writing (electronic communications are acceptable) that they have a valid Section 475(f)(1) election in effect and identify to the broker the accounts that are affected by this election. Short sales will now be reported when the transaction closes rather than when the short sale is entered into, as it is currently being done. The proposed regulations had a provision in them that would require the reporting brokers to conform to this new reporting regime on short sales that were entered into in 2010 but not closed by the end of the year. The newly released final regulations have provided for an exception in this case.

Short sales entered into in 2010 will be eligible to be reported as they have been in the past, as gross proceeds, at the time the transaction is opened, regardless of the timing of the "cover" to close the transaction. The biggest change will be for short sale transactions entered into on or after January 1, 2011. The broker will be required to not only report the information from the opening of the transaction, but also information on the securities used to close the transaction, on the same reporting form. The short sale reporting rules are further complicated with regard to securities that are borrowed to close a short sale. Section 1233 states that the delivery of borrowed property does not close a short sale. In this instance, the broker receiving the borrowed property to close the short sale will not report the short sale as closed and instead, report to the transferor of the additionally borrowed property information on the short sale. When this transaction is finally closed the party effecting the transfer that was meant to originally close the short sale has the reporting responsibility and will file a Form 1099-B with the applicable information.

If there is a transfer of a covered security to a broker, that broker, within fifteen days, must be provided a statement that allows the broker to conform to the new reporting regime. A covered security, as defined under the proposed regulations with regard to transfers, is any share of stock in a corporation whose custody changes to a broker or other professional custodian on or after January 1, 2011 and that transfer is not a sale. If such a transaction occurs, the transferor will need to provide a "transfer statement" to the broker or custodian containing specific information as outlined in Final Regulation Section 1.6045A-1(b) with regard to the transferred property. New Form 1099-B Reporting Rules Start January 1, 2011 If the transfer statement is not received by the broker, the broker has the responsibility to ask once, and no more, for the information. If nothing at that time is received, these transferred securities will be considered noncovered and reported as such on Form 1099-B. The complicating issue here is that, with these new provisions, corrected/amended Form 1099s will be the norm, as there is not a de minimis exemption. That being said, if the transferred property is treated as noncovered due to the lack of a transfer statement, and at a later date the broker or custodian becomes aware of a value that is different from the one being used, amended Form 1099s will be issued. The final regulations did institute a time limit with regard to the issuance of corrected reports, which was a request made by commenters when the IRS was seeking input on the new law. Brokers will not be required to issue corrected reports after 3 years from the date of issuance if they receive updated information, nor will they be required to provide corrected transfer statements after 18 months.

Issued concurrently with the final regulations was Notice 2010-67 that addresses the transfer statement provisions and their requirements for reporting starting in 2011. The notice states that, for 2011 only, there will be no assessed penalties for failure to provide a transfer statement for any stock transferred in 2011. All stock falling within the definition of this section will be considered a noncovered security at the point of sale or subsequent transfer.

There are many other changes to the way items will be considered for reporting, including the impact of gifted and inherited securities, as evidenced by the fact that the final regulation package issued by the IRS, including explanation and actual final regulation language, totaled 139 pages.

Financial Services Insights - November 2010 

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