Tax Off-Season: Changing Cost Basis Reporting Requirements

Prudent investors shouldn’t limit “tax season.” It’s not just the early-year filing period or the late-year scramble to take advantage of pre-December 31 portfolio moves that may trim your IRS bill. Your investing checklist should always include reviewing tax impacts with the help of your tax professional. This means knowing your reporting requirements—including cost basis—well ahead of the stress of filing deadlines.

TD Ameritrade’s Ticker Tape is taking advantage of the tax off-season to help investors anticipate tax-law changes and other factors. Don’t worry: we’ll offer end-of-year and filing-time help, too.

First up: cost-basis reporting requirements.

“The biggest client-impacting change on the regulatory front is the final phase of cost-basis regulations,” says Becky Groves, director of tax services at TD Ameritrade Clearing. “So even though these latest changes aren’t effective until 2016, we’re working now to ensure we’re ready.” 

Definition Time

Cost basis is the original value of an investment adjusted for wash sales, fixed-income adjustments, stock splits, certain types of dividends, corporate actions, return-of-capital distributions, and more. An investment's original value is usually just its initial purchase price. Cost basis is most often used for tax purposes; when an asset is sold, it’s used to determine the capital gain or loss, which is the difference between the asset's cost basis and its current market value. The higher your basis, the less gain there is to be taxed, and the lower your tax bill. See why you’ll want to accurately track the basis of any investment you own?

Covered securities, which include most but not all of the stocks trading in the U.S., are subject to cost basis reporting rules. This class of securities is defined under the National Securities Markets Improvement Act, and they qualify for federally imposed exemptions that free them from state restrictions and regulations. Brokerages, including TD Ameritrade, are required to report cost basis information on covered securities to the IRS.

What Changed?

As you may know, cost basis reporting has changed in recent years, and it will continue to change under the three-phase Emergency Economic Stabilization Act of 2008. The act requires that brokerage firms report their customers' cost basis and holding period on covered securities to the IRS on their Consolidated Form 1099s when securities are sold. Before 2011, firms such as TD Ameritrade reported only sale proceeds.

Subsequent phases covered mutual funds and dividend reinvestment plan (DRIP) securities. Plus, as of 2014, the law applies to options/stock warrants and basic debt instruments acquired as of or after January 1, 2014. This includes options with one or more specified securities, as well as options on an index in which the components are substantially specified securities (for example, equity options and certain index options—your tax professional can tell you if this applies to you). The 2014 regulations also apply to basic debt instruments, such as municipal and corporate bonds, that meet certain criteria. This all means that your Consolidated Form 1099, and the way the information is organized, changed, too.

Still to Come

Remember: phases. Here’s step three.

Beginning in 2016, the law will apply to more complex debt instruments acquired on or after January 1, 2016. This will include but is not limited to debt instruments with stepped interest rates; convertible debt instruments; separate trading of registered interest and principal securities (STRIPS); debt that can be paid in kind; foreign debt; and instruments that require interest or principal payments in non-U.S. currency.

The new law will not apply to all securities. Notable exceptions include select short-term debt and other instruments, so it's always best to check with the professionals.

The goal of the act is to help ensure the accurate reporting of gains and losses, as well as to simplify your year-end tax preparation. Brokerages including TD Ameritrade are working ahead of phase three’s implementation to make information and form management as seamless as possible. At least now you’ll better understand what you’re looking at.

Understanding the basics of cost basis empowers you to take an active role in your tax situation, but enlisting the help of a tax professional is certainly always a smart move, too.