Compliance Solutions

How will you handle the average 300% increase in data volume to track wash sale deferral tax ‘sub-lots’?

Brokers must accurately adjust basis for wash sales. Further, to determine whether a transaction has created a wash sale deferral, brokers additionally will need to manage tax sub-lots. There will be a significant data volume increase due to the need to track the sub-lots.

Most systems are not equipped to process this significant increase in data volume. As a result, most brokerages are actively augmenting their existing technology through third party vendor solutions to accommodate this. To meet the initial effective date of this law, brokers must have systems in place capable of handling the significant increase in data volume associated with these wash sale calculations.

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How will you track corporate actions on foreign securities?

Since the cost basis reporting law does not carve out foreign securities, they must be accounted for to comply. The challenge of tracking basis adjustments intensifies when dealing with foreign issuers that use different corporate event types under their own laws and accounting rules and may not report U.S. tax consequences. If foreign securities are held in the form of ADRs, there is an extra layer of complexity. Brokers must understand the details of the local event, and the elections the U.S. depositary made, in order to understand how to treat proceeds and other distributions paid to U.S. holders.

It is essential that brokers have access to accurate foreign securities corporate actions information to accurately calculate basis. Optimally, brokers will align with corporate actions experts for analysis and data feeds to ensure accurate booking of corporate actions for foreign securities.

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How will you handle account transfer cost basis reporting?

The law obligates a transferring broker to furnish a receiving broker with information necessary for cost basis reporting within 15 days of the transfer, per Code Section 6045A(c). A particular concern under cost basis reporting relates to transfers of customer accounts from one broker to another, as currently there is no standard transfer statement and brokers will be subject to potential IRS penalties relating to incorrect or late statements. Additionally, failure to correctly report basis on transferred accounts could result in customer service issues.

Brokers will need to develop systems that generate the statements required to meet their obligation when a customer transfers his or her account to another broker─on time. Therefore, a broker’s cost basis information must be readily accessible throughout the year in order to permit the broker to comply with this statement requirement. For brokers of almost any size, their systems should probably accommodate daily account transfers.

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How will you adjust for the full-range of corporate actions?

Brokers must adjust basis for the full-range of corporate actions. As the complexity of corporate actions increases, the difficulty in accurately calculating the affect on cost basis also increases. Brokers will also need to obtain the unique corporate action ID required under the proposed cost basis regulations. Although, U.S. issuers will provide some of this information, to meet their reporting obligations, brokers will likely still need to track and review issuer corporate action information.

Each year there are more than one million corporate actions. Accounting for these is tedious, time-consuming and error prone. Ideally, brokers will leverage real-time corporate actions data feeds and have access to experts for in-depth analysis and understanding these events.

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How will you explain the difference of covered versus noncovered securities? What are the streamline’ options for this process?

A critical facet of client communications is the challenge explaining why basis is shown for some covered securities holdings, but not for other noncovered securities holdings. This will likely create a call surge for explanations, with steep increases in associated customer service costs.

Brokers can ramp up customer service personnel in advance and outreach to clients well ahead of the initial effective date. As an alternative, brokers could additionally provide basis for noncovered securities with associated customer communications and potentially minimize the surge in service calls. The simplest method to address this would be access to a ‘batch basis service’ that could efficiently calculate pre-effective date basis. This would be a value add feature that can ultimately reduce support costs.

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How will you manage of the anticipated spike in customer service costs?

Recently, TowerGroup conducted an industry survey in which 85% of the financial services institutions polled believed that they would spend less than $1 million (USD) on cost basis customer service annually¹. In another outreach, Securities Industry News noted that more than 27% of firms that they polled anticipate 10 or more full-time employees dedicated to basis reporting customer service calls².

However, given the complexities of explaining these challenges, these estimates are likely low. The vendors contacted by Securities Industry News unanimously said they are hiring project managers and other staff to accommodate the anticipated rush. They all acknowledged the likelihood that latecomers may be unable to implement and test systems by the start of the year.

Although intermittently offered by some brokers, in general, cost basis has not been reported on the 1099 form. The novelty alone will likely spike customer inquires. Additionally, since customers will learn that the cost basis is also being reported to the IRS, there is potential for confusion around what this means that will likely result in a greater volume of calls to broker customer service centers. Further, as brokers only need to report basis for ‘covered securities’, listing both ‘covered’ with basis, and ‘noncovered’ without, will likely create a call surge for explanations. Finally, as the law calls for increased reporting flexibility, (such as tracking all allowable tax lot relief methods), as this has never been offered previously, it will likely also increase customer confusion and related inquires to advisors and service centers.

Financial services institutions must develop and execute comprehensive client communication plans in 2010 to educate clients fully in 2011 on cost basis reporting to minimize customer confusion and contain associated customer support costs. Further, such a plan should include communications when 2011 reporting materials are sent to clients in 2012.

¹Hidden cost of Cost Basis Reporting: (1099s x Confused Clients) + Phone calls = $$$, Tower Group January 11th, 2010

²Y2K Plus 10? Cost-Basis Rules Producing Technical Jitters, John Hintze, Securities Industries News, March 8, 2010

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Where will you find issuer corporate actions reporting information?

Issuers of specified securities are also subject to new tax return obligations under the cost basis reporting law in connection with corporate actions under new Code Section 6045B. This requires issuers of securities to provide customers or their nominees with a statement that includes tax information detailing the effect of a corporate action on the investor’s basis in his or her security no later than 45 days after the date of the corporate action or January 15th of the following year (if earlier).

The cost basis reporting law does not provide many details of this new corporate action statement requirement, and brokers will bear the burden of processing such statements. Therefore, brokers will need close to real-time access to issuer corporate action information and will need to continuously monitor it. Optimally, issuer statements will be available from a readily accessible source in a consistent format.

GainsKeeper^® is inherently scalable, already able to process ‘tax sub-lots’ which are needed to determine whether a transaction has created a wash sale deferral. Such deferrals must be accounted for with this law and will likely result in a 300% increase in data volume.

“When the new cost basis laws go into effect beginning in 2011, the ability to track and manage cost basis information must become more automated in order to make tax-efficient strategies available to a much wider audience of investors and advisors, who can then gain from tax-efficient trading strategies.”

TowerGroup Report: “Cost Basis Technology for Broker-Dealers: Build, Buy, or Both?” by Sean Cuniff, January, 2009 Reference # V57:38O.

By providing investors and their advisors with detailed running cost basis and capital gains reports, including Schedule D, GainsKeeper^® also offers brokers a competitive edge. With its tax-efficiency tools, GainsKeeper^® helps investors make intelligent decisions about which positions to sell to minimize their capital gains taxes. By allowing investors to make tax efficient decisions, GainsKeeper^® makes it possible for them to realize greater after-tax performance. With these decision and analysis tools seamlessly integrated into your web site, clients can make better informed trading decisions, enabling your firm to generate higher trading volumes.

GainsKeeper^® FundTaxPro takes the ‘tedious’ out of fund tax compliance.

GainsKeeper^® FundTaxPro delivers automated tax calculations & reporting solutions for more than 3,000 U.S. mutual and hedge funds. By helping funds avoid wash sales, manage capital gains distributions and increase after-tax performance, GainsKeeper^® FundTaxPro can significantly reduce the amount of time spent on tax compliance. By automating these processes, GainsKeeper^® FundTaxPro can help minimize the risk of tax reporting errors. This solution:

• Automates the calculation of the wash sale adjustments, eliminating the tedious manual process.
  
• Automates the linking and tracking of straddle positions, calculating loss deferral and holding period adjustments.
  
• Automates the calculation of return of capital, long-term capital gain and §1250 amounts paid on REIT securities.
  
• Automates QDI reporting
  

GainsKeeper^® BasisPro™ simplifies calculating historic cost basis information.

GainsKeeper^® BasisPro™ provides brokers, tax preparers, financial advisors and back offices with a simple way to automate cost basis calculations — fully adjusted for corporate actions and for dividend reinvestments, for all U.S. equities and mutual funds. This solution:

• Saves time by quickly calculating the complete cost basis — realized gain/loss — for any U.S. stock or mutual fund;
  
• Complies with Internal Revenue Code (IRC) by using Capital Changes data, the same solution the IRS depends on for cost basis corporate action information;
  
• Accesses historic prices as far back as 1972;
  
• Tracks historical corporate actions back to 1950.

Capital Changes' editors are aware of how critical corporate actions information is to its customers, and accuracy is the highest priority. Nothing is assumed. All information that is published can be traced to a dependable, primary source.

In order to help ensure customers have a thorough understanding of corporate actions, we encourage our subscribers to contact our editors if they have any questions or even if they just want to talk through a specific transaction and its tax impact. Every transaction that is published in our daily products contains the name and direct telephone number of the editor most familiar with the transaction.

In cases in which no U.S. tax opinion is provided by the company, or if the tax opinion provided is ambiguous or incomplete, Capital Changes will often research vital facts and relevant Internal Revenue Code provisions and provide guidance to its subscribers in the form of Capital Changes Commentary. Capital Changes does not provide tax advice. Due to the nature of the transaction or the availability of information, Capital Changes is not able to provide Commentary on every transaction. Capital Changes understands that its customers need to book every transaction, whether or not the company provides a tax opinion. Our Commentary helps them do that.

Comments are included when a company's tax opinion omits a basic, well-settled principle of tax law that subscribers need to remember when booking a transaction or calculating their basis or gain/loss. A Comment may also highlight and explain portions of a company's tax opinion that needs to be emphasized.

Capital Changes alerts its subscribers of potential adverse tax consequences that may arise in a particular transaction.

Capital Changes' methodology strictly follows the U.S. Internal Revenue Code.

Your Source For Corporate Action Information.

• Maintain accounting systems
• Calculate missing cost basis

• Calculate cost basis from transfers
• Obtain details from corporate events
• Populate 1099's

• Calculate cost basis from transfers
• Calculate missing cost basis due to system restrictions

• Obtain details on asset allocation, taxability, fair market value data from corporate events
• Calculate cost basis from inheritance and gifts