Cost Basis Reporting Law: Compliance Complexities with Foreign & Domestic Corporate Actions

Transcription

1 Securities Investment Compliance Solutions Cost Basis Reporting Law: Compliance Complexities with Foreign & Domestic Corporate Actions Authored by John Kareken, Tax and Regulatory Analyst, Richard Ryndak, Senior Product Manager, and Robert Oh, Product Manager, CONTENTS: Introduction Significant Noncompliance Penalties Top Ten Compliance Challenges with Corporate Actions Focus On Challenges with Foreign Securities Focus On Challenges with Issuer Statements Focus On Challenges with Reporting Timing Additional Broker Operational Challenges The Solution

2 Cost Basis Reporting Law Introduction The cost basis reporting law radically shifts the corporate actions tax reporting paradigm. As a result of this law, tax, legal and operations professionals responsible for corporate actions processing now need real-time access to corporate actions taxability details to accurately adjust the basis of covered foreign and domestic securities when reporting the sales or transfer of those securities for accurate tax reporting. Failure to do so can result in significant tax penalties. For example, incorrect Form 1099 reporting penalties can now add up to millions of dollars a year. Cost basis reporting became law as part of the Emergency Economic Stabilization Act of This law requires brokers to provide detailed information regarding the cost basis of stock and securities when sold, to the IRS and to taxpayers. To accurately adjust basis, the law requires that brokers take into account any quantitative effect of corporate actions on the cost basis of covered securities to comply. Further, since this law does not carve out foreign securities, foreign corporate actions generally must also be taken into account. This law has staggered effective dates for different types of securities: Stock acquired on or after Jan. 1, 2011; Mutual fund & dividend reinvestment plan stock acquired on or after Jan. 1, 2012; Debt & options acquired on or after Jan. 1, 20141; There are numerous complexities and challenges around the corporate actions requirements of this law that must be immediately understood and addressed by brokers to comply. For example, the industry must address the need to cover the tax consequences of corporate actions events for foreign stocks. Further, as part of this law, the new IRS Form 8937 for reporting on corporate actions by issuers which must be filed by issuers within 45 days of an event, also poses some unanticipated challenges to brokers. Additionally, there are some serious tax reporting timing of information concerns, particularly related to transfer reporting which requires delivery of adjusted basis by brokers within 15 days of a transfer. Yet, as stated above, issuers have 45 days to file the Form These challenges result in a new and urgent need for additional resources staff and/or systems, to effectively meet these greater tax reporting obligations. This paper provides insight into some of these critical challenges and complexities as well as ways to address them. Significant Noncompliance Penalties As stated above, failure to comply with the cost basis law can result in millions of dollars in penalties as well as potentially immeasurable reputation damage. Specifically, the Small Business Jobs Act of 2010 (P.L. No , Sept. 27, 2010) significantly increased penalties relating to Form 1099-Bs, transfer statements and issuer corporate action statements that must be provided under the cost basis reporting law and a summary of the old penalties compared to those established through the act is provided below. Additionally, the act provides that every five years, penalties will be increased to account for inflation. Plus, other IRS designated securities after Jan. 1, Pursuant to IRS Notice (May 2, 2012) Summary of Penalty Changes Returns to IRS Statements to Recipents Old per Return or Statement Maximum Penalty $50/Return $50/Statement New Per Return or Statement Maximum Penalty $100/Return $100/Statement Old Aggregate Maximum Penalty $250K $100K New Aggregate Maximum Penalty $1.5 Million $1.5 Million Old Minimum Intentional Disregard $100/Return $100/Statement Penalty New Minimum Intentional Disregard Penalty $250/Return $250/Statement 2

3 Compliance Complexities with Foreign & Domestic Corporate Actions Avoid significant noncompliance penalties $200 per inaccurate Form 1099-B (to IRS and investor) up to $3mil aggregate annual limit (plus interest) If due to intentional disregard, 10% of what should have been reported no annual maximum limit Top Ten Compliance Complexities with Corporate Actions 1. Significant NEW noncompliance penalties up to millions of dollars, in some cases with no annual limit 2. The tax impact of foreign events must be accounted for 3. Information about foreign events is often unavailable, vague and/or incomplete 4. Understanding foreign details requires access to content expertise 5. Issuer Returns NEW IRS Form 8937, information must be accounted for 6. Vague instructions for Form 8937 can result in (a) failure to fill out the form or inconsistencies and complexities in issuer reporting of corporate actions and in (b) a need for additional in-depth analysis by brokers for such forms and corporate action events 7. Issuers are not obligated to send Form 8937 Issuer Returns to brokers 8. Three year window to update/correct Form 1099-Bs for subsequently filed or discovered Issuer Returns can significantly increase corrected 1099-Bs 9. For transfer reporting, 30-day time lapse between when brokers need tax effect of corporate actions and when issuers must file the Form Workflow crunch between Jan 15th deadline for Form 8937 filing and Feb 15th 1099 taxpayer delivery deadline Focus On Challenges with Foreign Securities Do you have adequate resources to track the tax impact of corporate actions on foreign securities? Going into the 2011 tax reporting season the first year that the cost basis law was in effect, many brokers expressed a lack of awareness of the obligation to account for the impact of foreign corporate actions to the basis of securities held. As stated previously, 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 who often use different event types and accounting rules under their own laws and who may not even report U.S. tax consequences. Further, although this law requires that issuers of specified securities provide certain corporate actions taxability information via new IRS Form 8937 for issuer reporting of corporate actions, it is uncertain if foreign issuers of covered securities have a binding obligation to or will consistently complete this form. Yet, when it comes to corporate actions involving foreign stock, brokers must understand the details of the event, as well as the elections made by the applicable U.S. depositaries for ADRs relating to choices and cash payments in order to understand how to properly treat proceeds and other distributions paid to U.S. holders. Although some firms already have resources allocated for tracking foreign events, many do not. Further, the level of detail needed for cost basis compliance creates additional resource burdens. Therefore, brokers are now required to both fully understand this foreign reporting obligation and have adequate resources in place to access and apply the essential foreign corporate actions tax information required to comply. Optimally, brokers will implement automation including foreign and domestic corporate actions tax data feeds and will work with corporate actions experts for analysis and details so that they can efficiently access taxability details and upload that information into their portfolio accounting systems for compliance. 3

4 Cost Basis Reporting Law Focus On Challenges with Issuer Statements Do you have adequate resources to navigate the sea of Form 8937s? With the cost basis law, come new tax reporting obligations for issuers of specified securities, such as stock, mutual fund shares, options and debt instruments. These issuers are now required to report the quantitative effect of corporate actions on basis under Internal Revenue Code Section 6045B (Issuer Reporting). As mentioned earlier, under these rules, issuers are generally required to report corporate actions to the IRS (via new IRS Form 8937 Issuer Returns) within 45 days of the date the corporate action occurred. Issuers must also provide information statements to holders of the affected securities by January 15th of the following calendar year. Alternatively, issuers can satisfy these requirements by posting the required IRS Form 8937 on their public websites for 10 years (Public Website Option). Note that the completed Form 8937 must be posted to the website, which raises additional interpretation questions. Form Not a panacea for brokers However, although some of the information required for cost basis compliance is included on the new Form 8937, in many cases brokers still need to allocate additional resources to track and review supplementary issuer corporate action tax information. Further, many Issuer Returns include lengthy tax discussions, as might be found in a prospectus or proxy statement, and some also qualify their conclusions, or provide alternative tax outcomes, based on factual or legal assumptions. The burden of unraveling this information is now on the brokers, since they are required under this law to take into account all information furnished on an Issuer Return when reporting the sale or transfer of a security. Thus far, Form 8937 the official Issuer Return Statement, has not been a panacea for brokers in computing corporate action related basis adjustments. In fact, these forms often provide brokers with substantially less assistance in complying with the cost basis law than had been hoped. The value of Issuer Returns may be further undermined to the extent the issuer is unwilling or unable to take a clear position on the taxability of corporate actions and particularly with foreign events. Additionally, since the cost basis law requires brokers to correct basis information and file corrected Form 1099-Bs with the IRS and investors for up to three years, corrections to Issuer Returns can also result in a substantial increase in 1099 correction work volume for brokers. Furthermore, since issuers have no obligation to publicly post Form 8937 information or to provide it directly to brokers, additional resources and/or an automated solution become essential to track, interpret, aggregate and upload the taxability impact of events into broker portfolio accounting systems. Focus On Challenges with Reporting Timing Do you have adequate resources to manage critical reporting timing gaps? Under Internal Revenue Code Section 6045A, for purposes of transfer reporting, brokers must include the adjusted cost basis of covered securities to the transferee within 15 days of the transfer. However, since issuers have 45 days to report a corporate event to the IRS via Form 8937 Issuer Returns, brokers now face a serious reporting time gap relative to their transfer obligations. Further, since issuers have until January 15th of the calendar year following the corporate action to report to holders, brokers who are typically already deep into Form 1099s preparation for delivery to investors by February 15th, may face yet another real time crunch if they wait until the January timeline to incorporate essential corporate action details into their systems for nontransfer related activities. To meet the cost basis transfer and 1099 reporting requirements, additional resources and/or an automated solution become essential to timely collect and upload the taxability impact of corporate actions into their portfolio accounting systems for compliance. Optimally, brokers need to leverage real-time corporate actions taxability data feeds and have access to experts for in-depth analysis and understanding of both foreign and domestic events. Additional Broker Operational Challenges Even before cost basis reporting became law, one of the most challenging aspects of processing corporate actions was determining and incorporating the resulting basis related adjustments typically described in complex corporate action tax opinions into automated portfolio accounting systems. Historically this difficult task was handled manually by internal teams to make reasonable efforts in the determination of taxability based on the information available. Although corporate actions data feeds are readily available, most do not include indepth taxability information and detail necessary for cost basis compliance. 4

5 Compliance Complexities with Foreign & Domestic Corporate Actions Yet, accounting for the expanded breadth including foreign, and depth of the tax consequences of foreign and domestic corporate actions to the basis of covered securities is essential to meeting the additional tax reporting requirements of this new law. Optimally, broker operations departments will have technology that automates delivery of these essential foreign and domestic corporate actions tax content details to upload directly into their portfolio accounting systems to adjust the basis of the securities held by their organizations. Relative to the new issuer reporting Form 8937, brokers now also bear the burden of accounting for information on such statements. Therefore, brokers will need close to real-time access to issuer corporate action information and will need to monitor it continuously. Is there any penalty relief? The cost basis law provides some penalty relief for brokers that rely solely on issuer statements Form 8937, Issuer Returns. Treas. Reg. Sec (d)(2)(iv) issuer statements. When reporting a sale of a covered security, a broker must take into account all information furnished or deemed furnished on an issuer statement (as described in B-1), unless the statement is incomplete or the broker has actual knowledge that it is incorrect A failure to report correct information that arises solely from reliance on information furnished on a transfer statement or issuer statement is deemed to be due to reasonable cause for purposes of penalties under sections 6721 and See (a)(1). However, as discussed previously, Form 8937 poses challenges particularly regarding what and how much information is included. Further, in the case of inclusion of complex tax discussions on this form, the responsibility of tax determinations can shift to the broker. Additionally, as the tax consequences of events can change after this form is filed, it becomes essential to have resources dedicated to monitoring 8937s, and, in the case of corrections, then updating systems for broker reporting corrections. Clearly this task quickly becomes tedious and labor intensive. Finally, since it has been observed that the information on these forms, especially regarding foreign events, can be incomplete, interpreting and gap filling creates additional, manual work for the broker. The law also provides penalty relief for good faith reliance on third party information. Treas. Reg. Sec (d)(2)(iv) Information from other parties and other accounts Other information. A broker is permitted, but not required, to take into account information about a covered security other than what is furnished on a transfer statement or issuer statement, including any information the broker has about securities held by the same customer in other accounts with the broker. For purposes of penalties under sections 6721 and 6722, a broker that takes into account information received from a customer or third party other than information furnished on a transfer statement or issuer statement is deemed to have relied upon this information in good faith if the broker neither knows nor has reason to know that the information is incorrect. See (c)(6) of this chapter. Treas. Reg. Sec A-1(b)(8)(ii) provides similar language for transfers of a security. Therefore, when evaluating the increased in-house resources required to comply with the corporate actions facets of the cost basis reporting law, it may be advantageous to assess third party providers. Ideally, brokers should have access to tools that allow them to focus on their foreign and domestic securities of interest. These tools should provide real-time automation of collection and delivery of resulting tax impact of corporate actions to their securities. Such tools should include corporate actions tax data feeds that are easy to upload into the broker portfolio accounting system. Additionally, brokers need access to event interpretation and analysis and ideally need a source that provides critical taxability details, even in absence of a Form 8937, such as in cases of certain foreign corporate actions. Brokers need efficient and optimally automated resources that provide detailed foreign and domestic corporate actions taxability information and interpretation for cost basis reporting adjustments. 5

6 Cost Basis Reporting Law The Solution Corporate Actions Taxability Management Solutions for Cost Basis Reporting Compliance Responding to the urgent industry need for greater foreign and domestic corporate action tax details for cost basis compliance, and specifically for automated delivery of taxability feeds as well as for more efficient access to Form 8937 information and interpretation, launched two new solutions within our Corporate Actions Taxability Management Suite. Both of these services start with the corporate actions tax expertise of our Capital Changes team, which has been dedicated to providing in-depth analysis and taxability details for foreign and domestic corporate actions since FCATS Automation Automated Delivery of Foreign & Domestic Tax Details for Cost Basis Compliance Our Foreign Corporate Actions Taxability Service FCATS automates delivery of the essential corporate actions taxability details that brokers need to adjust the basis of covered foreign and domestic securities for cost basis reporting. CISR 8937 Content & Analysis One Source for All Publicly Available Issuer Statements with Analysis Our Capital Changes Issuer Statement Reporting Service CISR 8937 is a centralized repository for all publicly available issuer statements and includes expert analysis, as well as fielded corporate action, security and taxability details and links to original Form 8937s. FCATS Automate Delivery of Foreign & Domestic Tax Details for Cost Basis Compliance FCATS combines the deep corporate actions expertise of our dedicated Capital Changes expert corporate actions content team with the efficiency of our proven GainsKeeper technology. FCATS accounts for Form 8937 information when available, and applies a rules-based logic to fill information gaps. Because it automates coverage of the taxability consequences of foreign and domestic corporate actions to covered securities to assist with basis adjustments for cost basis reporting, FCATS saves time and reduces resource burdens. Challenges with Foreign Securities - Solved FCATS automates targeted coverage of the tax consequences of foreign and domestic corporate actions to assist with basis adjustments for cost basis reporting. This highly customizable service simplifies access to the corporate actions tax details needed to process events impacting the foreign and domestic securities held. Clients simply specify and upload the securities they cover into the system. Leveraging data from SIX Financial Information and Capital Changes, FCATS then applies a rules-based logic to determine taxability for corporate actions affecting the client s securities. On a daily basis, clients can create corporate actions taxability XML data files to upload into automated portfolio accounting systems to adjust the basis of their SOI, and can also produce custom taxability reports for processing and validating. This flexible service allows clients to update and continuously customize their covered securities, ensuring access to the corporate actions tax consequences needed for cost basis reporting. Challenges with Form 8937 Tax Details- Solved The data that FCATS leverages from SIX Financial Information and Capital Changes CISR 8937, includes Form 8937 details when available, as well as updates when issued. This eliminates the need for clients to dedicate staff to this tedious process. Further, because this service then applies a rules-based logic to determine taxability for corporate actions affecting the client s securities even when tax details are not available, such as with certain foreign events, this challenge with issuer statements is also resolved. Challenges with Reporting Timing Solved Because FCATS is real-time relying on a proven rules-based logic to determine the taxability, it eliminates transfer reporting time gaps as clients can process and apply a reasonable tax determination virtually instantly. 6

7 Compliance Complexities with Foreign & Domestic Corporate Actions FCATS At-A-Glance Specify & upload foreign & domestic Securities of Interest (SOI) into the system Create custom corporate actions views Generate daily, corporate actions taxability XML data files to upload into portfolio accounting systems Export corporate actions taxability information into custom reports for processing and validating Access the key taxability attributes behind the corporate actions Automate corporate actions taxability processing & reduce resource burdens Improve operational efficiencies Reduce manual activity Minimize tax reporting error risks Meet cost basis reporting corporate actions requirements CISR 8937 One Source for All Publicly Available Issuer Statements with Analysis Wading through issuer details for cost basis compliance can be extremely time-consuming and tedious. Yet, under the cost basis law, the burden of tracking and unraveling this information is now on the brokers, since they are required to take into account all information furnished on a Form 8937 when reporting the sale or transfer of a security. Responding to the market need for essential issuer tax information, we launched CISR Because it centralizes coverage of issuer statements and provides fielded corporate action, security and taxability details and links to the original Form 8937, CISR 8937 saves time and reduces resource burdens. statements, brokers must devote time and energy to search for and interpret the stream of Form 8937s being posted online every day. Capital Changes takes on the burden of locating issuer statements, and provides a link to the original document for customers to use as a reference and for compliance purposes. Challenges Interpreting Form 8937 Tax Details- Solved Each CISR 8937 report is prepared by a Capital Changes expert corporate actions analyst who reviews and interprets the tax information and converts it into actionable data. Further, since key tax information is fielded by our tax experts who also provide comments and cautions, where necessary, Form 8937 tax interpretation guess work is eliminated, saving time and reducing risk. Challenges When Form 8937 Not Available - Solved Currently CISR 8937 is the only resource centralizing all publicly available issuer statement information into a single location, highlighting critical details and interpreting the taxability information. Additionally, because CISR 8937 is available exclusively as an add-on to Capital Changes Daily Corporate Action Updates which cover many corporate actions for which an issuer statement is not required or may not be provided (such as with foreign events), this critical cost basis compliance taxability gap is closed. CISR 8937 At A Glance One source for all publicly available issuer statements Key tax and operational data fielded and exportable Links to the original issuer statement Links to the Capital Changes analysis Challenges Locating Form 8937 & Essential Tax Information - Solved There are thousands of issuers engaging in corporate actions every year, and each company website is unique. A Form 8937 can be posted deep within the site map, with little or no clue where to find it. With no uniform way to identify and locate posted issuer 7

8 DISCLAIMER: The information and views set forth in this communication are general in nature and are not intended as legal, tax, or professional advice. Although based on the law and information available as of the date of publication, general assumptions have been made by that may not take into account potentially important considerations to specific taxpayers. Therefore, the views and information presented in this communication may not be appropriate for you. Readers must also independently analyze and consider the consequences of subsequent developments and/or other events. Readers must always make their own determinations in light of their specific circumstances. provides audit, risk and compliance solutions that help financial organizations improve efficiency and effectiveness across their enterprise. Whether complying with regulatory requirements, addressing a single key risk, or working toward a holistic risk management strategy, more than 15,000 customers worldwide count on for a comprehensive and dynamic view of risk management and compliance. With more than 30 offices in 20 countries, the company s prominent brands include: FRSGlobal, ARC Logics for Financial Services, PCi, Bankers Systems, VMP Mortgage Solutions, AppOne, GainsKeeper, Capital Changes, NILS, AuthenticWeb and Uniform Forms. is part of Wolters Kluwer, a leading global information services and publishing company with annual revenues of (2011) 3.4 billion ($4.7 billion) and approximately 19,000 employees worldwide. Please visit our website for more information. Headquarters GainsKeeper 100 South 5th Street 130 Turner Street Suite 700 Building 3, 4th Floor Minneapolis, MN Waltham, MA option 2 Copyright 2012, Inc. All Rights Reserved. Learn more about the cost basis reporting law at For more information about FCATS or CISR 8937, contact Gail.Pierce@WoltersKluwer.com or call and select option 2.