2014 Cost Basis Legislation and Tax Reporting

Transcription

1 2014 Cost Basis Legislation and Tax Reporting Fixed Income and Options Advisor Toolkit Volume II

2 Table of Contents Introduction....2 NEW Reporting Requirements for Options NEW Form 1099-B....3 NEW Reporting Requirements for Long Options Expirations Cost Basis Tax Reporting Requirements For Fixed Income Securities....5 Section 1256 Reporting...24 NEW Form 1099 Reporting for Fixed Income Securities....7 Year-End Summary Section Updates: Options NEW 2014 Form 1099 and Year-End Summary Changes Due to Fixed Income Reporting Requirements Sample Communication: Inform Your Clients about New Tax Reporting Requirements for Fixed Income Securities and Options Glossary

3 Introduction In August, we provided you with Volume I of our Advisor Toolkit. It contains information about cost basis legislation and the system changes we made to comply with new IRS requirements for Fixed Income and Options reporting. In November, we ll be making the remainder of the required system changes in preparation for year-end tax reporting. This updated edition highlights the system changes taking place in November and provides a preview of the changes you and your clients will see on 2014 IRS tax forms. August Implementation In August 2014, Schwab made adjustments to its amortization settings that affected the calculation of whether a bond purchased at a premium or discount has a gain/loss when sold to conform to IRS reporting rules: The methods used to calculate amortization and accretion were based on whether a bond is purchased at a premium, original issue discount, or market discount, and/or if there is a call or put feature. Market discount on a bond purchased on the secondary market is now calculated using the straight line accounting method, which is parallel to the IRS default for taxpayers. The amount of the market discount is no longer incorporated in current income or adjusted cost basis until the position has been sold, matured, or called. Before this change, Schwab assumed that clients included market discount in their current income and adjusted cost basis daily. November Implementation In addition to the changes made in August 2014 (detailed in Volume I of the Toolkit), Schwab will be making the following system changes to conform to IRS reporting rules: Closing transactions of covered fixed income securities in taxable accounts that occurred between January 1, 2014, and the August 2014 system implementation, will be reprocessed in November using the IRS broker-required amortization settings. This may affect a client s realized gain/loss. We will implement system functionality for calculating Yield to Best for taxable bonds purchased at a premium with a call feature. Clients holding these types of bonds may see a change in their adjusted cost basis and unrealized gain/loss. 2

4 NEW Form 1099-B Some of the Cost Basis changes may affect reporting for all security types, others are more specific. In this Toolkit, we ll start by highlighting the changes that may affect all securities, and then go into specific examples for Fixed Income securities and Options Consolidated section headings into one 2 Quantity is now part of Description field 3 New location for CUSIP/Symbol 4 New option Symbol display 5 New option activity codes BC (Buy to Close), SC (Sell to Close), and X (Expiration) 6 Date of acquisition is now Date acquired 7 Date of sale or exchange is now Date sold or disposed 8 Net proceeds displays only when proceeds were adjusted for option premium 9 Sales price of stocks, bonds, etc. is now Proceeds 10 Cost or other basis has moved to Box 1e 11 Former Wash sale loss disallowed column is now 1g-Adjustments and 1f-Code, if any: W = Wash Sale Loss Disallowed D = Market Discount C = Collectibles 12 New Realized Gain or (Loss) column is not reported to the IRS 3

5 The Notes for Your Form 1099-B page was updated so that box numbers correspond with box numbers and descriptions on the new Form 1099-B. New for

6 2014 Cost Basis Tax Reporting Requirements for Fixed Income Securities The cost basis of fixed income securities can be affected by accruals of income as well as tax elections the holder of the instrument makes. Many of the changes made by the IRS align broker reporting on Form 1099-B with taxpayer reporting requirements. Less Complex Fixed Income: Subject to 1/01/14 Reporting Taxable and non-taxable bonds that have a fixed rate, fixed maturity, and fixed payment schedule, even if they are callable by the issuer. These include: Treasury notes and bonds Fixed-rate corporate bonds Fixed-rate municipal bonds More Complex Fixed Income: Subject to 1/01/16 Reporting The IRS will address fixed income securities that are more complex in terms of calculating adjusted cost basis in These include: Variable-rate bonds Stepped-rate bonds Convertible bonds Stripped bonds Certain tax-credit bonds Contingent-payment bonds Inflation-indexed fixed income securities Foreign-issued bonds or bonds that pay in foreign currency Payment-in-kind bonds Fixed income securities issued as part of an investment unit Fixed income securities for which terms are not reasonably available to brokers within 90 days of acquisition by client Fixed income securities evidenced by a physical certificate not held by a custodian or clearing agent (physical debt) Fixed Income Excluded from Reporting The IRS specifically excluded fixed income securities described in Section 1272(a)(6) of the IRS regulations from cost basis reporting requirements: Certain specific interests in or mortgages held by a Real Estate Mortgage Investment Conduit (REMIC) Certain other fixed income securities with payments subject to acceleration Pools of fixed income securities whose yield may be affected by prepayments Short-term fixed income securities (with a fixed maturity rate not more than one year from the date of issue). 5

7 Default Yield Methods Following is a summary of amortization methods that will be modified for taxable/non-taxable accounts with amortization enabled. NEW 2014 Schwab Settings Bonds A/A Rule Type Yield Method Apply de Minimus Rule? Original Issue Discount No Call or Put Feature Constant Yield Yield to Maturity Yes Market Discount Straight Line N/A Yes OID Call Feature Constant Yield Yield to Worst (Lowest Yield) Yes OID Put Feature Constant Yield Yield to Best (Highest Yield) Yes OID with Acquisition Premium Constant Yield Original Yield to Maturity, then apply Yes acquisition premium Bond Premium No Call or Put Feature Constant Yield Yield to Maturity No Bond Premium Call Feature Constant Yield Yield to Best (Highest Yield) No Taxable Bonds Yield to Worst (Lowest Yield) Tax-Exempt Bonds Bond Premium Put Feature Constant Yield Yield to Best (Highest Yield) No Client Instructions that Differ from Broker Default Settings The new IRS-designated defaults may not coincide with what your clients have used for tax filing purposes in the past. But the IRS will allow taxpayers to instruct their brokers to use settings for taxable bonds that differ from the defaults. They can choose to: Accrue market discount using constant yield. Include market discount in current income. Disable bond premium amortization. Treat all interest as OID. If your client is considering changes to their default settings, instructions for the 2014 tax year must be submitted in writing to Schwab by December 31, 2014, and will be retroactive to January 1, Schwab will ensure that all forms received by December 31 will be processed in time for 1099 reporting for that tax year. The Letter of Authorization (LOA) to Change Fixed Income Amortization & Accretion Settings form must be signed and completed by the account holder for each affected account. Advisors cannot execute the LOA on their client s behalf. Some instructions are not revocable and others require IRS commissioner approval for revocation. Your clients are also responsible for filing the appropriate instructions with the IRS on their tax returns. To obtain the Letter of Authorization (LOA) to Change Fixed Income Amortization & Accretion Settings form, contact the Client Reporting Services Team at

8 NEW Form 1099 Reporting Requirements for Fixed Income Securities Schwab will be reporting proceeds, cost basis and market discount on less complex fixed income securities acquired and sold after January 1, 2014 to the IRS. Schwab will report all principal payments, including partial principal payments, on the Form 1099-B in the noncovered securities Cost Basis Is Missing and Not Reported to the IRS section. Annual Bond Premium, if any, will now be reported to the IRS on Form 1099-INT for covered bonds. Market Discount will be reported when a bond is sold or matured, unless your client provided instructions to include it in current income. In that case, Schwab will report Market Discount annually on Form 1099-INT or Form 1099-OID for covered taxable bonds. The amount of bond premium amortization for a tax year can be reported only up to the stated interest payment on the bond. Excess amortization will be carried forward to the next tax year. Acquisition Premium for OID securities will now be reported to the IRS on Form 1099-OID for covered taxable bonds. Form 1099-INT Bond Premium-Amortization Let s use a simple example to illustrate how bond premium is calculated and reported per new broker defaults. Example On 4/1/2014 you purchased a 10,000 face corporate bond for a purchase price of $10,500 The bond was issued on 4/1/2005 and matures on 4/1/2015 Form 1099-INT Bond Premium-Amortization ON (Default) For tax year 2014, the amount of amortized bond premium from purchase through the 10/1/2014 coupon date of $ ($10,500 Cost Basis at Purchase: $10, Cost Basis on 10/1/2014) is reported in Box 11-Bond Premium on the Form 1099-INT 7

9 Form 1099-INT Bond Premium-Amortization OFF (Election) If the election is made to disable bond premium amortization, Box 11-Bond Premium on the Form 1099-INT will show $0.00 Even if your client elects to disable bond premium amortization, Schwab will report tax exempt bond premium in box 11 for covered bonds. 8

10 Market Discount Accrued at Disposition Let s use a simple example to illustrate market discount calculated and reported per new broker defaults. Example On 4/1/2014 you purchased a $10,000 face 10% corporate bond for a purchase price of $5,000 The bond was issued on 4/1/2005 and matures on 4/1/2015 Under the new IRS default, you will always see your original cost basis for the bond displayed until the bond is sold, matures or is called away (if applicable). Here is what the purchase looks like on the Schwab Advisor Center Unrealized Gain/Loss screen: 9

11 At maturity, the cost basis is adjusted for the accrued market discount. Here is what the adjusted cost basis looks like on the Schwab Advisor Center Realized Gain/Loss screen: The original cost basis of $5,000 has been fully adjusted at maturity for the accrued market discount of $5,000. The adjusted cost basis now reflects $10,000. Here is what the adjusted cost basis looks like on the schwaballiance.com Realized Gain/Loss screen: The original cost basis of $5,000 has been adjusted for the market discount at maturity to $10,000. The cost basis is only reported on schwaballiance.com and client statements if an advisor has requested these reporting preferences. 10

12 Here is what the adjusted cost basis looks like on the client statement: Original Cost Basis Adjusted for Market Discount at maturity Here is what the adjusted cost basis looks like at maturity on the 2015 Form 1099-INT: Interest Income will show the $ coupon received at maturity on 4/1/2015 Market Discount is $0.00 since it is not reported in Current Income Here is what the adjusted cost basis looks like at maturity on the 2015 Form 1099-B: Original Cost Basis of $5,000 Market Discount Adjustment Proceeds-Cost Basis- Adjustments=$0 Realized Gain or (Loss) 11

13 Market Discount Election to include in Current Income Let s use a simple example to illustrate market discount calculated and reported with the election to include in current income: Example On 4/1/2014, you purchase $10,000 original face of a 10% Corporate Bond The bond was issued on 4/1/2005 and matures on 4/1/2015 The price you paid for the bond on 4/1/2014 is $5,000 total Here is what the purchase will look like on the schwaballiance.com Unrealized Gain/Loss screen: Under the election to include Market Discount in current income, the cost basis is adjusted daily for the market discount and reports annually on the Form 1099-INT. Market Discount on the INT with Election to include in Current Income Form 1099 INT Interest Income will show the $500 coupon received on 10/1/2014 Market Discount will show the $3, accrued from the 4/1/2014 purchase date through 12/31/

14 Market Discount with Election to include Current Income (at Maturity). At maturity on 4/1/2015, the cost basis has been fully adjusted for the accrued market discount. Here is what the purchase looks like on the Schwab Advisor Center Realized Gain/Loss screen: The original cost basis of $5,000 has been fully adjusted at maturity for the accrued market discount of $5,000 and the adjusted cost basis now reflects $10,000. At maturity, the cost basis has been fully adjusted for the accrued market discount. Here is how it looks on the schwaballiance.com Realized Gain/Loss screen: At maturity, the original cost basis of $5,000 has been fully adjusted to $10,000 reflecting the market discount. 13

15 Here is what it will look like on your client s statement: Original Cost Basis Here is what it will look like on the 2015 Form 1099-INT: Adjusted for Market Discount at maturity The $500 coupon payment will be reported in Box 1 Market Discount will show the $1, accrued from 1/1/2015 to maturity on 4/1/2015 Here is what it will look like on the 2015 Form 1099-B: 1g Due to the election to include in current income, Box 1g-Adjustments will be blank on 2015 Form 1099-B. Box 1e-Cost or other basis will be adjusted for the amount of Market Discount for an adjusted cost basis of $10,000 resulting in a Realized Gain of $

16 NEW 2014 Form 1099 and Year-End Summary Changes Due to Fixed Income Reporting Requirements Form 1099-INT Two boxes were added to report Market Discount (if a client election was made to include it in current income) and Bond Premium. Form 1099-OID Two columns were added for Market Discount (if a client election was made to include it in current income) and Acquisition Premium. Two lines were added for Total Market Discount and Total Acquisition Premium. 15

17 Year-End Summary Section Updates Under Detail Information of Interest Income, sections were added for Market Discount and Bond Premium. Market Discount will display if a position has been sold or has matured, or if a client has elected to include market discount in current income. A detailed breakdown of the market discount and acquisition premium boxes on Form 1099-INT has been added to the Year-End Summary. 16

18 Amortization and Accretion for Fixed Income Updates There was a complete redesign of the Amortization and Accretion for Fixed Income section of the Year-End Summary. The section has been split into taxable and non-taxable sections. Year-to-Date (YTD) and Life-to-Date (LTD) Bond Premium and Market Discount have been added. Market Discount will display only if a position has been sold or has matured, or if a client has elected to include market discount in current income. Added Notes for Your Amortization and Accretion section page. 17

19 Under the Realized Gain/Loss section, there was a change to column headings, and a ( ) Market Discount adjustment was added. Sales of short-term debt instruments that are no longer reportable to the IRS on Form 1099-B were added here. 18

20 New Reporting Requirements for Options The latest cost basis regulations change the reporting requirements for brokers for specific options contracts acquired in an account on or after January 1, Options Subject to 1/1/14 Reporting Options Subject to 1/1/16 Reporting Options Excluded From Reporting Options on a single security Options on more than one specified security, including an index in which the components are considered covered securities Options on financial attributes of specified securities, such as interest rates or dividend yields Warrants or stock rights Investment units in which options, stock rights, or warrants are issued together with a fixed income security Incentive stock options Foreign currency options Commodity options Options acquired prior to January 1, 2014, that were sold or that expired during 2014 are considered noncovered securities and are not reported by Schwab on Form 1099-B or to the IRS. Noncovered option transactions are displayed in the Realized Gain/Loss section of the Year-End Summary. 19

21 Year-End Reporting Requirements for Options Schwab is required to report adjusted cost basis and proceeds for sales transactions on IRS Form 1099-B for options that are acquired on or after January 1, We will report sale date, acquisition date, proceeds, cost basis, and Wash Sale disallowed loss data to the IRS, as we do for all other covered securities. Please note that if you trade multileg options strategies such as spreads, straddles, and strangles, Schwab will report the individual legs of the strategy as separate transactions. The following chart illustrates the reporting requirements for opening option transactions: Opening Trade Closing Trade Resulting Position Premium Adjustment Report on 1099-B? Buy Call to Open Sell Call to Close Y Buy Call to Open Call Expires Y Buy Call to Open Call is Exercised Long Underlying Security OR Added to Cost Basis N Close out existing short position in underlying security Sell Call to Open Buy Call to Close Y Sell Call to Open Call Expires Y Sell Call to Open Call is Assigned Short Underlying Security OR Add to Sales Proceeds N Close out existing long position in underlying security Buy Put to Open Sell Put to Close Y Buy Put to Open Put Expires Y Buy Put to Open Put is Exercised Short Underlying Security OR Subtract from Sales Proceeds N Close out existing long position in underlying security Sell Put to Open Buy Put to Close Y Sell Put to Open Put Expires Y Sell Put to Open Put is Assigned Long Underlying OR Subtract from Cost Basis N Close out existing short position in underlying security Y-The underlying security transaction is reported Y-The underlying security transaction is reported Y-The underlying security transaction is reported Y-The underlying security transaction is reported 20

22 Cost Basis Adjustments for Options There are certain adjustments that brokers are NOT permitted to make to the original cost basis on options transactions per the IRS. Schwab cannot take into account the impact of options purchases or sales in determining disallowed losses on sales of the underlying securities. If a client sells shares of XYZ Corporation at a loss and purchases or sells certain options on that position, the client is responsible for disallowing the loss on the sale and tracking the deferred loss for future transactions. We provide an example in the Wash Sale section that follows. Brokers may not apply Section 1092 straddle rules on options when reporting adjusted cost basis to the IRS. These straddle rules affect your basis and holding period for stocks when you buy and sell options on the same stocks. A straddle is any set of offsetting positions on personal property. As an example, a straddle may consist of a purchased option to buy (long call option) and a purchased option to sell (long put option) on the same number of shares of the security, with the same exercise price and expiration date. The IRS only allows deductions on a loss on the disposition of one or more positions to the extent that the loss exceeds any unrecognized gain that a client may have on offsetting losses. Any unrecognized losses must be deferred. Brokers may not adjust the basis of the remaining position for the deferred loss. A client who has additional questions about Section 1092 straddles should consult his or her tax advisor for more information. New Reporting Requirements for Options Exercise and Assignment If an option contract is exercised or assigned, brokers will be required to adjust the cost basis or proceeds of the underlying position by the option premium. Schwab currently makes this adjustment, and there will be no change in the client experience. Call Put Seller (Writer) Option Assigned Increase sales proceeds on sell of underlying security by option premium received Decrease cost basis on buy of underlying security by option premium received Buyer (Holder) Option Exercised Increase cost basis on buy of underlying security by option premium paid Decrease sales proceeds on sell of underlying security by option premium paid Call Example: An XYZ call trades for $2.00. Later the buyer exercises the call. Call Buyer: Cost basis of underlying stock = $9,500 + $200 option premium paid ($2.00 x 100 shares/contract) = $9,700 Adjusted Cost Basis Call Seller: Proceeds of underlying stock = $9,500 + $200 option premium received = $9,700 Total Proceeds Put Example: An XYZ put trades for $4.00. Later the buyer exercises the put. Put Buyer: Sales Proceeds = $9,500 $400 option premium paid = $9,100 Total Proceeds Put Seller: Cost Basis of underlying stock = $9,500 $400 option premium received = $9,100 Adjusted Cost Basis 21

23 NEW Reporting Requirements for Long Options Expirations Expired long options will show the premium amount as a negative number in the Proceeds column with a cost basis of $0.00. Realized Gain/Loss sections on the Schwab Advisor Center and schwaballiance.com/statements will also show the premium amount as a negative number in the Proceeds column with a cost basis of $0.00. Before expiration, Unrealized Gain/Loss sections will continue to show $0.00 in the Proceeds column and the amount of the premium in the Cost Basis column. Example Client buys 10 March calls on 3/14/2014 for $1.05 each or a total of $1, The calls expire worthless on 3/21/2014. Schwab Advisor Center Here is what it will look like on the Schwab Advisor Center Unrealized Gain/Loss screen: Realized Gain/Loss sections in the Schwab Advisor Center and schwaballiance.com/statements will show the premium amount as a negative number in the Proceeds column with a cost basis of $0.00 Here is what it will look like on the Schwab Advisor Center Realized Gain/Loss screen: The long option premium amount is in the Proceeds column as a negative number Cost Basis amount is $0.00 The realized gain/loss amount remains the same 22

24 Here is how it will look on the client s Form 1099-B: The long option premium amount is in the Proceeds column as a negative number Cost Basis amount is $0.00 The Realized Gain/Loss amount is $(1,050) Reporting Requirements for Broad-Based Index Options (Section 1256 Contracts) Schwab is also required to report on Broad-Based Index Options acquired on or after January 1, These are defined as non-equity options that are marked to market under Section 1256 (i.e., listed options on non-equity securities and broadbased stock indexes such as the S&P 500 Index or the Russell Index) and will be reported under the rules for regulated futures contracts. Section 1256 contracts are taxed 60% at long-term capital gains tax rates and 40% at short-term capital gains tax rates. Section 1256 contracts are reported on Form 6781 and not on Form Clients will find reporting for Broad-Based Index Options on their Form 1099-B in a new section titled Options Subject to Section 1256 Reporting. Schwab is required to report the following to the IRS: The realized gain/loss on options that were sold during the tax year The unrealized gain/loss for Broad-Based Index Options positions held open at the end of the previous tax year The unrealized gain/loss for Broad-Based Index Options positions held open at the end of the current tax year The aggregate gain/loss on Section 1256 contracts Please note that for tax year 2014, Schwab will report a $0.00 amount in Box 10 Unrealized profit/loss: Open contracts 12/31/2013, because options purchased before 1//1/2014 are not covered. This may be different from what the client needs to report. Below we ve provided an example of the reporting for Section 1256 contracts and how the aggregate gain/loss is calculated. 23

25 Section 1256 Reporting The following example shows how a Section 1256 option contract is reported on the Form 1099-B: Example Buy Broad-Based Index Options contract for $3 during On 12/31/2014, Options contract is worth $7. On 6/30/2015, sell contract for $9. An Options Subject to Section 1256 Reporting section was added to the end of Form 1099-B. This section will display if the client has options that are subject to Section 1256 reporting. An instruction page will also display after the new section. This amount in box 10 becomes the amount in box 9 in the next year. 24

26 Year-End Summary Section Updates: Options Under the Realized Gain/Loss, there was a change to column headings Description changed to Description OR Option Symbol (option symbol from Item Screen Display field); Date of Acquisition changed to Date Acquired; Date of Sale changed to Date Sold; Cost Basis changed to ( ) Cost Basis; Wash Sale Loss Disallowed changed to (+) Wash Sale Loss Disallowed; and Realized Gain/Loss changed to (=) Realized Gain/Loss. Note: this follows the same format as the Form 1099-B. Investment Activity for Options (Year-End Summary): Description Changed to Option Symbol The Option symbol that is displayed comes from enhancements to our security descriptions. 25

27 Sample Communication: Inform Your Clients About New Tax-Reporting Requirements for Fixed Income Securities and Options You may wish to adapt this sample communication as a letter or to your clients. If you have enabled cost basis reporting preferences for their accounts, your clients may have seen changes on schwaballiance.com and/or on their monthly statements starting in August Please note that these sample communications are relevant only if cost basis is displayed on schwaballiance.com or your clients statements. For confirmation of your current reporting preferences, view your settings under the Cost Basis tab on schwabadvisorcenter.com. Go to the Subscription/Status link for the applicable master account to view schwaballiance.com and statement settings. You may also contact Client Reporting at or ascostbasis@schwab.com to obtain this information. Re: IRS Rule Changes Affecting Fixed Income Securities and Options Reporting for 2014 In August 2014, Schwab made changes to the amortization settings in its cost basis system to conform to new IRS reporting rules. For tax year 2014, Schwab will report to the IRS adjusted cost basis on less complex fixed income and select options securities purchased and sold in Schwab will also include the adjusted cost basis for these types of securities on clients 2014 tax reports. In addition, the following changes will be made in November 2014: Fixed Income Securities Closed fixed income transactions that occurred in your account between January 1, 2014, and August 15, 2014 will reflect the new IRS-required amortization settings. Existing taxable bonds purchased at a premium with a call feature will be updated to reflect the IRS required yield amortization of Yield to Best. Options Expired Long Options will show any premium amount as negative proceeds, with a cost basis of $0.00. Wash Sales will be turned off for Broad-Based Index Options (BBIO). Any existing positions will be updated to remove Wash Sale adjustments. Please note that the adjusted cost basis for Fixed Income securities purchased on or after January 1, 2014, will be reported to the IRS. The Adjusted Cost Basis for Fixed Income securities purchased before January 1, 2014, will not be reported to the IRS. If you have any questions or would like to schedule time to discuss these changes, please don t hesitate to call to set up a time to talk. Sincerely, [Advisor Name] Independent investment advisors are not owned by, affiliated with, or supervised by Schwab. 26

28 Glossary Fixed Income 171 Election A taxpayer (a bondholder or client) instruction under Internal Revenue Code Section 171 to amortize bond premium on a taxable fixed income security. Accretion The process of adjusting the purchase price of a bond upward to par. The difference between the price of a bond bought below par and its par value is called the discount. When an investor buys a security in the secondary market at a discount (if the security was purchased below par of 100), the purchase price is adjusted upward to 100 over the remaining life of the security until it reaches par on the maturity date. Acquisition Premium The excess of a fixed income security s adjusted cost basis immediately after purchase, including purchase at original issue, over the fixed income security s adjusted issue price at that time. Amortization The process of adjusting the purchase price of a bond downward to par. The difference between the price of a bond bought above par and its par value is called the premium. When an investor buys a security in the secondary market at a premium (if the security was purchased above par of 100), the purchase price is adjusted downward to 100 over the remaining life of the security until it reaches par on the maturity date. Bond Call Feature Allows the issuer the right to redeem the bond, under specific conditions, prior to its maturity date. Bond Premium Amount by which your cost basis in the bond right after you buy it is more than the total of all amounts payable on the bond after you get it (excluding payments of qualified stated interest). Bond Put Feature Allows the holder to force the issuer to repurchase the security at specified dates before maturity. Constant Yield A method of amortizing bond premium. The constant yield amount is calculated by multiplying the adjusted cost basis by the yield to maturity at issuance and then subtracting the non-qualified stated interest. Debt Instrument or Fixed Income Security De Minimus Fixed Income Security or Debt Instrument Market Discount Original Issue Discount (OID) Qualified Stated Interest Straight Line Amortization Yield to Best Yield to Highest Yield to Maturity Yield to Worst Yield to Lowest The IRS defines debt instruments (also referred to by Schwab as fixed income securities) as any instrument or contractual arrangement that constitutes indebtedness under the general principles of federal income tax law, including notes, bonds, debentures, or other evidence of indebtedness. Under federal tax laws and regulations, for the discount rules to apply to a security, the discount must be at least 0.25% of the stated redemption price for the bond at maturity, multiplied by the number of full years from the date of original issue for OID securities or purchase date for market discount to maturity. Otherwise, the discount is considered to be zero. The IRS defines debt instruments (also referred to by Schwab as fixed income securities) as any instrument or contractual arrangement that constitutes indebtedness under the general principles of federal income tax law, including notes, bonds, debentures, or other evidence of indebtedness. The stated redemption price of a bond at maturity minus your cost basis in the bond immediately after you acquire it. Market discount arises when the value of a debt obligation decreases after its issue date. The amount by which the stated redemption price at maturity of a fixed income security is more than its issue price. In general, qualified stated interest is stated interest that is unconditionally payable in cash or property (other than fixed income securities of the issuer) at least annually over the term of the fixed income security at a single fixed rate (e.g., bond coupon payments). A simple amortization method that spreads out the cost of an asset equally over its lifetime. The yield that would be realized on a callable bond if it were redeemed on the date that would result in the highest yield. The average annual return on a bond, assuming the bond is held to maturity and all interest payments are reinvested at the same rate. The yield includes an adjustment for any premium or discount from the face value. The yield that would be realized on a callable bond if it were redeemed on the date that would result in the lowest known yield to the holder. 27

29 Options Assignment Broad-Based Index Options Compensatory Option Employer Stock Purchase Plan Exercise Expiration Incentive Stock Options Index Options Marked to Market Narrow-Based Index Options Options Section 1256 Contract Stock Rights Straddle Straddle Rules Under Section 1092 An assignment occurs when an options seller s (writer s) position is chosen by random lottery conducted by the Options Clearing Corporation. The options seller (writer) is contractually obligated to either buy or sell the underlying stock at the option s strike price; or, in the case of index options, to provide the cash settlement value equal to the difference between the strike price and the set/ settlement price. Options whose value is determined by reference to a security index that contains stocks from many different industries. An option that grants an employee the right to buy shares of the company s stock at a set price. Stock options are often included in compensation packages. Also known as incentive stock options. An organized program for employees of a company to buy shares of its stock, often at a discount from the current market price. Refers to the process whereby an option buyer (holder) converts their option position into a long or short position in the underlying security. The date on which an option contract becomes void. An option that grants an employee the right to buy shares of the company s stock at a set price. Stock options are often included in compensation packages. Also known as compensatory stock options. Options whose underlying instrument is an index instead of a specific stock. The treatment of each Section 1256 contract held by a taxpayer at the close of the year as if it were sold for its fair market value on the last business day of the year. Options contracts whose underlying instrument is an index that usually consists of fewer than 10 securities and only one industry group. Standardized contracts that give the buyer the right, but not the obligation, to buy or sell a particular asset (the underlying security for equity options, cash for index options) at a fixed price for a specific period of time. Options contracts also obligate the seller to meet the delivery terms if the buyer exercises the contract right. A type of investment defined as a regulated futures contract, foreign currency contract, Broad- Based Index Options contract, dealer equity options contract, or dealer securities futures contract. Rights to subscribe to additional shares of stock at a set price, which may be offered to some or all shareholders. The purchase or sale of an equal number of puts and calls having the same terms. Deferred recognition of losses on positions in a straddle where the taxpayer continues to hold gain positions of the straddle that were offsetting the loss positions. 28

30 Questions? The Client Reporting Services Team is available at to answer any additional questions you may have. Options carry a high level of risk and are not suitable for all investors. Specific requirements must be met to trade options through Schwab. Please read the options disclosure document Characteristics and Risks of Standardized Options. Futures trading carries a high level of risk and is not suitable for all investors. Specific requirements must be met to trade futures. Please read Risk Disclosure Statement for Futures and Options before considering any futures transaction. Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. For general informational purposes only. Meant for an institutional audience. Schwab Advisor Services serves independent investor advisors and includes the custody, trading, and support services of Charles Schwab & Co., Inc. ( Schwab ). Independent investment advisors are not owned by, affiliated with, or supervised by Schwab. This general information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice and is not intended to be construed as tax advice. This information cannot be used for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Where specific advice is necessary or appropriate, Schwab recommends consulting with a qualified tax advisor, CPA, financial planner, or investment manager Charles Schwab & Co., Inc. All rights reserved. Member SIPC. CS ( ) MKT (10/14)