New rules for fixed income cost basis reporting

Transcription

1 New rules for fixed income cost basis reporting On January 1, 2011, the cost basis reporting requirements began a multiyear phased implementation, during which time specified securities become covered under the law. As a result of the cost basis regulations, brokers (including Fidelity Investments) now report adjusted cost basis (often referred to as basis ) for specified securities on the annual IRS Form 1099-B and indicate whether the holding periods of disposed securities were short- or long term in nature. Fidelity Investments (Fidelity) has prepared this educational guide to help your firm become acquainted with the cost basis reporting requirements related to debt instruments. Effective January 1, 2014, the multi-year phase in of reporting requirements for debt went into effect. On the following pages, we provide an explanation of these requirements, as well as: Which debt instruments are covered and when The timing and nature of transfer statement reporting Cost basis adjustments for amortization and accretion IRS changes to tax reporting For additional information that may help you prepare for the implementation of the next phase of the regulations, you can review our set of published cost basis guides that are listed in the Additional resources section and available on our Cost Basis Resource Center, which is located at Your Fidelity Client Service Team stands ready to serve you. We encourage you to reach out to and rely on them for any questions you may have. Inside Reporting requirements 2 Cost basis adjustments for amortization and accretion 4 Customer reporting 5 Frequently asked questions 5 Additional resources 7 Appendix 8 Key takeaways: Final regulations categorize debt instruments as two distinct categories, each with its own effective dates for implementation of the reporting requirements. Cost basis reporting for less complex debt became effective on January 1, 2014, with reporting for complex debt commencing on January 1, The regulations delay transfer statement requirements by one year from the effective implementation dates of the regulations. Brokers are now required to accommodate client elections for the treatment of bond premiums and discounts.

2 Reporting requirements SPECIFIED SECURITIES AND IMPLEMENTATION SCHEDULE Final regulations issued by the IRS distinguish debt as two distinct categories: Less complex debt instruments Complex debt instruments As the table below indicates, each debt category has its own effective date for implementation of the cost basis reporting requirements. DEBT: DEFINITION AND EFFECTIVE DATES FOR FORM 1099-B REPORTING INSTRUMENT AND IRS DEFINITION IMPLEMENTATION DATE Less complex debt issues Complex debt issues Bonds, notes, and debentures that have a single fixed payment schedule as well as a maturity date. These include debt with more than one stated rate of interest (such as stepped and variable rate debt), convertible debt, stripped bonds or stripped coupons, non dollar denominated debt, tax credit bonds, debt with a PIK (payment in kind) feature, foreign debt issued by a non-u.s. issuer, contingent payment debt, and inflation-indexed debt. Acquired on or after January 1, 2014 Acquired on or after January 1, 2016 There are several exclusions to the cost basis reporting requirements for debt. These include: Short-term debt (maturity of less than 366 days). Please note that any covered fixed income security with a term of more than one year, but purchased with less than one year left to maturity, is still subject to basis reporting. Debt instruments subject to section 1272(a)(6) of the cost basis regulations. Examples of this type of debt include mortgage-backed securities such as REMICs and agency (e.g., GNMA and FNMA) pass-throughs. 2

3 TRANSFER STATEMENT REQUIREMENTS The regulations delay transfer statement requirements by one year from the effective implementation dates of the regulations. TRANSFER STATEMENT REPORTING REQUIREMENTS January 1, 2015 Required for less complex debt issues that are covered as of January 1, January 1, 2017 Required for complex debt issues that are covered as of January 1, The transferring broker must send enough additional information on the transfer statement to the receiving broker so that it can determine how to calculate basis going forward. Examples of the type of information that the transferring broker must provide on the statement include the following: Information about the terms of the bond including issue date and price of the instrument, payment terms used by the transferring broker to compute any basis adjustments, and adjusted issue price of the bond as of the transfer date Customer s initial basis A list of customer elections for amortization and accretion that the broker has taken into account Any market discount accrued as of the transfer date Any bond premium amortized as of the transfer date Any acquisition premium accrued as of the transfer date It s important to note that if a covered fixed income security is transferred from one brokerage firm to another, prior to the effective date of the transfer requirements for that security, then the security will not be considered covered once at the receiving firm. Consider the following example of investor activity and corresponding security treatment: DATE INVESTOR ACTIVITY SECURITY TREATMENT January 5, 2014 The investor purchases a less complex debt instrument. The purchase is made within investor account at Brokerage Firm A. Security is considered covered. November 1, 2014 The investor transfers the security to Brokerage Firm B Brokerage Firm B, the receiving broker, records the debt instrument as a noncovered security since transfer statements are not required until January 1, 2015, for less complex debt. Because a transfer statement is not required, the delivering broker may or may not provide one to the receiving firm. And if a transfer statement is provided, it may not contain all the information required for the receiving firm to accurately calculate and maintain cost basis on the security. 3

4 Cost basis adjustments for amortization and accretion For purposes of calculating adjusted cost basis on debt, the regulations require a series of default methods for determining amortization and accretion for the following four components: Original Issue Discount (OID) Market discount Taxable and nontaxable debt premiums Acquisition premium The table below describes each component in more detail: DEFINITIONS OID The discount from par value at the time a bond is issued. It is the difference between the stated redemption price at maturity and the issue price. Over the life of the instrument, original issue price is adjusted up to the redemption price at maturity. Market discount For debt issued at par, market discount is the difference between the instrument s stated redemption price and the purchase price. For OID bonds (debt issued at a discount), market discount is the difference between the adjusted issue price and the purchase price. Taxable and nontaxable debt premiums Amount paid above a debt instrument s par value. Acquisition premium Amount paid above a debt instrument s adjusted issue price. As shown in the table below, taxpayers also have the option to change their elections with the IRS. Instructions must be received by Fidelity by December 31 of the year they wish the election to become effective. FIXED INCOME ELECTIONS Default Taxpayer Election Application Revocation with IRS Commissioner Consent Treat all interest as OID None applicable Yes Instrument by instrument (taxable only) and from the earliest taxable year owned Permitted Market discount computation method Straight line Constant yield Instrument by instrument from the earliest taxable year owned Not permitted Recognition of market discount At disposition (sale, redemption, or maturity) Current inclusion All debt acquired during the calendar year of the election and thereafter Permitted Amortize bond premium on taxable debt* Amortize over the life of the instrument Do not amortize All taxable debt held during the year elected and thereafter Permitted *Cost basis regulations do not provide for a taxpayer election for nontaxable debt. 4

5 It is important to note that these elections can only be made with the IRS. Instructions to Fidelity only change the calculation and reporting of the relevant accruals. We encourage all clients to consult with their tax advisor before making any elections. Advisors can find the form for submitting taxpayer instructions to Fidelity in the Forms Library on WealthCentral. This form, which is named Fixed Income Reporting Instructions, must be signed by the taxpayer. Submission of this form does not negate the taxpayer s responsibility of notifying the IRS of any chosen elections. Customer reporting The following table provides an overview of the type of information brokers are required to include on tax forms. The information in the table is in addition to the requirement for brokers to send adjusted cost basis to the IRS for realized gains and losses for covered securities. Our upcoming guide, Understanding the Fidelity 2014 Tax Reporting Statement will provide detailed information of actual changes to Form 1099-B and related forms.* TAX REPORTING CHANGES COVERED INSTRUMENTS (LESS COMPLEX DEBT PURCHASED ON OR AFTER JANUARY 1, 2014, AND COMPLEX DEBT PURCHASED ON OR AFTER JANUARY 1, 2016) Form 1099-B Form 1099-INT Form 1099-OID The addition of reportable accrued market discount for bonds purchased at a market discount and disallowed loss for wash sales The addition of the amount of reportable market discount for bonds purchased at a market discount and reportable amortized bond premium for bonds purchased at a premium The addition of reportable accrued market discount for bonds purchased at a market discount and reportable amortized acquisition premium for a bond purchased with an acquisition premium *Planned for Q4 2014, date subject to change. Frequently asked questions Here is a list of sample questions about fixed income and cost basis that we ve been asked by advisors. We hope the responses provide a greater sense of clarity to assist you when managing client accounts. 1. Why is the cost basis being adjusted on my fixed income security? Fidelity adjusts cost basis on fixed income securities on a daily basis, as required. We make these adjustments for several reasons, including: Return of principal payments to asset-backed securities (mortgage pools, CMOs, etc.), which we are notified of by the transfer agent Amortization of market premium Accrual of OID 5

6 2. Can you explain how the adjusted cost basis is calculated? We use the formula below for calculating adjusted cost basis: Original cost + OID accrued to date Acquisition premium to date Premium amortization to date + Applicable market discount to date (we default to defer market discount until redemption) Principal repaid to date Adjusted cost basis For our amortization and accretion calculations, Fidelity defaults to a constant yield to maturity method. 3. On WealthCentral, it does not appear that cost basis is being adjusted by principal payments on fixed income securities. Why? Fidelity recognizes market premium and discount adjustments on asset-backed securities when principal is returned to the holder. Therefore, if a client purchased a security at a premium, the cost basis adjustment will be for an amount that is proportionally greater than the principal payment so that an appropriate loss is recognized. Conversely, if the security was purchased at a discount, the cost basis adjustment will be proportionally lower than the discount in order to recognize an appropriate gain. 4. I sold a bond on behalf of my client, and the cost basis reported on WealthCentral was not adjusted for accrued market discount. Why? This could be the result of a purchase price on the bond that meets the definition of the de minimis rule. In such instances, there is no adjustment to cost. This most likely occurs when a purchase is made close to or approximately at par value. 5. Does WealthCentral display which debt securities are covered? If so, how is this shown? WealthCentral and our transmissions include covered and noncovered indicators for less complex debt securities to indicate the status of each instrument. Complex debt instruments display noncovered indicators, until the time the securities are considered covered. 6. How can taxpayers make elections for fixed income securities? The elections must be made with the IRS directly, and, in some cases, they are irrevocable. It s important to note that providing instructions to Fidelity changes only the calculation and reporting of certain accruals on a customer s fixed income securities. The instructions to Fidelity do not bind the IRS and do not change the amount of any taxes that may be due. Taxpayers should consult their tax advisors regarding the advisability of, and timing and requirements for, making these elections with the IRS. Advisors can download the Fixed Income Reporting Instructions Form on behalf of their clients from the Forms Library on WealthCentral. 7. When does the taxpayer need to notify Fidelity regarding the elections he or she has made, or intends to make with the IRS? The relevant tax rules require that taxpayers provide their instructions to Fidelity by December 31 of the calendar year their elections with the IRS would be effective. Taxpayers should consult their tax advisors regarding the determination of when a tax election is effective under the tax rules. Customers should also note that the deadlines for providing instructions to Fidelity and for making elections with the IRS are different, and, in some cases, the law imposes a due date for instructions to Fidelity that is before the due date for the relevant election with the IRS. Customers should consult their tax advisors regarding the advisability of, and timing and requirements for, making these elections with the IRS. 6

7 Additional resources Our Client Service Team is committed to providing your firm with answers to questions relating to these new enhancements, as well as technical support for additional questions you may have on other topics. In addition to relying on our Client Service Team, don t hesitate to review our previously released cost basis educational and operational guides that are described below. If you have not yet accessed these guides through our e-newsletter Insight & Outlook, please visit our Cost Basis Resource Center at RECENT COMMUNICATION PURPOSE READERSHIP PRINCIPALS OPERATIONS TEAM RELATIONSHIP MANAGERS/ CLIENT SERVICE Cost Basis Regulations and Your Firm New Rules for Corporate Account Cost Basis Reporting New Rules for Mutual Fund Cost Basis Reporting New Rules for Options Cost Basis Reporting Understanding the Fidelity 2013 Tax Reporting Statement Cost Basis Impact to Client Reporting, Transferring Assets, and Gifting Shares Best Practices for Using Fidelity s Trading Features Using Various Portfolio Management Systems to Reconcile Cost Basis Data with Fidelity Frequently Asked Questions about Cost Basis Explains reporting requirements and potential impact to your firm Describes rules for corporate accounts, along with the account certification process Explains new reporting requirements as well as how to prepare your practice and clients Explains the rules for options and potential client impact Provides a step-by-step review of the annual Tax Reporting Statement, including changes to Form 1099-B Describes impact on client reporting, transferring assets, and gifting of shares Provides instructions on how to place trades with Fidelity using ADMs Offers a series of best practices for systems that are widely used by Fidelity clients Answers more than 50 cost basis related questions across a range of topics 7

8 Appendix Cost basis reporting requirements SPECIFIED SECURITIES AND IMPLEMENTATION SCHEDULE January 1, 2011 January 1, 2012 January 1, 2014 January 1, 2015 January 1, 2016 All stock held in a corporation, except those for which average cost is permissible, acquired on or after January 1, Some adjustments to the original cost basis of equity securities may include the following: Adjustments associated with wash sales. For 1099-B reporting purposes, wash sales include only those securities held within one single shareholder account (instead of across accounts for the same shareholder) that have the same CUSIP number (versus substantially identical securities, which may have different CUSIP numbers). Adjustments resulting from corporate actions. Any stock for which average cost is permissible. This includes, but is not limited to, registered investment companies, including open-ended mutual funds and shares in dividend reinvestment plans (DRIPs) acquired on or after January 1, Closed-end funds acquired on or after January 1, 2012, also qualify as covered securities. Less complex debt issues, such as bonds, notes, and debentures that have a single fixed payment schedule as well as a maturity date, acquired on or after January 1, Equity options and Section 1256 options, as defined by the IRS, also qualify as covered securities as of this date. Transfer statement reporting begins for all equity options, regardless of whether the security is considered covered. Transfer statement reporting also begins for less complex debt issues that are covered as of January 1, Complex debt instruments, as defined by the IRS, that are acquired on or after January 1, These include debt with more than one stated rate of interest (such as stepped and variable rate debt), convertible debt, stripped bonds or stripped coupons, non dollar denominated debt, tax credit bonds, debt with a PIK (payment in kind) feature, foreign debt issued by a non-u.s. issuer, contingent payment debt, and inflation-indexed debt. January 1, 2017 Transfer statement reporting begins for complex debt issues that are covered as of January 1, Note: With regards to debt instruments, short-term debt (maturity of less than 366 days) and REMICs (FNMA, GNMA) are not considered covered securities. 8

9 For more information, please contact your Fidelity Relationship Manager or Client Service Team. FIDELITY INSTITUTIONAL WEALTH SERVICES 200 SEAPORT BOULEVARD Z2B1 BOSTON, MA For investment professional use only. Not for distribution to the public as sales material in any form. The information contained in this guide is general in nature and is provided for informational purposes only. Fidelity Investments is providing this guide as a service to your firm. You are responsible for evaluating your own practice and making appropriate decisions for your firm. Those decisions may be based on these and other factors you deem relevant. This guide is not meant to be exhaustive of all possible options you may consider. Fidelity Investments is not responsible for your action or inaction as a result of this service. The tax information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. Fidelity Investments does not provide legal or tax advice. Fidelity Investments cannot guarantee that such information is accurate, complete, or timely. Laws of a particular state or laws that may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of this information. Clearing, custody, or other brokerage services may be provided by National Financial Services LLC or Fidelity Brokerage Services LLC, Members NYSE, SIPC