Frequently Asked Questions

Transcription

1 Northwestern Mutual Investment Services (NMIS) is enhancing its cost basis reporting services in preparation for and in response to IRS mandated changes in the Emergency Economic Stabilization Act of The act requires financial services firms to report cost basis and detailed gain or loss information for the first time on clients IRS 1099-B tax forms. The new tax rules will be phased in over time beginning with equities in January 2011, mutual funds and dividend reinvestment plans (DRPs) in January 2012 and all other securities in January For information regarding 2010 tax reporting please go to mytaxhandbook.com. Q: What prompted this reporting change? A: The IRS by requiring financial institutions to record and report cost basis information hopes to minimize taxpayers incorrectly reporting capital gains and losses on securities sales. It has been estimated that 38 percent of individual taxpayers misreported their capital gains or losses, accounting for $11 billion of the gross tax gap of $345 billion. Q: How does this change benefit me? A: Investors are encouraged to retain records but the fact that financial institutions are required to track cost basis will simplify obtaining the information regarding what was paid for shares allowing you to easily and accurately report your gains and losses. Another upside of the regulation is that currently not all firms capture, much less transfer, cost basis information to another company, going forward all firms will be required to do so. Q: Realized Gains and Losses were already displayed on my 2009 Tax and Year End Statement, so what is changing? A: Northwestern Mutual Investment Services (NMIS) publishes cost basis on client statements and on NMIS Online for your information. Pershing, LLC provides tax reporting services for NMIS and they currently provide a Schedule of Gains and Losses on your Tax and Year End Statement in the TRANSACTIONS WE DO NOT REPORT TO THE IRS section. Prior to this regulation Pershing only reported the amount of sale to the IRS. After the effective dates, they are required to report not only the amount of the sale but your cost basis and the resulting gain or loss to the IRS. Q: Does this new reporting regulation affect my IRA account? A: No, since IRA accounts are exempt from reporting gains and losses on transactions within the account no IRS form 1099-B is issued. Cost basis will continue to be provided on statements although you will note changes to statements, confirmations and other correspondence designed to provide information for tax reportable accounts. Q: What are covered and uncovered securities? A: Covered refers to securities acquired on or after the effective dates of the legislation (January 1 of 2011 for equities and Exchange Traded Funds (ETFs), January 1 of 2012 for Mutual Funds and Dividend Reinvestment Plans, or January 1 of 2013 for all other securities). Uncovered refers to securities acquired prior to the effective dates.

2 Q: In the past I completed an IRS form Schedule D to report my gains and losses when I sold an asset in my account. Since Pershing is now supplying that information to the IRS do I still have to complete the Schedule D? A: You must still complete and file the IRS form Schedule D to report cost basis for short-term and long-term capital gains and losses. Q: What if there s a difference between what I report and what Pershing reports to the IRS? A: The IRS recognizes that there will be reasonable differences in taxpayer reporting compared to broker-dealer reporting. When completing the Schedule D your records are based on all of your holdings while Pershing is reporting information to the IRS based on transactions occurring only in your account. Q. What tax lot disposition methods are available through Northwestern Mutual Investment Services? A: Unless you provide your representative with instructions to the contrary, new accounts are opened using Average Cost for mutual funds and First In-First Out (FIFO) for all other securities. Note: If your account was opened prior to January 1, 2011 the methods listed on your account were retained, typically Average Cost for mutual funds and First In-First Out (FIFO) for all other securities. The methods assigned to your account will be displayed in the Customer Service Information section of your account statement. The methods available are: Disposal Method First In- First Out High Cost High Cost Long Term High Cost Short Term Low Cost Last In-First Out Low Cost Long Term Default Sell Selection Default Sell Selection Method -the oldest shares you own are sold or transferred first without consideration of realized Sell Selection Method- the highest cost shares you own are sold or transferred first without consideration of the term of the realized Sell Selection Method- the highest cost for the Longest term shares you own are sold or transferred first considering both the amount and the term of the realized Sell Selection Method- the highest cost for the shortest term shares you own are sold or transferred first considering both the amount and the term of the realized Sell Selection Method- the lowest cost shares you own are sold or transferred first without consideration of the term of the realized Sell Selection Method- the newest shares you own are sold or transferred first without consideration of amount realized Sell Selection Method- the lowest cost shares you own are sold or transferred first with consideration of the term of the realized Low Cost Short Term Sell Selection Method - the lowest cost shares you own are sold or transferred first with consideration of the term of the realized

3 Average Cost Displayed on your statement as FIFO (Using Average Cost) - the oldest shares you own are sold or transferred first and the realized gain/loss is calculated based upon an average cost of all the lots you have ever owned.*nmis default method available only for mutual funds. Q. What is the default tax lot disposition method for converted accounts? A. In 2006 Northwestern Mutual Investment Services change it clearing provider from Robert W. Baird to Pershing LLC. The tax lot disposition method used at Baird was Highest In, First Out (HIFO), where the highest valued shares are sold first. If you account was originally opened at Baird and moved to Pershing, your account retained the HIFO tax lot disposition method for individual securities and adopted average cost for mutual funds. On the Pershing platform, mutual funds gains/losses are calculated using "Average Cost". Q. How do I change my cost basis election? A. There are two ways that you can change the shares identified to sell or transfer (Tax Lot Disposition method): You can request that your representative change the default method at the account level. Note: This will only apply to future sales or transfers. A onetime change can be made by instructing your representative at the time of sale or transfer to use a particular method or you can identify a specific set of shares. This election will be displayed on your confirmation of the sale. Note: The option to identify specific shares may not be available for certain Signature Advisory accounts since they are designed to align to a specific asset allocation model and are periodically rebalanced to maintain the targeted model. Assets are bought and sold according to the default tax lot disposition method associated with your account. Q: Why can t I change the average cost tax lot disposition method for my mutual funds? A: Average Cost displayed on your statement as FIFO (Using Average Cost) is a tax lot disposition method unique to mutual funds and certain Dividend Reinvestment Plans (DRPs). Conceptually this method is intended to spread your tax liability over multiple tax years rather than having a potential large gain on a specific low cost lot. Once this method is used for reporting gain/loss the shares will retain the average cost method. The effective date for reporting gains and losses on mutual fund sales to the IRS is not until January 1, As that date draws closer clients will be given the opportunity to: Change the average cost election if they have never sold any of their mutual fund shares. Revoke their election if they have sold shares. The shares owned prior to the revocation would retain average cost and shares purchased going forward would use the new tax lot disposition method. Q: What if I want to change my mutual fund election now? A: Our cost basis maintenance system is designed to maintain the integrity of average cost calculations and will not allow another method to be elected for mutual funds. You can however contact your financial representative to establish a new account using another method and transfer the shares to the new account. Once the average cost tax lot disposition method is used for reporting gain/loss the IRS

4 requires that the shares retain the average cost method. Please consult your tax advisor if this is an appropriate action. Q. How do I change what shares were sold? A. In the event that a tax lot other than the shares that you intended to sell are closed contact your representative. Northwestern Mutual Investment Services must be notified of the request to change which shares were sold by settlement date or three days after the sale (whichever is earlier). Note: This option is not available for mutual funds since the gain/loss is calculated using the Average Cost of all tax lots. Q. How is Average Cost calculated? A. Average Cost is an accounting method unique to mutual funds displayed on your statement as FIFO (Using Average cost) and is not available for individual securities. To compute the average cost, the total cost of all shares purchased, including all dividends reinvested in fractional shares, are divided by the total number of shares owned. Here is an example using the Average Cost method. Norma Weston has multiple purchases of the Russell Index 500 fund. On 5/1/06 she requests that her registered representative sell 200 shares. This is how the gain/loss calculation will look using the Average Cost method. Transaction date Transaction Type Quantity Price Cost 8/1/03 Purchase $1, /23/ $7.57 9/24/04 Purchase $1, /09/05 Purchase $1, /20/05 Purchase $1, average $4, $4, divided by = $12.56 average cost per share. This is the basis used to determine the gain/loss for all shares sold, including those averaged in to this calculation that will be sold after 5/1/06. To arrive at 200 shares, Norma sold the following: All of the shares purchase on 8/1/03 The.683 shares purchased as a dividend on 12/23/03 All shares purchased on 9/2/ of the shares purchased on 8/09/05 ( =200.00) Of the shares remaining, $12.56 will be used for the average cost the next time there are shares sold and gain/loss is calculated. For example:

5 Transaction Date and Type Shares Remaining Actual Price Avg. Price Used in Calculating Gain/Loss 8/09/05 Purchase $1, /20/05 Purchase $1, Note: Any additional purchase or dividend reinvestments will adjust the average cost. Q: I know that some of my cost basis information is missing, what action do I need to take? A. If your assets were purchased prior to the effective dates beginning with equities in January 2011, mutual funds and dividend reinvestment plans (DRPs) in January 2012 and all other securities in January 2013 the assets are uncovered. Although you are not required to do so you may want to contact your financial representative to update your account. If your assets have been recently transferred and cost basis information is incomplete on your statement, Pershing within will reach out to the delivering firm to obtain the information. Q: Why did my cost basis change when I transferred the assets in my account? A. Depending on the individual circumstance and variables in state tax law, when shares are transferred to another account due to a death or divorce, re-registration to a trust, or other similar change all shares or a portion of the shares may establish a new basis or retain the original basis. Q. What tax lot disposition method is best for me? A. You are strongly encouraged to speak with your tax professional since this is their area of expertise and they would be most familiar with your individual tax situation. Northwestern Mutual Investment Services, its financial representatives and operational staff cannot provide tax advice. Additional information on cost basis accounting methods is available on the IRS Web site. Commonly used Cost Basis Terms Cost basis- the amount paid for a given asset or security. It includes the purchase price plus commissions or fees incurred by the buyer as part of the process to complete the purchase. Knowing the cost basis of an asset is important in measuring realized and unrealized gains and losses. Covered- refers to securities that are purchased or acquired after the effective date of the Emergency Economic Stabilization Act of 2008 regulation. The effective dates differ by security

6 type, as follows: For equities, including stocks and ETFs, the effective date is January 1, 2011 For mutual funds and dividend reinvestment plans, the effective date is January 1, 2012 For all other securities, such as options, corporate and municipal bonds, the effective date is January 1, 2013 Realized Gain- is a gain resulting from selling an asset at a price higher than the original or adjusted cost. The security has been sold, so the gain has been realized and is reportable to the IRS (for tax reportable accounts). Realized Loss- is a loss resulting from selling an asset at a price lower than the original purchase price. The security has been sold, so the loss has been realized and is reportable to the IRS (for tax reportable accounts). Tax lot -the details of a purchase or acquisition of a security, including trade date, price per share, and total cost. Each acquisition of a security on a different date or for a different price makes up a new tax lot. The tax lot details are used to determine the amount of a gain or loss and whether the asset was held long or short term. Tax Lot Disposition Method- determined by the cost basis method used when selling shares or to identify what shares would be transferred upon a client s request. For example, if a client is using First in-first Out as their cost basis method the tax lot disposition method would identify the oldest shares to sell or transfer first. Uncovered- refers to securities that are purchased or acquired before the effective date(s) of the regulation. Unrealized Gain- is an increase in the current market value of a security in comparison to its cost. Since the security has not been sold, the gain has not been realized and is not reportable to the IRS. Also known as a paper gain. Unrealized Loss-is a decrease in the market value of a security in comparison to its cost. Since the security has not been sold, the loss has not been realized and is not reportable to the IRS. Also known as a paper loss. Wash Sale- when an asset is sold at a loss and the same or a substantially identical security is repurchased within 30 days the loss or portion of the loss is disallowed. The Emergency Economic Stabilization Act of 2008 requires that broker dealers report wash sales and adjust the cost basis for disallowed losses based upon the sale and repurchase of the same security in the same account. A taxpayer is required to report wash sales across all of their securities holdings.