Cost Basis Reporting for Options On January 1, 2011, the cost basis reporting requirements began a multiyear phased implementation, during which time specified securities are considered covered under the law. As a result of these regulations, brokers report adjusted basis (often referred to as cost 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. These reporting requirements became effective for options entered into on or after January 1, 2014. The IRS classifies specified securities for options in two categories: equity and Section 1256. Closing transactions on equity options are reported on Form 1099-B in the same year they are closed. Closing transactions can include the purchase, sale, or expiration of an equity option. Section 1256 options are subject to mark-to-market reporting rules, which means that, at the end of each tax year, they are treated as disposed or closed, even if they are still open contracts. Inside Highlights of the Reporting Requirements Case Study Examples Additional Resources Appendix The IRS also requires transfer reporting for options. The IRS requires delivering brokers to issue transfer statements for the transfer of all options, regardless of whether they are covered securities. This requirement became effective January 1, 2015, for equity options, one year after the implementation of the reporting requirements for options. However, transfer statements for 1256 options, regardless of whether they are covered securities, are required effective January 1, 2016.
Highlights of the Reporting Requirements The following pages provide an explanation of the reporting requirements for options. Definition of specified securities Equity options. These are defined by the IRS as options granted or acquired on or after January 1, 2014, on a share of stock, an equity index, or an ADR. Section 1256 options. These are defined by the IRS as any regulated futures contract, debt options, nonequity options, broad-based stock index options, dealer equity options, dealer security futures contracts, and cash-settled options. Section 1256 options are subject to mark-to-market reporting rules, which means that, at the end of each tax year, they are treated as disposed or closed, even if they are still open contracts. The gain (or loss) is reported by the customer as 40% short term and 60% long term. Corporate actions. If an option is exercised or assigned and a corporate action occurred on the underlying security during the life of the option, the premium on the option and any associated cash amount will be allocated on a pro rata basis to the cost basis or proceeds of the purchase or sale of the underlying securities. Options issued as part of an investment unit. Because investment units are considered to be complex debt and are covered in 2016, options issued as part of these securities were not covered until 2016. Compensatory options. Acquired through equitybased compensation programs, these types of options are not considered a specified security that would be covered by the cost basis reporting requirements. As such, they are not subject to 1099-B reporting. It is important to note that the IRS has issued additional rules regarding the adjustment of basis for stock acquired as a result of the exercise of a compensatory option issued on or after January 1, 2014. Under these rules, brokers are not permitted to adjust the cost basis for such stock reported on Form 1099-B by the income recognized (by the investor) upon the exercise of the option. This means that investors and their advisors may need to track and report any adjustments to cost basis in these situations independent of broker 1099-B reporting. Rights and warrants. For purposes of the cost basis regulations, rights and warrants became covered if they were acquired on or after January 1, 2014. Brokers are permitted to presume that a distribution of rights and warrants has a cost basis of $0. Consequently, if these types of instruments are sold, the proceeds from the sale will equal the capital gain associated with proceeds from the transaction. Rights and warrants purchased on the open market will have a cost basis equal to the cost of the asset. Commodities and foreign currency options. The IRS does not consider these types of contracts as specified securities that are covered under the cost basis regulations, because their underlying securities (commodities and foreign currencies) are not considered covered. Transfer statement reporting. Effective January 1, 2015, the IRS requires cost basis transfer statements for the transfer of equity options, regardless of whether or not they are covered (cost basis may be sent as unknown for noncovered option positions). Transfer statements for 1256 options are required effective January 1, 2016. 2
IMPLICATIONS FOR CUSTOMER REPORTING REPORTING FOR EQUITY OPTIONS What is reported under the cost basis rules on Form 1099-B For options granted or acquired on or after January 1, 2014, closing transactions on options are reported on Form 1099-B in the same year they are closed. Closing transactions can include the purchase, sale, or expiration of an equity option. Further, the cost or proceeds on covered securities purchased or sold as a result of an option exercise or assignment must be adjusted by the amount of the option premium. How these changes impact reporting by Fidelity Fidelity s tax-lot accounting system tracks cost basis on both covered and noncovered options and adjusts the cost or proceeds by the option s premium on underlying securities purchased or sold as a result of an options exercise. The 1099-B annotates whether or not a security is covered. For written options, cost basis regulations include modified reporting requirements, which apply when written options are closed. In this case, brokers are required to report a) a cost basis of $0 and b) proceeds as the difference between the proceeds on the written option and the cost basis on the purchase to close the option. Case Study Examples The following examples are intended to demonstrate an array of transactions and corresponding reporting. They are intended for illustrative purposes only. EXAMPLE 1: EXERCISE OF EQUITY OPTIONS A. EXERCISE: LONG CALL On January 11, 2016, an investor purchases 10 contracts of XYZ November 2016, 70 calls at $5. Total premium paid: $5,000. On July 21, 2016, the investor exercises the above-referenced contracts and buys 1,000 shares of XYZ. Total purchase price: $70,000. On November 21, 2017, the investor sells 1,000 shares of XYZ stock at $100/share. Transaction proceeds: $100,000. B. EXERCISE: LONG PUT Cost basis: $75,000 (the purchase price of the stock plus the premium paid on the option) Transaction proceeds: $100,000 Holding period: Long term On March 20, 2013, an investor purchases 1,000 shares of XYZ. Purchase price: $50/share. Total cost basis: $50,000. On January 11, 2017, the investor purchases 10 contracts of XYZ November 2017, 70 puts at $5. Total premium paid: $5,000. On September 29, 2017, the investor exercises the above-referenced puts and sells 1,000 shares of XYZ. Transaction proceeds: $70,000. Cost basis: $50,000 Transaction proceeds: $65,000 (strike price of $70/option minus the $5,000 premium paid for the purchase of the options) Holding period: Long term 3
EXAMPLE 2: ASSIGNMENT OF EQUITY OPTIONS A. EXERCISE: SHORT CALL On March 21, 2016, an investor purchases 1,000 shares of XYZ. Purchase price: $50/share. Total cost basis: $50,000. On January 11, 2017, the investor sells 10 contracts of XYZ November 2017, 70 calls at $5. Total premium received: $5,000. On July 21, 2017, the stock is called away due to an assignment, resulting in the sale of 1,000 shares of XYZ at a strike price of $70/share. B. EXERCISE: SHORT PUT Cost basis: $50,000 Transaction proceeds: $75,000 (total proceeds of sale plus premium received on sale of option) Holding period: Long term On February 22, 2017, an investor sells 10 contracts of XYZ November 2017, 70 puts at $5. Total premium received: $5,000. On August 10, 2017, the stock is put to the investor due to an assignment, resulting in the buy of 1,000 shares of XYZ at the strike price of $70/share. Cost basis: $70,000. On October 4, 2017, the investor sells the 1,000 shares of XYZ at $75/share. Total proceeds: $75,000. Cost basis: $65,000 (strike price of $70/option minus the $5,000 premium received for the sale of the options) Transaction proceeds: $75,000 EXAMPLE 3: DISPOSITION OF EQUITY OPTION CONTRACTS BEFORE EXPIRATION A. DISPOSITION: LONG CALL (OR PUT) On January 11, 2017, an investor buys 10 contracts of XYZ November 2017, 70 calls (or puts) at $5. Total cost basis: $5,000. On October 24, 2017, the investor sells the 10 contracts at $7. Total proceeds: $7,000. Cost basis: $5,000 Transaction proceeds: $7,000 B. DISPOSITION: SHORT CALL (OR PUT) On January 11, 2017, an investor sells 10 contracts of XYZ November 2017, 70 calls (or puts) at $5. Total proceeds: $5,000. On October 24, 2017, the investor buys to cover 10 contracts of XYZ November 2017, 70 calls at $7. Cost basis: $7,000. Cost basis: $0 Transaction proceeds: $5,000 4
EXAMPLE 4: EXPIRATION OF EQUITY OPTIONS A. EXPIRATION: LONG PUT (OR CALL) On January 11, 2017, an investor buys 10 contracts of XYZ November 2017, 70 put (or calls) at $5. Total premium paid: $5,000. The option expires worthless on November 17, 2017. Cost basis: $5,000 Transaction proceeds: $0 B. EXPIRATION: SHORT PUT (OR CALL) On January 11, 2017, an investor sells 10 contracts of XYZ November 2017, 70 put (or call) options at $5. Total proceeds: $5,000. The option expires worthless on November 17, 2017. Cost basis: $0. Cost basis: $0 Transaction proceeds: $5,000 EXAMPLE 5: SECTION 1256 OPTIONS A. PURCHASES AND SALES On March 2, 2016, an investor purchases Section 1256 options for $10,000. On December 30, 2016, the fair market value (FMV) for this position is $15,000. On June 15, 2017, the client sells the position for $17,000. 1099-B reporting For 2016, the $5,000 difference between the cost basis and the year-end mark-to-market will be reported as an unrealized loss on open contracts (Box 10). The $5,000 is reportable by the customer as 40% short term and 60% long term. For 2017: The $7,000 difference between the cost basis and the proceeds will be reported as Profit or (loss) realized in 2017 on closed contracts (Box 8). The $5,000 unrealized gain reported in 2016 will be reported as Unrealized profit or (loss) on open contracts 12/31/2016 (Box 9). The $2,000 unreported gain (the difference between the entire realized gain and the previously reported unrealized gain) is reported as Aggregate profit (or loss) on contracts (Box 11). This amount is reportable by the customer as 40% short term and 60% long term. 5
Additional Resources Your Fidelity Client Service Team is committed to providing your firm with answers to questions related to cost basis regulations. Don t hesitate to review previously released cost basis educational and operational guides, which are described below. RECENT COMMUNICATION PURPOSE SUGGESTED READERSHIP PRINCIPALS OPERATIONS TEAM RELATIONSHIP MANAGERS/CLIENT SERVICE Cost Basis Regulations and Your Firm Cost Basis Reporting for Fixed Income Understanding the Fidelity 2017 Tax Reporting Statement Frequently Asked Questions about Cost Basis Explains reporting requirements and potential impact to your firm Explains the multiyear implementation of the rules and potential client impact Provides a step-by-step review of the annual Tax Reporting Statement, including changes to Form 1099-B Answers more than 50 cost basis related questions across a range of topics 6
Appendix COST BASIS REPORTING REQUIREMENTS: SPECIFIED SECURITIES AND IMPLEMENTATION SCHEDULE January 1, 2011 January 1, 2012 January 1, 2014 All stock held in a corporation, except that for which average cost is permissible, acquired on or after January 1, 2011. Brokers must provide cost basis transfer statements for the transfer of covered securities. 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, 2012. Closed-end funds acquired on or after January 1, 2012, also qualify as covered securities. Cost basis reporting for covered securities in S-Corp accounts began in 2012. Noncomplex 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, 2014. Options as defined by the IRS are also covered securities as of this date. Options include equity options, Section 1256 options, rights, and warrants. January 1, 2015 January 1, 2016 Transfer statement reporting is required for all equity options, rights, and warrants, regardless of whether the security is considered covered. Transfer statement reporting is also required for noncomplex debt issues that are covered as of January 1, 2014. Complex debt instruments, as defined by the IRS, acquired on or after January 1, 2016. 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. Transfer statement reporting is required for Section 1256 options, regardless of whether the security is considered covered. January 1, 2017 Transfer statement reporting is required for complex debt issues that are covered as of January 1, 2016. Original Issue Discount on tax-exempt debt is reportable on the 1099-OID or 1099-INT. Note: Debt instruments, short-term debt (maturity of less than 366 days), REMICs, and agency pass-through securities (FNMA, GNMA) are not considered covered securities. 7
FIDELITY CLEARING & CUSTODY SOLUTIONS 200 Seaport Boulevard, Boston, MA 02210 For more information, please contact your Fidelity Client Service Team. For investment professional use only. Not for distribution to the public as sales material in any form. The information contained herein is as of the date of its publication unless otherwise noted, is subject to change, and is general in nature. Such information is provided for informational purposes only and should not be considered legal, tax, or compliance advice. Fidelity Investments does not provide legal, tax, or compliance advice. Fidelity cannot guarantee that such information is accurate, complete, or timely. Federal and state laws and regulations are complex and are subject to change. Laws of a specific state or laws that may be applicable to a particular situation may affect the applicability, accuracy, or completeness of this information. This information is not individualized; is not intended to serve as the primary or sole basis for your decisions, as there may be other factors you should consider; and may not be inclusive of everything that a firm should consider in this type of planning decision. Some of the concepts may not be applicable to all firms. Always consult an attorney, tax professional, or compliance advisor regarding your specific legal or tax situation. Third-party marks are the property of their respective owners; all other marks are the property of FMR LLC. Fidelity Family Office Services is a division of Fidelity Brokerage Services LLC. Fidelity Clearing & Custody Solutions provides clearing, custody, or other brokerage services through National Financial Services LLC or Fidelity Brokerage Services LLC, Members NYSE, SIPC. 663489.11.0 1.9584722.104 0917