Complying with new

cost basis legislation:

What brokers, banks, transfer agents,
mutual funds and issuers need to know

A White Paper to the Industry – December 2008

Table of Contents
Introduction................................................................................................................... 1

Executive Summary....................................................................................................... 2

Challenges of Cost Basis Accounting............................................................................. 3

A New Compliance Requirement................................................................................... 5

Brokers and Banks......................................................................................................... 6

Transfer Agents............................................................................................................. 8

Mutual Funds............................................................................................... 10

Equity Issuers.............................................................................................. 12

Penalties for Inaccurate Reporting................................................................... 15

Conclusion.. ................................................................................................. 16
Introduction

T he Emergency Economic Stabilization Act, commonly referred to as the “bailout bill,”

was signed into law on October 3, 2008. Included in the $700 billion rescue pack-
age are new and stringent requirements on financial intermediaries1 to report adjusted
cost basis2 to investors and the Internal Revenue Service (IRS) for securities transactions
posted after January 1, 2011. A principal aim of the legislation is to provide investors with
the means to accurately report gains or losses on the sale of securities for their annual tax
filings.

This paper will discuss:

hh T
 he historical challenges of cost basis accounting and the traditional obstacles to re-
porting accurate cost basis.
hh T
 he challenges that the new legislation poses for various market segments including
brokers, banks, custodians, transfer agents, mutual funds and issuers.
hh T
 he vague nature of the legislation and questions that still need to be addressed by
the IRS and the Treasury Department in dealing with the day-to-day administration
and processing complexities of cost basis reporting.
hh Those aspects of the legislation that intermediaries should address immediately.
hh Recommendations on how to best use the legislation to obtain a competitive advantage.

Defined within the legislation as any intermediary that “...is otherwise required to make a return under subsection (a) with
1 

respect to gross proceeds of the sale of a covered security...” Generally, any intermediary that is now reporting a form
1099-B to an investor will be required to provide cost basis information to the shareholder and the IRS.
The original value of a securities asset for tax purposes (usually the purchase price), adjusted for stock splits, dividends,
2 

and any other corporate action events such as a reverse split, and return of capital distributions. This value is used to
determine the capital gain or loss, which is equal to the difference between the asset’s original cost basis and the current
market value at the time of a sale.

1
Executive Summary
New Cost Basis Reporting Legislation Places the Burden on Financial Intermediaries

C ost basis accounting is one of the most challenging thickets of tax reporting: How to
report accurate cost basis whose history can be difficult and expensive to document.

Though United States tax law has theoretically required full cost basis reporting for years,
the Internal Revenue Service (IRS) has never had a broadly reliable way to confirm cost
basis filings. Investors, issuers, mutual funds, brokers and banks have also lacked an ef-
ficient, dependable means to gather information on assets whose history may be clouded
by corporate action events including takeovers, spin-offs, rights offerings, conversions,
dividend reinvestment, cash allocations, and bankruptcies.

Tracking such events has typically required time-consuming, labor-intensive projects that
– if and when they are undertaken – often fail to produce accurate results.

A study conducted by the IRS in 2005 estimated that the federal government was losing
an estimated $11 billion in tax revenues by the failure of investors to accurately report
adjusted cost basis information. This finding, coupled with recent budget-deficit issues,
corporate accounting scandals and calls for broader changes to the tax code, fueled a
push to close the cost basis compliance gap.

The gap has now been bridged. Stringent compliance requirements for cost basis report-
ing were signed into law on October 3, 2008 with The Emergency Economic Stabiliza-
tion Act, commonly referred to as the “bailout bill.” Included in this rescue package are
new requirements placed on financial intermediaries such as brokers, banks, custodians,
transfer agents, mutual funds and issuers to report accurate, adjusted cost basis to inves-
tors and the IRS for:

hh Stock transactions posted on or after January 1, 2011.

hh Mutual funds and dividend reinvestment plans on or after January 1, 2012.
hh Financial instruments such as debt securities and options on or after January 1, 2013.

The new legislation remains vague on a number of issues regarding the administration
and processing complexities of cost basis reporting, and the industry will need additional
guidance.

2
The Challenge of Cost Basis Accounting

I nvestors need cost basis information when filing taxes. Cost basis accounting has long
been hampered by the tedious process required to conduct it, and the sometimes limited
access investors have to historical pricing and corporate action event information. Typical
cost basis research can involve sorting out corporate action events conducted over decades.
Such events can involve changes to the capital structure or the financial position of a com-
pany, and ultimately affect the underlying value of shares.

The Internal Revenue Service (IRS) itself has struggled to monitor cost basis filings. The
agency estimates that tens of millions of dollars in capital-tax obligations go underre-
ported annually. An IRS National Research Program in 2005 found $11 billion in under-
reported capital-gains taxes. Since then, the volume and value of unreported cost basis
tax obligations has most likely risen as corporate events have grown more frequent and
complex, making manual cost basis calculations more difficult than ever. The demand for
better cost basis accounting has also been fed by an enormous increase in the number of
retail investors who have entered the market in the past decade

Through the passage of the cost basis legislation, Congress confirms it is ready to enforce
new compliance requirements to prevent investors from underreporting gains and over-
reporting losses on securities assets.

For investors, tracking what they paid for each share of stock or a mutual fund can be a
tedious, difficult and time-consuming job. Investors often assume that the issuer, broker
or transfer agent can supply them with the cost basis information they need. But too
often, they find themselves gathering stock prices, dividend and corporate action histo-
ries on their own from sources that may not be accurate. Then they are faced with the
complicated matter of correctly calculating adjusted cost basis. Unfortunately, they may
inaccurately calculate their cost basis, leading to possible tax penalties or over payments
to the IRS.

Reporting of adjusted cost basis has also been a major problem for issuers. While their
shareholders have often complained about the lack of accurate and accessible cost basis
information, many issuers have hesitated to provide it. Issuers do provide component in-
formation on cost basis, but they won’t do the calculation for the investor, fearing that the
information could be inaccurately or incorrectly reported and lead to legal implications.

For brokers and banks, one of the major problems they face in reporting cost basis rests
in the fact that the shares they hold may be delivered to them from another broker, bank,
custodian or transfer agent without cost basis information or with inaccurate cost basis

3
information. The receiving broker may have the task of updating and recalculating miss-
ing or inaccurate cost basis information. In addition, many will face systems challenges
capturing data necessary for cost basis calculations in the accounts of existing customers.

While mutual fund companies have tracked share lot accounts and cost basis information
for some time, their cost basis calculations are complicated by the fact that they include
direct reinvestment plans (DRiP), multiple purchases and sales and frequent distributions
in a given investor’s account.

4
A New Compliance Requirement

T he Emergency Economic Stabilization Act of 2008, enacted mainly to establish the

$700 billion bailout package, contains new and stringent requirements on financial
intermediaries such as issuers, transfer agents, brokers, banks, and mutual funds. In es-
sence, the new legislation is an expansion of longstanding requirements that brokerages
and mutual fund companies report gross proceeds. It has the practical effect of augment-
ing standing 1099-B income-reporting forms that brokerages are already required to
submit simultaneously to investors and the IRS.

The Securities Industry and Financial Markets Association (SIFMA)3 helped shape the
language in the legislation, especially as it relates to the deadline for implementation and
the parameters of the requirements. Though implementation begins in two years, the leg-
islation puts intermediaries in the position of needing to take immediate action towards
compliance by updating procedures and systems technology.

Schedule for implementation

The legislation establishes three stages of implementation for cost basis reporting:

hh All equity stock acquired on or after January 1, 2010.

hh A
 ll mutual funds and dividend reinvestment plans (DRiP) shares acquired on or after
January 1, 2012.
hh O
 ther specified securities types, such as debt issues, options, private placements acquired
on or after January 1, 2013.4

3 
SIFMA is a leading financial industry organization committed to enhancing the public’s trust and confidence in the U.S.
financial markets (www.sifma.org).
4
In order for a security to be subject to cost basis reporting it must be a “specified security” that is also a “covered
security” under Internal Revenue Code (Code) Section 6045(g)(3)(B). The rule defines specified securities as any stock in a
corporation (note that real estate investment trusts are treated as corporations for U.S. federal income tax purposes); any
note, bond, debenture, or other evidence of indebtedness; any commodity, contract or derivative with respect to a com-
modity and any other financial instrument (if the IRS so chooses). IRS Code Section 6045(g)(3)(A) defines a “covered secu-
rity” as a specified security acquired on or after the applicable effective date but provides an exception for pre-effective
date securities that are transferred to another account or broker.

5
Brokers and Banks

Compliance
Brokers, custodians and banks (herein referred to as brokers) have three years to imple-
ment systems upgrades to track and capture the adjusted cost basis information for secu-
rities transactions that occur for securities acquired on or after January 1, 2011, for form
1099-B reporting.

Matters to Consider
Commission charges are required to be part of the cost basis calculations for shares bought
on the open market as well as share lots purchased through broker dividend reinvest-
ments plans (DRiP). This process and calculation have inherent complexities which will
affect accuracy. As many current broker and bank shareholder systems are not capable of
providing calculations that include lot purchases with corresponding commissions, careful
and detailed systems upgrades are needed.

Brokers are required to provide cost basis information to the counterparty receiving an
investor’s account. The share positions can move independently of the cost basis infor-
mation. Under current industry practice, the cost basis information must be sent to the
receiving counterparty within 15 days after the actual share positions have been moved.

Brokers have an edge on many other intermediaries because their systems customarily
track share lots. However, in many cases, for shares delivered to the broker or bank from
another party, such as a transfer agent or another broker or bank, the cost basis informa-
tion might be missing, or worse, inaccurate. The receiving broker or bank may need to
cleanse older share lot records, adding and recalculating the missing cost basis information.

For an investor’s securities positions received from another broker, the delivering broker
must provide cost basis information to the receiving broker. If the broker’s systems are
not ready to collect the cost basis information and share lots, the shareholder accounting
systems will need to be upgraded accordingly, as these transactions are mandated in the
new legislation. The receiving broker must decide to accept the prior broker’s cost basis
information or to run an internal event capture and calculation process to verify the cost
basis information received.

Since the new legislation only mandates that shares acquired after a specified date be cap-
tured and subsequently reported for cost basis, a broker must decide what level of service
to provide and the cost for such systems upgrades. If the broker opts to provide an investor
cost basis for all positions in the investor’s account, no matter when the share lots were
acquired, the broker’s systems must accurately calculate the cost basis for older share lots.
Some event information, such as corporate action events and pricing, may be missing from
the broker’s records and must be accumulated to provide accurate cost basis calculations.

6
In the above example, the broker will need to determine if the missing information can
be easily and cost-effectively added to the broker’s system from internal sources, or if
they will seek a vendor to fill in the gaps.

If the broker decides to be guided by the legislation as written – only reporting cost basis
on securities acquired after the implementations dates – then the broker must keep track
of those share lots where cost basis is to be reported and those lots where cost basis is
not to be reported. The mechanics involved in developing and maintaining a dual system
can be just as difficult as one that will report on all share lots in an investor’s portfolio.

Brokers generally elect the default rule for cost basis reporting as first-in, first-out (FIFO).
A shareholder can change the default to their personal preference, such as specific lot
basis, last in, first out, and highest (cost) in, first out. Consequently, brokers must be
prepared to provide a default basis method and to accept a shareholder’s instruction to
change that default. For DRiP shares and mutual funds, average basis reporting can be
the default basis reporting method. The average cost method can be used for the initial
purchase of the DRiP shares, and any subsequent reinvestment or voluntary contributions.
Changes must be effected when an investor notifies the broker of a different preference.

The cost basis legislation requires brokers to adjust cost basis on form1099-B for any
wash sales; 5 those sales that defer a loss and other related adjustments. The legislation
specifies two criteria for wash sale reporting:

hh O
 nly securities assets held within one single shareholder account, as opposed to like
accounts for the same shareholder, and;
hh O
 nly identical securities – same CUSIP number – are subject to the wash sale provi-
sion, as opposed to “substantially identical securities.”

Brokers will need to change their shareholder accounting systems to capture and report
short sales in the year they are closed, rather than the year the short sale is opened, as
is the current methodology. The effective date to report short sales under the new meth-
odology is linked to the implementation date of the securities type used for the short sale.
For example, a short sale on equity securities will be reported beginning January 1, 2011.

The form 1099-B will change to include the new information for adjusted cost basis. Bro-
kers reporting directly to the IRS and the shareholder will need to retool the form print-
ing process. Also, brokers must determine if they will buy, build or partner to handle the
complexities of implementing an adjusted cost basis accounting system.

5
T he wash sale rule disallows a loss arising from a security’s sale if the same security is bought within 30 days of the sale
(either before or after).

7
Transfer Agents

Compliance
Like issuers, commercial transfer agents will be required to report adjusted cost basis to
the shareholder and the IRS through the updated form 1099-B. Transfer agents who are
required to track and report adjusted cost basis include:

hh T
 ransfer agents who administer dividend reinvestment plans, employee stock option
plans (ESOP) and other such plans
hh Transfer agents who report gross proceeds of a sale of a security to a shareholder, and,

hh Generally, those transfer agents who now distribute form1099-B.

For equity issues, transfer agents must begin to report adjusted cost basis on or after
January 1, 2011. For shares accumulated in dividend reinvestment plans, and possibly
other plans such as ESOPs, transfer agents have until January 1, 2012 to begin reporting
adjusted cost basis. Transfer agents that administer issuer-sponsored or “bank”-spon-
sored plans, (reinvestment plans, ESOPs and the like), will be required to report adjusted
cost basis on the new 1099-B forms.

Matters to consider
Within the next two years, transfer agents’ shareholder recordkeeping systems will need
to be upgraded to capture and track share lots – those shares accumulated at different
times under different circumstances: gifts, reinvestment shares, ESOP shares, voluntary
cash purchases, transfers into and out of the registered name and others. In addition, each
underlying share lot must be tethered to cash or stock allocations, such as cash dividends,
stock splits, stock dividends, other corporate action events and mergers.

Transfer agents must also decide what level of service to provide to their issuers. To effec-
tively manage investor satisfaction, the transfer agent might decide to provide cost basis
on all of the shares acquired in the investor’s account, including those shares acquired
before the applicable implementation dates. Conversely, the transfer agent can elect to
provide adjusted cost basis for only those shares acquired after the implementation date.
As this is a customer (issuer) service matter, the transfer agent might elect to make a deci-
sion on an issuer-by-issuer basis.

The actions a transfer agent might take will affect the deliverable time of the systems’
upgrades as well as the cost for the upgrades. These are important decisions which must
be made soon as the two year ramp-up time is short; the first of a series of implementa-
tion dates is scheduled for January 1, 2011.

Additional problems arise if a transfer agent decides to provide adjusted cost basis
for shares accumulated in an investor’s account prior to the implementation date. The

8
transfer agent must determine if all of the records, such as pricing, dividends, corporate
action events, and transfers are resident on the transfer agents shareholder services
recordkeeping systems to accurately calculate and report adjusted cost basis information
to the shareholder and the IRS. For example, a transfer agent that took over the books
and records of a prior transfer agent might find that the information about past corporate
action events is not complete, or that there are details missing from shares acquired in
a dividend reinvestment account. The transfer agent might have to update older share-
holder records.

Transfer agents are required to provide cost basis information to the counterparty receiv-
ing an investor’s account. The investor’s account share positions can move independently
of the cost basis information. By current industry standards, the cost basis information
must be sent to the receiving counterparty within 15 days after the actual share positions
have been moved.

The default rule for cost basis calculation is first-in, first-out (FIFO). The transfer agent can
default to this method. Shareholders can notify the transfer agent of a preference to use a
different cost basis reporting method, such as specific lot basis, highest (cost) in, first out.
Consequently, the transfer agent must have a mechanism to accept shareholder’s instruc-
tion to change the basis reporting method. For DRiP shares, average basis reporting is al-
lowed, and most likely this will be the preference by most transfer agents. The averaging
basis method can be used for the initial purchase of the DRiP shares, and any subsequent
reinvestment or voluntary contributions.

The form 1099-B will change to include the new information for adjusted cost basis.
Transfer agents reporting directly to the IRS and the shareholder will need to retool the
form printing process.

The cost to enhance the current transfer agent shareholder recordkeeping systems will
be expensive. As the changes are dictated by legislation, issuers may not feel compelled
to pay for the systems’ enhancements. Transfer agents must determine if they will buy,
build, or partner a portion or all of their systems’ upgrades to handle the complexities of
an adjusted cost basis reporting system.

9
Mutual Funds

Compliance
Under the legislation, mutual funds must begin reporting cost basis information to inves-
tors and the IRS after January 1, 2012.

Matters to consider
In general, mutual fund companies have tracked share lot accounts and cost basis infor-
mation for some time. They are uniquely prepared to deal with the new legislation, but
there are questions to consider.

The cost basis calculations of mutual funds, like DRiP share lots, are more complicated
due to the potential of multiple purchases and sales in a given investor’s account, as well
as frequent distributions. Incorporating the cost to administer the mutual fund, commonly
called loads, further complicates the cost basis calculations.

As with equity issues, mutual funds must consider reporting only share lot transactions
acquired after the appropriate implementation dates or providing cost basis on all inves-
tor lots. As sales take place, the mutual fund must determine if the shares being sold
are before the implementation date or after the implementation date. Without effective
identification of pre-effective dates and post-effective dates, a mutual fund will lack the
ability to properly identify those shares lots which require cost basis reporting.

An additional challenge is the bifurcation of tax lots by acquisition date and sale methods,
i.e. FIFO, average cost, and specific ID. Mutual funds typically report using the average
cost method. Average cost mutual fund positions acquired after the effective date must be
kept separate from average cost positions acquired prior to the effective date.

The cost basis carries over to anyone receiving a gift or inherited shares. An exemption
to this rule is when the cost basis of the gifted shares is in excess of the fair market value
at the time of the gift. The cost basis is then determined when the shares are ultimately
sold. Reinvested shares acquired through an inheritance present their own set of prob-
lems. The Alternative Date Value (six months after the date of death) must account for
those reinvested shares as well as any other applicable adjustments in value.

Wash sales adjustments must incorporate the frequent purchasing of fund shares through
systematic investment programs, installment agreements and dividend reinvestments and
frequent redemptions resulting from systematic withdrawals and unexpected liquidations.
This rule can trigger post year amended tax statements if a redemption occurs at year end
and the purchase was made after the first of the year.

Fund class exchanges, such as “B” to “A” share conversions, have been problematic for
mutual funds to track and accurately report with their current accounting tax lot environ-

10
ment. System enhancements are necessary to properly track and report these conversions.

Other mutual fund class exchanges that factor CDSC fees6, redemption fees and 12b-1
fees must all be accurately tracked and calculated as they have to be taken into account
in the basis calculation when fund class exchanges have occurred. Failure to properly
enhance systems to deal with these and other accounting and reporting complexities of
the new legislation is a compliance risk that can result in serious consequences.

The form 1099-B will change to include the new information for adjusted cost basis.
Mutual funds reporting directly to the IRS and the investor will need to retool the form
printing process. Also, mutual funds must determine if they will buy, build, or partner to
handle the complexities of further enhancing their cost basis accounting systems.

6
C
 ontingent deferred sales charge (CDSC) is a fee investors pay when selling some mutual funds. This fee generally applies
to Class B mutual funds which do not charge a front-end fee.

11
Equity Issuers

Compliance
The legislation obligates “brokers” to report adjusted cost basis to shareholders and the
IRS for equity securities that have been acquired on or after January 1, 2011. The term
broker is used generically in the legislation and can be misleading. The term refers to all
financial intermediaries who report 1099-B financial information to shareholders. These
intermediaries will be required to report adjusted cost basis. As the legislation is currently
understood, those intermediaries include, but are not limited to, issuers, transfer agents,
mutual funds, brokers, banks, and other custodians.

Issuers who will shoulder the additional burden of tracking and reporting adjusted cost
basis include:

hh Issuers acting as their own transfer agent

hh Issuers who administer their own dividend reinvestment plan, employee stock option
plans (ESOP) and other such plans
hh Issuers who report gross proceeds of a sale of a security to a shareholder, and
hh Generally, those issuers that now report form 1099-B

For equity securities, issuers must begin reporting adjusted cost basis on or after January 1,
2011. For shares accumulated in dividend reinvestment plans, and possibly other plans, such
as ESOPs, issuers have until January 1, 2012 to beginning reporting adjusted cost basis.

Cost basis reporting has always been a customer service matter, though many issuers
have elected not to incorporate a cost basis reporting module in their shareholder ac-
counting systems, worried that providing such information could lead to litigation if the
information was calculated inaccurately or reported incorrectly. In spite of these concerns,
the issuer, as an intermediary, is now obliged to report adjusted cost basis.

Matters to consider
Equity issuers have slightly less than two years to upgrade shareholder recordkeeping
systems to include the accounting and algorithms to calculate and report adjusted cost
basis. The complexities of such system upgrades are extensive and challenging, and with
the implementation date looming, it’s critical to prepare early.

Shareholder recordkeeping systems must capture all event changes7 that affect the total
shares in the shareholder’s account and each share lot. For example, if a shareholder has
a dividend reinvestment account8 and is enrolled in an automatic reinvestment program,

7 
Event changes include purchase of additional shares, stock splits, cash distributions such as dividend payments, spin-offs,
stock dividends, reinvestments, etc.
8
Dividend reinvestment shares are reportable on or after January 1, 2012.

12
each time additional shares are purchased, the issuer will have to capture and keep –
possibly for many years – all of the details of the reinvestment, including the date of the
purchase, the dividend rate, purchase price per share, number of shares bought, the frac-
tional share price, and more. If that same investor purchases additional shares through a
voluntary contribution, the same information must be accumulated and captured for future
reporting.

When the shareholder sells all or part of the shares accumulated through a plan, the ad-
justed cost basis will be calculated for each share purchased for a specific purchase date.
If there are corporate action events, such as a spin-off, stock dividend, stock split, or other
cash or stock distributions during the time the shareholder held the underlying securi-
ties assets, those events must be considered for the adjusted cost basis calculations. Each
share lot must be kept separate and distinct. Most current shareholder recordkeeping
systems are not prepared for such complexities, especially the calculation of the adjusted
cost basis and determining if the transaction was short-term or long-term.

The legislation requires issuers of securities to provide all registered shareholders with
a statement that includes tax information detailing the effect of a corporate action event
on the shareholder’s cost basis. The legislation is silent on the specifics of this reporting
requirement and how other intermediaries will process such tax statements. It is expected
that the Treasury Department will further define these requirements in the coming months.

A further challenge is how to track those shares accumulated prior to the legislation
implementation date. For example, a shareholder purchases shares through a dividend
reinvestment program prior to the January 1, 2012 implementation date, and more shares
after the implementation date. When the shareholder sells all or part of the acquired
shares, the issuer will have to distinguish between which shares were acquired before
the legislation and which shares were acquired after the applicable implementation
dates. The automated systems to sort and calculate pre- and post-accumulated shares are
complex and could be difficult and potentially costly to implement.

For shareholder accounts moving from one intermediary to another, issuers are required
to provide cost basis information to the counterparty receiving a shareholder’s account.
The share positions in a shareholder’s account can move independently of the cost basis
information. The cost basis information must be sent to the receiving counterparty within
15 days after the actual share positions have been moved to the receiving intermediary.

Issuers who provide superior services to their investors may consider providing adjusted
cost basis information for all shares acquired and subsequently sold for an investor’s ac-
count, whether before or after the implementation dates. To this purpose, the issuer might
need to cleanse past account holdings by updating each purchase, sale, corporate action,

13
cash dividend, and other actions for adjusted cost basis. Further, the issuer must deter-
mine if they have all of the required daily market prices and stock and cash allocation
events to calculate cost basis. In some cases, especially issuers that have been in exis-
tence for a long time, have purchased other companies or have had a substantial number
of stock and cash allocation events, the required data might not be available on their
shareholder services recordkeeping systems.

Issuers who use a commercial transfer agent will probably not need to invest in systems
upgrades. However, the issuer will most likely be asked to absorb some of the transfer
agent’s cost to make the systems upgrades.

The default rule for cost basis reporting is first-in, first-out (FIFO). The issuer can elect to
use this reporting method, unless a shareholder notifies the issuer of a preference to use a
different cost basis reporting method, such as specific lot basis, highest (cost) in, first out.
Consequently, issuers must be prepared to provide a default basis method and to accept
shareholder’s instruction to change the default. For DRiP shares, average basis reporting
is allowed and can be chosen by the issuer as the default method, unless the shareholder
requests other lot methods. The average cost method can be used for the initial purchase
of the DRiP shares, and any subsequent reinvestment or voluntary contributions.

Issuers with a commercial transfer agent must also decide what level of service to pro-
vide their shareholders. For example, will the transfer agent provide cost basis based on
the share lots acquired after the implementation date, or will the transfer agent provide
adjusted cost basis for share lots acquired before the applicable implementation dates?
This is an important decision an issuer will need to make with its transfer agent. Time is
short for the necessary automated systems upgrades, as the first phase of the implemen-
tation schedule is January 1, 2011.

The form 1099-B will change to include the new information for adjusted cost basis. Issu-
ers reporting directly to the IRS and the shareholder will need to retool the form printing
process. Also, issuers using their own shareholder services recordkeeping system must
determine if they will buy, build, or partner to handle the complexities of implementing
an adjusted cost basis accounting system.

14
Penalties for Inaccurate Reporting

T he penalties can be very steep, especially for those intermediaries that report inac-
curate cost basis for a high number of investor/shareholder accounts. The penalty
is $100 for each incorrect form 1099-B; $50 for the incorrect form sent to the investor/
shareholder, and $50 for the incorrect form sent to the IRS. The maximum penalty is
$350,000 a year.

While not stipulated in the legislation, penalties are expected to be steep for non-compli-
ance. The House and Senate bills that were the precursor of the cost basis bailout legisla-
tion called for a penalty of $150,000 per occurrence. It is expected that the IRS will seek
similar penalties.

15
Conclusion

N ew federal requirements for cost basis tax reporting enacted in October 2008 require
intermediaries to submit accurate and timely cost basis information to investors and
the IRS. The change is the result of a government effort to end under- and overreporting
of capital gains and losses, while raising revenue to support The Emergency Economic
Stabilization Act.

As a result of the new legislation, financial intermediaries will be required to report cost
basis information to investors and the Internal Revenue Service for:

hh Equity securities transactions on or after January 1, 2011.

hh Mutual funds and dividend reinvestment plans on or after January 1, 2012.

hh Debt securities, options and other specified securities on or after January 1, 2013.

The new regulations present an enormous challenge to brokers, banks, issuers, transfer
agents, mutual funds and other intermediaries who must now prepare to provide cost
basis information to millions of individual investors as well as the IRS. They must choose
whether to build an in-house solution, buy a service from an industry vendor, or partner
with a cost basis service provider. Firms need to focus on this now if they are to meet the
deadlines set by Congress.

Please send questions and comments to:

Joyce Rosen
Product Manager
The Depository Trust & Clearing Corporation
212.855.3935
E-mail: jrosen@dtcc.com

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