Cost Basis Reporting

The Basis of Truth

Cost Basis Reporting has been raised in the Senate, the House, the U.S. Treasury and it was even included in the Presidential Budgets in both 2007 and 2008, but has yet to become law. There are arguments both for and against the proposal, which could explain its slow progress and still-uncertain future.

Cost Basis Reporting

If enacted, the legislation would mandate that financial institutions, brokerages, transfer agents and individual investors provide Cost Basis Reporting to the IRS and customers for all stocks, bonds and mutual funds that are transferred, bought or sold.

Currently the law only requires that the gross proceeds of stocks or mutual funds sales be reported, but this pending legislation would require the price paid for these shares to be reported as well. This additional reporting would better ensure that both cost basis and profit were reported and taxed more accurately.

Why is there a Need for this Legislation?

Some feel that this proposal is needed to cut down on the under-reporting of capital gains. The Internal Revenue Service (IRS) claims a significant loss of revenue each year due to the cost basis on stock and mutual fund transactions being under-reported at tax time, and as a result, under-taxed. There are currently no systems in place to track these transactions accurately.

Based on analysis of 2001 taxes, the IRS claims that it loses $345 billion annually on owed, but unpaid taxes. This loss is coined a “tax gap”. It is also estimated that of the $345 billion unaccounted for tax dollars, at least $11 billion are lost due to under-reporting of taxable gains.

If passed, this measure would provide specific reporting requirements, help taxpayers calculate their taxable gains more easily and accurately, and fill in a significant segment of the IRS’s “tax gap”.

History of the Legislation

The concept of enacting a Cost Basis Reporting system into law has seen much political play in the government over the past couple of years.

Many in congress see it as a great way to generate revenue without raising taxes, since President Bush has promised to veto any tax hikes.

The Senate Finance Committee or SFC members have pushed to legally force financial organizations, brokerage firms, and investors to report actual costs and proceeds to the IRS when securities are bought and sold.

In fact, in May of ’07, the SFC released its proposal for Cost Basis Reporting for public comment, an unusual step, which showed where it stood on the issue.

Also in the summer of 2007, there was a bi-partisan introduction in the House of Representatives, which proposed requiring basis reporting in legislation as a way to pay for revenue costs.

The U.S. Treasury also recommended that the President require Cost Basis Reporting in both his 2007 and 2008 Presidential budgets.

So far, the Cost Basis Reporting legislation has not made it to a final bill in either the House or the Senate and it remains un-enacted in the 2008 Presidential budget plans.

Possible Problems with Requiring Cost Basis Reporting

There are arguments against enacting the legislation, such as lack of time to implement and the potential creation of many headaches, reporting problems, and other issues.

Fortunately, for the majority of cases, where securities and mutual funds are bought and sold by individuals from a single account at one brokerage house, Cost Basis Reporting should be a relatively easy and straightforward task. Things do get trickier though when other factors come into play.

For example, when stocks are transferred from other companies, brokers must track the basis and they may be lacking crucial information, such as if the securities were purchased or a gift, etc.

Brokerages could also run into problems figuring out basis when there are company mergers, divided reinvestments, and when shares are gifted and a company goes under.

Brokers and their customers may face issues with discrepancies in reporting too. Since there are a variety ways to figure gains from mutual funds, it’s likely that an individual may report a different cost basis on his or her 1040 than a brokerage will to the IRS.

Election Year Implications

With Bush’s presidency (and annual budget) nearly concluded, the question of whether or not this bill will pass under his tenure remains undetermined. There could be marked changes to it and other capital gain tax and reporting requirements depending on the outcome of the presidential election and other election year politics.

For example, the presumed democratic candidate, Senator Barack Obama has proposed increasing capital gains tax rates, while the presumed republican presidential candidate, Senator John McCain, would like to keep capital gains taxed at 15%.

If the tax is raised it could possibly influence whether or not Cost Basis Reporting will be required. As it stands now, this legislation would apply to securities bought or sold 18 months after its enactment, but if taxes are increased on capital gains, there may no longer be a need to generate more revenue with Cost Basis Reporting.

Will it Pass or Not?

Most in the financial industries consider it only a matter of time until Cost Basis Reporting legislation is enacted into law. Many brokerage firms and transfer agents, such as First American Stock Transfer, Inc., are already moving forward with Cost Basis Reporting to ensure that potential new reporting requirements do not distract from investments and customer experiences in the future.