The Emergency Economic Stabilization Act, more commonly referred to as the bailout of the U.S. financial system, was enacted by the U.S. Congress and signed into law by President Bush in 2008.
Part of the legislation includes new rules to ensure the accurate reporting of gains and losses of securities by investors on their personal tax returns.
Prior to this legislation, financial service firms were only required to report gain and loss information to the investor, who was responsible for including this information in their tax filings. Only gross proceeds of the sale were reported to the IRS.
Beginning in tax year 2011, financial services firms are required to report cost basis to the IRS as well as to the investor for equities acquired on or after January 1, 2011.
This reporting expands to mutual fund, exchange traded fund (ETF), and dividend reinvestment plan (DRIP) shares acquired on or after January 1, 2012.
Finally, cost basis reporting to the IRS will be required for fixed income, options, and other securities acquired on or after January 1, 2013.
So what is cost basis, you ask? It is the original price you paid for a security, plus commissions and any other fees. Seems simple, except that it is the adjusted cost basis that is used to determine the capital gains or losses of an investment for tax purposes. The longer an investment is held, the more likely it is that the original price will need to be adjusted to reflect changes over time.
These changes include wash sales, amortization and accretion, or corporate actions such as capital returns, stock splits and dividend payments. The actual calculation can therefore become quite complex. The good news is, the law requires that your financial service provider prepares the calculation.
To further complicate matters, investors now have a choice of several methods for calculating cost basis. Your investment advisor has likely already discussed these with you, but if they haven’t or you can’t remember, this would be a good time to have that conversation. Together you can determine the appropriate cost basis method for your unique situation.
