The “final” Internal Revenue Service (IRS) regulations on cost basis reporting for fixed income securities and options securities are phasing in between now and 2016.

Here’s the bottom line:  It’s going to be MORE difficult to keep cost basis in PortfolioCenter in sync with your broker and LESS LIKELY that tax reports run from PortfolioCenter will match the information on your broker’s 1099.

In my opinion, the new rules provide yet another reason why you should designate your broker the System of Record and stop sending tax reports from PortfolioCenter.

As part of the Emergency Economic Stabilization Act of 2008 (a regulation that probably created more havoc than it prevented), cost basis reporting requirements were to be phased in by the end of 2013.   However, rules concerning Fixed Income & Options Securities were delayed.

The delay is over.  The new rules are being phased in between 2014 and 2016.  Here’s my basic understanding of the new rules:

What do the new Fixed Income rules affect?

The IRS classified fixed income securities (which they call “debt instruments”) into 2 types: “less complex” and “more complex” and assigned different reporting requirements to each.

  • “Less Complex”  are considered “covered” if acquired January 01, 2014  or later.  Less complex are taxable and tax-exempt bonds which have a fixed rate, fixed maturity and fixed payment schedule (e.g. Treasury Notes, Treasury bonds, Fixed-rate Corporate bonds and Municipal bonds)
  • “More Complex” are considered “covered” if acquired January 01, 2016 or later.  More complex do not have a fixed rate, maturity and payment schedule — basically everything else (e.g. variable rate bonds, foreign bonds, inflation-indexed bonds, convertible bonds, etc).

Some fixed income securities are neither category and are exempt from reporting (for example, some mortgages and short-term securities that mature in less than 1 year).  See the IRS rules for a complete list.

What’s changing?

Cost basis on fixed income securities can change daily depending on client elections, and how premiums and discounts are applied. The IRS has decreed that brokers must make the following assumptions about their account holders when calculating adjusted cost basis on fixed income securities:

  • clients elected to amortize bond premium on taxable bonds  (this is NOT the current taxpayer default).
  • clients are not including market discount in income currently (this is the current taxpayer default).
  • clients are accruing market discount with a straight-line method (this is the current taxpayer default).

Brokers are also required to accommodate the following client elections if clients make their elections in writing by December 31:

  • Accrue market discount using constant yield (instead of straight line).
  • Include market discount in income currently (instead of at disposition).
  • Treat all interest as Original Issue Discount (OID).
  • Turn off bond premium amortization on taxable bonds.
  • Use spot rate for interest accruals, if currency is denominated in non-US dollars (doesn’t apply until 2016).

Now what?

Right now, take advantage of the slower summer months to do some cost basis homework.  Check with your cost basis team to see how implementing the new rules is affecting your broker’s current practices and get a copy of their timetable for implementing the changes.

Schwab advisors: You are in luck! Schwab is already offering their advisors detailed, valuable information, including a webcast (well worth watching!) and a very helpful toolkit.

In the future, as your broker implements the new rules, both the realized and unrealized cost basis for your existing fixed income securities may change and it’s likely that cost basis in PortfolioCenter will no longer reconcile. I’m still investigating what we PortfolioCenter users can/should do in response.  Watch for another blog post.

DISCLAIMER:  I am a PortfolioCenter expert only.  I do not offer legal, tax or cost basis advice.  This blog post is general information to help PortfolioCenter users understand how to keep their data clean.  It is not intended as legal, tax or investment advice. Please consult a tax or legal professional and/or your broker’s cost basis team for guidance on your specific situation.

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