With new cost-basis reporting requirements in effect for the 2011 tax year, Charles Schwab is warning investment advisers to brace for a hectic tax season and prepare for a flood of questions from clients who for the first time will receive a revised 1099-B form packed with new transaction information.
The new reporting rules stem from the 2008 Emergency Economic Stabilization Act, which laid out a three-phase process for submitting cost-basis information to the Internal Revenue Service.
That law, commonly known as the bank bailout bill, also created the $700 billion Troubled Asset Relief Program, or TARP.
The first phase of the rules will require custodians, broker-dealers and others to report the cost basis for all equities purchased on or after Jan. 1, 2011 on the new 1099-B form to the IRS and clients.
That means that in mid-February, millions of investors will receive an unfamiliar version of a vital tax document.
"It's fair to say everyone who receives a 1099 opens it and pays attention to it," says Brian Keil, director of cost basis and tax reporting at Charles Schwab. "This document is looked at," adds Keil, noting that Schwab is girding for "a very messy tax season."
The new 1099-B form will now include details on cost basis, holding period, whether a lot is covered or not, acquisition date and disallowed losses from a wash sale.
Under the legislation, the default method for brokers to calculate cost basis is first-in, first-out. Clients or their advisers can designate an alternate method (last-in, first-out, lowest price to highest, etc.) either as a default or for specific lots, but once a trade settles, the method cannot be changed. That method lock-in will also have implications for how advisers engineer tax-sensitive investments.
The result of the new forms, Schwab predicts, will be widespread confusion among investors, who can be expected to turn to their advisers in droves for an explanation.
"The adviser is going to be nine times out of 10 the first point of contact," says Keil. "Even if it's not the adviser's issue, they're going to turn to their advisor first."
At Schwab, which is planning to send out around 3.2 million 1099 forms in January and February, Keil says the firm is expecting to receive some 250,000 to 400,000 phone calls as tax season kicks into high gear, amounting to a 20% to 30% percent increase over last year.
"There's no question they're the biggest [tax] changes in my history at Schwab," says Keil, who has worked for the company for 16 years.
Schwab is recommending that adviser firms develop a communications and outreach strategy ahead of time, not only in their dealings with clients, but also with CPAs, as well as a training program for the staffers who will be fielding the calls.
Advisers who provide their clients with realized gain/loss information should also take the very important step of synchronizing and reconciling their calculations with their brokers to ensure that clients receive consistent information.
At the same time, Schwab also counsels advisors to look ahead to the next two phases of the law and adjust their bookkeeping and communications strategies accordingly. For the 2012 tax year, brokers will be required to report cost-basis data for mutual funds, dividend reinvestment plans and most exchange-traded funds acquired on or after Jan. 1, 2012. The 2012 rules apply only to ETFs that are designated as a regulated investment company, or RIC.
Other ETFs that are designated as corporations will be included in the 2011 rules, while still other classes may be exempted entirely, though the Treasury Department has broad authority to expand the asset classes covered under the statute.
In 2013, the reporting requirements will expand to include fixed income and options.
The IRS is still in the process of drafting the rules for the third phase, and has yet to issue a notice of proposed rulemaking, the first formal step in the regulatory process.
Schwab and other members of the Financial Information Forum met with IRS officials a couple months ago to discuss the coming rules, but Keil does not expect the agency to issue its NPRM until midway through next year.
Schwab began its education campaign on the legislation around December 2009, but has recently been ramping up its outreach to advisors as the tax season draws closer.
"We've been since June really I'd say spoon-feeding advisers information," says Keil. That month, the firm published a whitepaper on the rules, and has since been engaged in various outreach and education efforts to promote awareness of the changes and help advisors plan for the coming storm.
"There's no question that there's going to be a lot of confusion," says Keil. "If you're not prepared, you're in an eight-week trench — easily — that is not going to be pretty."
Keil says that the adviser firms Schwab works with are "all over the map" in terms of their level of preparedness for the new rules, with some still unclear on basic issues such as which lots are covered, while others have already reached out to clients and implemented training programs for their staffs, with some taking hiring additional personnel to facilitate the process.
Even for firms that have already reached out to their clients, though, Schwab is suggesting that it might be worthwhile to issue some form of reminder ahead of the mid-February deadline for mailing 1099 forms. Then again, the firm acknowledges that each adviser practice has a unique client base, so there is no one-size-fits-all communications strategy. Schwab recommends that firms place their clients in two "buckets" — those who prepare their own taxes, and those who enlist a CPA, and tailor their outreach accordingly.
Advisers should expect to field a sizable volume of questions from CPAs, who, while a professional class steeped in tax law, are still going to be in the position of having to negotiate a completely redesigned 1099-B form, according to Keil.
"We're preparing for the worst," he says. "Maybe this is going to be Y2K — nothing happens, and we've done all this preparation. I don't think that's going to happen."
— Kenneth Corbin writes for Financial Planning, a SourceMedia publication.
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