|
What is Cost Basis? The cost basis of an investment is the original value of an asset adjusted for stock splits, dividends and capital distributions. It is used to calculate the capital gain or loss on an investment for tax purposes.It can be stated either in terms of the dollar amount of the investment, or the effective per share price paid for the investment. The calculation of cost basis can be quite complicated due to the many changes that are likely to occur in the financial markets such as splits and takeovers. Statutory Regulations TheU.S. Internal Revenue Service (IRS) recent cost basis reporting rules have made cost basis calculation both cumbersome and extremely complicated. Their implementation is being phased over a four-year period. They became effective for U.S. equity securities including foreign securities and American Depository Receipts (ADRs) purchased as of January 1, 2011, and for shares in mutual funds purchased after of January 1, 2012. They will go into effect for fixed-income securities, options, warrants and rights acquired as of January 1,2013. The regulations exclude IRAs and other non-taxable accounts. The rules require that financial firms calculate the actual cost of investors' accounts so that they pay the appropriate income tax. Till fairly recently, the IRS depended on investors to do the calculations on their own with the help of some broker-dealers, mutual funds, custodian banks and transfer agents who were not legally required to do the work. Mutual fund companies and brokerage firms are now required to report clients’ cost basis and holding period to the IRS when covered securities are sold. Comments in respect of proposed regulations for cost-basis reporting for fixed-income securities are due by February 18. Final regulations might not be issued until June at the earliest; financial firms thus have barely six months or less to make the massive changes to their front and back offices to account for the differences between equities and fixed-income instruments and options instead of at least eighteen months which some operations specialists hadwarned would be needed. Waiting for the regulations to completely come out will not be a good idea. Firms, therefore, should get a head start. Some of the largest brokerages have had their operations and IT departments diligently spend the past two years preparing to face the challenges posed by the implementation of the IRS regulations. However, a far greater challenge going forward is equipping brokers and dealers so that they will be ready to facethe next cost basis round of calculations in respect of options and fixed income securities. The Challenges Being Faced 1. Identification of the actual value of the security for tax reporting purposes. This will vary, based upon the kind of security, maturity dates for securities and potential wash sales. To add to the complexity there are stock actions like corporate buy backs, dividend payouts, acquisitions, mergers and stock splits.Fixed income has more taxable events than equities. 2. The sheer number of products traded in options space makes it difficult to do these calculations manually. In comparison, cash equities have only a couple of thousands of products that get traded on a daily basis and even for cash equities the case would be different for products like pink sheets and warrants. A lot of calculations done today are manual and error prone. 3. Individual investors too will need to report capital gains on their tax returns, summarizing their loss and gain transactions. 4. The challenges are internal and external: facing employees trained in the new regulations and explaining to customers how and what these complex rules mean.A high level of user training and understanding as well as client education is required as failure to comply with the regulation would result in heavy fines. Research firm, Celent (a member of the Oliver Wyman Group, which is part of Marsh & McLennan Companies [NYSE: MMC]) has reported that consequent upon the first two of three phases of CBR regulations, financial services firms have experienced challenges with the automation and transfer of data between books and records, cost basis reporting systems and tax reporting systems.Although most firms have been conducting training programs and hiring additional staff to prepare internally, many have not yet adequately communicated the changes to investors for which a more proactive approach is necessary. Since the focus needs to shift to other asset classes now, the need of the hour is a highly efficient automated system that can help overcome these challenges and work out these complicated calculations.While there are severalreputed firms in the US which provide tax analysis and compliance software for the investment portfolio management community there is one such SaaS (Software as a Service) financial database software company, viz. NetWorth Services, Inc. (NWS), which was a pioneer in this field in 1997. It is now in the vanguard of provision of software financial solutions through its fresh and forward-looking redesigned Web-based application Netbasis, that has incorporated new features to enable compliance with IRS regulations. Till date it continues to provide accurate and efficient automated cost basis calculation solutions. Brokers and dealers would do well to avail themselves of its services.
Related Articles -
cost, basis,
| 
