Cost-Basis Accounting And Reporting For Stocks, Bonds, Mutual Funds…

And Reorg Transactions Is Widely Expected To Become Mandatory Stop This Train We Say, Or Put It On A Better Track… Before It’s Too Late, And Before Issuers Go Broke Trying To Comply

Both the House Ways and Means Committee and the Senate Finance/Joint Tax Committee are hell-bent to enact a new law that would close what they contend is a “reporting gap” that costs the Treasury somewhere between $7 and $10 billion a year.

It’s not entirely clear just how they came up with such a number – some say it’s equal to the gap they need to close to make up their “pay as you go” pledges - to pay for new spending with new tax revenues. Others say it’s the number that Charlie Wrangel thought would offset the much desired repeal of the AMT. Some say it came from a “study”.

But it sure ain’t clear to us that such a “gap” exists. For all anyone really knows, taxpayers may be overstating their capital gains by $7-10 billion a year – say by failing to take account of reinvested dividends, or by failing to take note of capital losses on some of the purchases they may have made along the way - or simply by erring on the side of caution, given the daunting task of figuring out one’s real cost basis on longish-term investments.

What is clear, however, is that both committees seem to believe it’ll be a source of instant riches, and they have been trying to piggy-back some sort of a deadline for cost-basis reporting onto all sorts of bills, under the theory that we can “figure out the details later”.

The Investment Company Institute and the American Bankers Association, representing Corporate Trustees, and trustees of Personal Trusts have been up in arms about the potential costs here, and they’ve been reasonably active in Washington too…But, so far, corporations themselves have been eerily silent.

Transfer agents have been up in arms - a bit, that is - although many of them seem to be quietly licking their chops in anticipation of a brand new and potentially big revenue stream – because to make this work, they will have to make major changes and major additions to their databases - and they will have all kinds of new forms to file – which isn’t the best thing for issuers, of course - and all kinds of data that they can potentially sell to tax-filers…like you and me.

For cost-basis accounting and reporting to actually work, transfer agents - and brokers too - would have to add unique ‘fields’ to record the ‘original acquisition date’, the ‘transferin date’ (to cover transfers upon death, where the tax basis may or may not have changed - or as minors reach maturity, when transfers are made as gifts, or if the ‘position’ is simply moved, say to another broker, or from the TA to the broker, or vice-versa and where the cost basis has not changed ). Systems would also have to account for and save ‘adjustments’ to the cost basis when there are splits, spin-offs or other reorg events - and to record ‘sale dates’ when there are sales. We would also expect TA and broker systems to maintain the ability of taxpayers to use ‘lot accounting’ when computing one’s capital gain or loss on a ‘partial sale’ of one’s investment – something that every savvy investor should do – and something that, so far at least, seems destined to survive, as indeed it should. If all this isn’t daunting enough, they’d also have to be in a position to transfer all this data, “bucket by bucket” whenever a shareholder moves his or her account; say from one broker to another - or from “registered form” to a broker - or say from a DRP or ESOP – to street-name.

Frankly, we are absolutely certain that this can not be done on a ‘look-back-basis’ as at least some of the draft legislation envisioned. We are far from certain that this can be done reliably on a going-forward basis – unless the sky’s the limit on what we’d have to spend to make it work, and to keep such a system rolling.

And, now that we think on it, we’re sure that a broker, or a transfer agent would NEVER be in a position to “automatically know” that a capital gain or loss needs to be recognized, much less to “automatically report” the actual capital gain or loss a given investor experienced on a given sale, as the legislators seem to imagine they’d know.

We’re also darned sure that no one could possibly justify such a monster-size data-collection, data retention and data reporting effort following a decent cost-benefit study – especially since the size of the purported benefit to the Treasury is such a sketchy one.

Thus, as we usually do in such instances, we try to think of a better and more cost-effective solution to this alleged problem, and we think there is one, albeit one with two or three prongs:

First and foremost, issuers need to be heard from here: Issuers need to insist that the burden should continue to be placed squarely on tax-filers and tax-payers themselves – and on IRS policing actions, if indeed the number of scofflaws is so huge - and not on U.S. corporations. Also, issuers, and their agents, need to do a better job of explaining why this will simply not work…as we believe a careful thinking through will show.

Second – and as the Treasury seems to have already realized, at least to some degree – there IS a commercially available system (see our 2007 Special Supplement for information about AccuBasis) that gives investors a tool, and a database of historical information, that will allow them to accurately calculate and report their capital gains and losses…just as it allows the Treasury to easily run ‘sanity checks’ on the capital gains and losses investors report. (Bear in mind too that U.S. companies are already paying to produce 1099-Bs – with copies to the IRS - when registered investors sell now.)

We have been urging clients to offer this service to their registered holders whenever there has been a merger, acquisition or divestiture and to ‘customize it’ to the fullest extent possible to their own files of registered and employee shareholders. It’s incredibly more helpful than the gobbledygook that most companies put in their public filings when there are such transactions (all of which basically end up with “consult your tax advisor” anyway). It’s a lot cheaper, for sure, than trying to answer such questions holder-by-holder. And in the best of all possible worlds, it might help to hold the legislation at bay.