Cost Basis Procedures at Schwab

Transcription

1 Cost Basis Procedures at Schwab This document is designed to provide guidance with some of the fundamental processes and procedures affecting the cost basis of investments.

2 Contents Overview of Cost Basis Regulations Cost Method Selection. 2 Lot instruction deadlines... 2 Reconciling data... 3 Lot mismatch... 4 Missing cost basis on form Cost basis edits... 5 Transferring cost basis... 6 Step up cost basis to date of death... 7 Gifting... 8 Return of capital... 8 Cash/stock mergers 368(a)... 9 Cash in lieu (CIL) of fractional shares... 9 Wash sales and disallowed losses Closing a Short Position Reporting Requirements.11 Options exercises and assignments

3 Overview of Cost Basis Regulations The Emergency Economic Stabilization Act of 2008 was created to ensure that investors accurately report investment gains and losses in their annual tax filings. To achieve this objective, custodians and brokers are required to report the adjusted cost basis of covered securities (including whether the gain or loss is short or long term) to taxpayers and the IRS on Form 1099-B. Cost basis reporting effective dates by security type Accounting Method Selection Use the Cost Basis Enrollment and Preferences Form to provide accounting methods selections. Please note that new accounting methods take effect on a going-forward basis only. Existing Charles Schwab accounts linked to your firm s master account will retain their previously selected accounting methods. To change the accounting methods on these accounts, please submit a new Cost Basis Enrollment and Preferences Form. Lot instruction deadlines The Advisor has the option to provide specific lot instructions as opposed to using the default cost basis method on account. Lots can be specified online through web trading for equities and mutual funds or by completing the Cost Basis Lot Specification Form. Type How to specify lots Deadline Trades Complete online through web trading. Upload instructions with the trade file. At time of trade or post-trade prior to settlement date Journals* Attach instructions to the Check and Journal Request form. At time of journal Lot instructions must be received by your Service Team no later than the same day the request was processed. Gifts* Include instructions on the Charitable Gift Transfer LOA form. At time of gift Transfers* Use the gifting form. Include instructions with the Letter of Authorization for transfer outside Schwab. At time of transfer request * Lots cannot be specified for mutual funds if the cost basis is being averaged. The Tax Lot Optimizer option only applies to sells; any other disposition of shares, including transfers or journals, will use the High-Cost method. 3

4 Reconciling data Advisors should reconcile daily to ensure that the firm data and Schwab data are in sync. If a portfolio management system (PMS) is being used, a tool may be available to automatically reconcile the two data sources. Reconciling data can also be performed manually by using Excel. Schwab is working with various PMS providers to incorporate this functionality into the application. Fixed income positions should be reconciled against original cost basis, not current cost, which could be adjusted due to amortization/accretion. PortfolioCenter 1 PortfolioCenter will use the Daily UGL file at the lot level for taxable accounts. Position- level data will continue to be provided as it is today. PortfolioCenter has added a new reconciliation report to help advisors reconcile between PortfolioCenter and Schwab. The output from PortfolioCenter is a report showing any discrepancies between Schwab and your firm s data. Please see the PortfolioCenter website for more details. Axys 2 Advent Axys will use the Daily UGL position file for taxable accounts to post and reconcile cost basis. Please see the Advent website for more details. Other PMS vendors Schwab has provided file specifications to third-party PMS vendors. Contact your vendor for specifics on how to reconcile data files. Excel Although advisors cannot view the cost basis data files in the existing SchwabLink Desktop or Schwab Data Delivery viewers, they will be able to view these files in Excel. To open cost basis files in Excel, take the following steps: 1. Open Excel. 2. Select Open. 3. Select All Files from the Files of Type drop-down. 4. Navigate to the folder where download files are stored and select a file to open. 5. In the Text Import Wizard, select Delimited for the Original File Type. 6. In step 2 of the Text Import Wizard, select Other for the Delimiter and enter a pipe character ( ). 7. Click Finish. Please note: Excel will automatically drop zeroes from numeric values. Additional column formatting will be needed in order to line up decimals for dollar amounts or other variables. View detailed file specifications on the Schwab resource page. Once the data files have been downloaded, review the cost basis details to verify the cost basis instructions submitted were processed. 4

5 Lot mismatch If specified lots are not available or not received after settlement date, a Cost Basis Lot Instructions Alert will be generated which will indicate that the account s default accounting cost basis method was used to fulfill the sell. This alert may be received under two circumstances: Partial match: If a portion of the specified lots do not match Schwab s records, an alert will be generated providing information of a partial match. In this case, Schwab will apply the lots able to be matched first, and then apply the remainder using the account s default cost basis method. No match: If we cannot match lots to the lot instructions provided, the alert will indicate that we could not match the lot instructions. Because we could not identify the lots specified, we will use the account s default cost basis method to fulfill the sell instead. Lot instructions can be adjusted as long as it is communicated to us before the settlement date of the trade. If you would like Schwab to adjust the lots prior to the settlement date: 1. Log in to Schwab Advisor Center and launch web trading. 2. Find trade in the Order Status via the Trading tab. 3. Highlight the order. 4. Click the Specify Lots button. This will launch an overlay that will allow the advisor to add or edit lot instructions. 5. Use the Specified Lot Trading functionality to submit the lot specification. Alternatively, advisors can complete the Cost Basis Lot Specification Form. Forward completed form by settlement to Advisor Services Client Reporting Team using Service Requests on SchwabAdvisorCenter.com and select Cost Basis and attach instructions, or by phone at Please note: Regulations do not allow changes to lot instructions after the settlement date. If instructions are not received by settlement date, an adjustment to the PMS must be made to match Schwab data. If Schwab data is correct: To correct advisor data, take the following steps: 1.Adjust the data in the PMS to match Schwab s data. The software may have a tool to import data from the Schwab data files, or corrections may need to be made manually. 2. Contact the PMS vendor for specific details on how to import data. After correcting a lot mismatch within either system, review the data files the next day to ensure that the systems are in sync. 5

6 Missing cost basis on Form 1099-B Schwab will display cost basis on Form 1099 Composite for covered and non-covered securities. Cost basis for non-covered lots will not be reported to the IRS. Form B includes a missing cost basis section for long- and short-term holdings. This emphasizes the need to update missing cost basis. Cost basis may be missing because the security was transferred from another financial institution and Schwab does not have the necessary information to determine cost basis. You can determine whether your clients accounts have missing cost basis by the following methods: You can view status on individual accounts through the Cost Basis tab on Schwab Advisor Center. The account will indicate missing in the cost basis column. To view status at the master level, use the daily download file, sort the Excel spreadsheet by cost and all the masters showing zero cost will appear together. Send a request via Service Requests from the Cost Basis tab on Schwab Advisor Center, provide the master numbers, and request a missing cost basis report. Please allow two to three days to receive the report. To determine missing cost basis information, you can take the following steps: Determine where the security was purchased. Review original statements or confirmations or request them from the purchasing broker. Check past statements and trade confirmations for the original purchase dates and prices. Contact the broker who transferred the securities to Schwab, or search online services such as NetBasis, to obtain the data. Provide Schwab missing cost basis using one of the following methods: Edit missing cost basis using the online tool at schwabadvisorcenter.com. Complete a Cost Basis Edit Form and fax to your service team. If you have the data in a format such as Excel, the file through the secure Service Requests link on schwabadvisorcenter.com. Direct the to the attention of Cost Basis 6

7 Cost basis edits The legislation places limitations on cost basis editing. Schwab will be able to change unrealized, non-covered cost basis data. Schwab is also able to update missing unrealized and realized cost basis as this is also considered non-covered. Schwab cannot change cost basis on realized positions after settlement date. The IRS regulations require that lot specifications be made by settlement date. Cost basis that is considered covered by the legislation cannot be changed by Schwab, whether the position is unrealized or realized unless for a Date of Death Step-up. Transferring cost basis IRS code 6045(a) provides that any applicable person (such as a broker) that transfers custody of a covered security to a receiving broker, must furnish a transfer statement that allows the receiving broker to satisfy the cost basis reporting requirements of section 6045(g). This requires all applicable persons (i.e. brokers, transfer agents, mutual fund companies) to transfer cost basis on covered lots only. If a position or tax lot is non-covered, and we receive the cost basis we will display the basis received on the clients account. The transfer statement must be furnished to the receiving broker within 15 days after the date of transfer. Schwab will send out a request for a cost basis transfer statement for taxable accounts on the 16th day after settlement of the transfer if cost basis transfer statements are not received. Most firms do not provide cost basis for Qualified (nontaxable accounts) since these account types are not covered by the cost basis legislation. The client will need to submit cost basis to Schwab on these account types if it is not provided by the previous custodian. Schwab participates in the Cost Basis Reporting Service (CBRS), which is used in conjunction with transfers of securities to pass cost basis information to other CBRS participating firms, regardless if it is an ACAT or NON-ACAT transfer. Firms that do not participate in CBRS, will send cost basis information via written format. Cost basis received from non-cbrs firms may take longer to update due to manual processing. Please note: The CBRS process is completely separate from the ACAT/NON-ACAT process. For incoming transfers, please make sure that the delivering firm has been contacted prior to settlement if there are specific tax lots to be transferred in to Schwab. Contra firms are may not be willing to send corrected records if they did not have lot instructions on file prior to the transfer. Additional Information DRIP plans/securities held at transfer agents Most transfer agents only maintain and keep track of cost basis for covered tax lots. Schwab may only receive partial cost basis information, which would leave lots unknown/missing cost basis. The client will need to reach out to the transfer agent to request historical information. Transfers directly from mutual fund companies Similar to transfer agents, most mutual fund companies will only track and maintain lots that are bought and reinvested the year mutual funds started to become covered securities (2012). In the event that Schwab receives partial information, please have the client provide historical information to update cost basis. For large transfers of multiple accounts (or if the advisor is currently onboarding accounts to Schwab), contact the AS Client Reporting team so we can help facilitate the transfers of cost basis from the contra firm to eliminate potential issues with reconciliation. 7

8 Step up cost basis to date of death Under the cost basis legislation, the IRS has requirements for brokers on inherited shares. Rules require that if Schwab processes an estate and assets are distributed from an account fully owned by the decedent that Schwab step up the basis 100% to the date of death automatically. Inherited tax lots will be tagged as such and the holding period will be long term. If the decedent was a partial owner of an account ( i.e., JT TEN or Trust account), Schwab will not proactively step up the basis because the percentage owned by the decedent is not known and thus the percentage of tax lots to be stepped up is not known. If a step up is required, submit a request using Schwab s new Step Up Cost Basis to Date of Death Request Form, a copy of the client s Death Certificate and forward to your service team. When inherited shares are transferred between accounts, brokers must identify and flag the individual security as inherited. Inherited tax lots are treated as Long Term, regardless of the date purchased by the decedent, the date the securities were received from the estate, or the date the securities were sold by the owner. If an inherited security is transferred, the transfer statement will indicate it as such. If the inherited security is Covered, the transfer statement must provide the following: The Date of Death (DOD) as the acquisition date Adjusted basis equal to the fair market value (FMV) of the security on the DOD, unless the broker received instruction to use an alternate date (exactly six months from DOD). Equities If DOD falls on a trading day, the FMV is calculated using the average of the high/low of the DOD. If DOD falls on a non-trading day ( i.e., weekends or holidays), the FMV is calculated using the average of the high/low of the trading day PRIOR to and the average price of the of the high/low of the trading day AFTER the DOD. Example: Weekends Use the average of Friday s average price and Monday s average price. Holidays Assuming Monday is a holiday, use the average of Friday s average price and Tuesday s average price. Mutual Funds If DOD falls on a trading day, the FMV is calculated using the Net Asset Value of the DOD. If DOD falls on a non-trading day ( i.e., weekends or holidays), the FMV is calculated using the Net Asset Value of the trading day PRIOR to the DOD. Fixed Income If DOD falls on a trading day, the FMV is calculated using the average of the high and low price on the DOD. If DOD falls on a non-trading day ( i.e., weekends or holidays), the FMV is calculated using the average of the closing price of the trading day PRIOR to and the trading day AFTER the DOD. 7

9 Gifting When calculating cost basis for gifts, Schwab maintains the following information: The donor s cost basis as of the gift date The donor s original acquisition date The FMV as of the gift date The date of the gift To calculate the gain/loss at the time of sale for shares received as a gift, refer to the guidelines below: If the FMV is equal to or greater than the donor s cost basis, the donor s cost basis is retained to calculate the gain/loss. If the FMV is less than the donor s cost basis, the proceeds amount must be considered when determining the cost basis. If the total proceeds are greater than the donor s cost basis ( i.e., gain), the donor s cost basis is retained to calculate the gain. If the total proceeds are less than the FMV (i.e., loss), the FMV is used to calculate the loss. If the total proceeds are less than the donor s cost basis and greater than the FMV, there is no gain or loss. The cost basis will be equal to the proceeds. The holding period is determined by whether the FMV or the donor s cost basis is used to calculate gain/loss. If FMV is used, the holding period begins on the date of the gift. If the donor s cost basis is used, the holding period is determined by the donor s original acquisition date. Unless Schwab is instructed otherwise, we will identify shares that move from one owner to another as gifted. Return of capital A return of capital event occurs when Schwab receives an updated file from our third- party vendor informing us that an issuer has reclassified income previously paid as a dividend to return of capital. When this happens, Schwab will decrease the cost basis by the amount of the return of capital. A Cost Basis Adjustment Alert will be generated after the cost basis has been adjusted. The cost basis adjustment amount should match the amount reported as return of capital on the client s 1099-DIV. Your PMS provider may have a tool that allows you to adjust cost basis for return of capital in your system. Please contact them for further details. Note: Return of capital is not automatically applied to non-taxable accounts. 8

10 Cash/stock mergers 368(a) The cost basis legislation has resulted in a change of how we determine cost basis on some cash/stock mergers. Section 368 of the Internal Revenue Code recognizes three types of corporate acquisitions that may qualify under 368(a) reporting. 368(a) mergers, in which a gain limit is applied, will require the FMV price of the distributed security (child security). Each individual tax lot of the parent security will need to be calculated separately to determine the total value being distributed per lot. The total proceeds used to determine the overall gain/loss will be the child security s FMV plus the cash received. The gain/loss limit will adjust the realized gain/loss that is actually being reported. Gain/loss limit rules result in three possible realized gain/loss outcomes: To Calculate Gain/Loss for each lot: FMV of shares received + Cash Received - Original Cost Basis 1. Gain is limited to the cash received Total proceeds minus cost basis results in a gain greater than the cash received in the cash/stock merger. Only the cash received will be reported as a gain. 2. Full gain Total proceeds minus the cost basis results in a gain less than the cash received in the cash/stock merger. The full difference between proceeds and cost basis will be reported as a gain. 3. No loss Total proceeds minus cost basis results in a loss. The IRS does not allow a loss to be claimed. Schwab will report the cost basis equal to proceeds, resulting in a gain/loss of zero. The amount of cost basis reported in realized gains and losses (RGL) will be deducted from the cost basis of the child security. Each tax lot could have a different outcome, resulting in the cost basis being adjusted differently in the unrealized gain/loss for the child security, and the realized gain/loss for the parent security. To adjust your data, contact your PMS provider. Cash in lieu (CIL) of fractional shares Schwab s corporate action department delivers whole shares into an account during a corporate action. The fractional shares are not credited to the account, but the cash received as payment for the fractional shares is received into the account as CIL. When processing corporate actions, the cost basis system credits the fractional shares to the account, and they are subsequently sold off according to the accounting method for the account when the cash is received for the CIL. This causes a temporary out of balance between the share quantity shown under the positions tab vs. the quantity on the cost basis tab until the CIL payment is received. Once the quantity discrepancy is adjusted, the fractional shares will be displayed as a realized transaction on the realized gain/loss tab with the proceeds equaling the CIL credited to the account. 9

11 Wash sales and disallowed losses A wash sale occurs if you sell securities at a loss and buy substantially identical replacement shares within 30 days before or after the sale. The wash sale period for any sale at a loss consists of 61 days: the day of the sale, the 30 days before the sale, and the 30 days after the sale. The wash sale rule postpones losses on a sale if replacement shares are bought during the 61 day wash sale period. Schwab tracks and adjusts for wash sales at the individual account level, not across all taxpayer accounts. If a wash sale occurs, all or a portion of the loss incurred on the original sale is disallowed. The disallowed loss amount is added to the cost basis of the replacement security. The holding period for the replacement shares you acquire in a wash sale includes the period you held the old stock or securities. To calculate the adjusted realized gain/loss, you need to determine: 1. The wash sale disallowed loss % total # of wash sale shares (shares repurchased) / total # of shares sold 2. The disallowed loss amount = wash sale disallowed loss % original loss amount 3. The adjusted realized gain/loss = original loss amount disallowed loss amount To calculate the adjusted holding period date, start with the closed lot acquisition date and add the number of days the position was not held. That is, the acquisition date is adjusted on the new lot to equal the closed lot acquisition date plus any days that it was not held. Lots are chosen based on the default accounting method assigned to the account or specified instructions given at the time of trade How does a wash sale work? Transactions over a 30-day period, beginning with a flat position, are being used for this example: 9/30/2010 Buy 100L ABC $1, /3/2010 Sell 50S ABC $400 Wash sale triggered 10/16/2010 Buy 1.250L ABC $15.60 Realized Gain/Loss 10/3/2010 Sell Proceeds ($400.00) - Cost ($500) = <$ $97.50 New Lots for ABC 1. A portion of the loss is disallowed; the dividend reinvestment of shares is considered a purchase. A loss of $97.50 is the amount that can be claimed because it is the loss on the shares that were not repurchased. 9/30/2010 Buy 50L ABC $ /13/2010 Buy 1.250L ABC $ The cost is adjusted on the replacement shares by the disallowed amount which is the total amount of the loss on the sale ($ $2.50 = $18.10). 3. The acquisition date is adjusted on the lot to equal the closed lot acquisition date plus any days it was not held (9/30/ days). 10

12 Closing a Short Position Reporting Requirements Due to IRS regulation, brokerages are required to report closing transactions on short positions based on the settlement date of the shares that were bought to cover the short sale, not the trade date. For example, if you are covering a short position in 2014 for 2014 tax reporting, then you need to ensure the shares bought to cover settles in

13 Year-End Reporting Requirements for Options Schwab is required to report adjusted cost basis and proceeds for sales transactions on IRS Form 1099-B for options that are acquired on or after January 1, We will report sale date, acquisition date, proceeds, cost basis, and Wash Sale disallowed loss data to the IRS, as we do for all other covered securities. Please note that if you trade multi-leg options strategies such as spreads, straddles, and strangles, Schwab will report the individual legs of the strategy as separate transactions. The following chart illustrates the reporting requirements for opening option transactions: 12

14 Example: Short Call Assignment In a short call assignment, the proceeds are adjusted by the option premium. Bill Blevins held 100 shares of ABC Corporation, which he bought for $120 per share. He sold (wrote) 1 ABC Oct $130 $5, and he received a premium of $500. proceeds $13,000 cost of underlying stock - 12,000 = + realized gain or loss option premium = + 1,000 (realized gain) 500 = adjusted realized gain or loss = $1,500 (adjusted realized gain) The call was assigned, which means the call option holder exercised the right to purchase the security. Mr. Blevins sold 100 shares of ABC at $130 per share. He received $13,000 (100 $130) in proceeds from the option holder. proceeds $13,000 + option premium = - adjusted proceeds cost = - 13,500 (adjusted proceeds) 12,000 = adjusted realized gain or loss = $1,500 (realized gain) When fulfilling an option assignment, the seller adds the premiums received to the proceeds of the underlying stock. The closing date of the underlying security is the effective date of the exercise. Since the premium received from the option is bundled with the proceeds of the underlying stock, a separate option transaction will not be displayed. The call option holder who exercises the right to purchase the security adds the premium paid to the cost basis of the shares. The opening date of the underlying security is the effective date of the exercise. Since the premium paid for the option is bundled with the cost basis of the underlying stock, a separate option transaction will not displayed. 13

15 Example: Long Put Exercise In a long put exercise, the proceeds are adjusted by the option premium. Bill Blevins held 200 shares of XYZ Solutions, which he bought for $5 per share. He bought 2 XYZ Nov $7 $1.50 and paid a premium of $300. Mr. Blevins exercised the put, which means he had the right to sell the security to the option writer. Mr. Blevins sold 200 shares of XYZ at $7 per share. He received $1,400 (200 $7) from the option seller. Put option buyers (holders) pay a premium for the option. When the underlying security is sold, they subtract the premium amount from the proceeds of the sale of the underlying security. The opening date of the underlying security is the effective date of the exercise. Since the premium paid for the option is bundled with the proceeds of the underlying stock, a separate option transaction will not be displayed. Put option sellers (writers) subtract the premium received from the cost basis of the underlying shares purchased through the option. The closing date of the underlying security is the effective date of the exercise. Since the premium received from the option is bundled with the cost basis of the underlying stock, a separate option transaction will not be displayed. proceeds $1,400 option premium = - adjusted proceeds cost = - 1,100 (adjusted proceeds) 1,000 = realized gain or loss = $100 (realized gain) Long option expirations will be displayed as zero proceeds with the premium paid reported as the cost basis. The closing and acquisition dates of the closed short option positions will be changed to the settlement date of the closing buy-to- cover transactions. These changes will be visible to advisors on Schwab Advisor Center and to clients on the Realized Gain/Loss page on SchwabAlliance.com, monthly statements and the Form 1099 Composite.

16 DISCLAIMERS 1. PortfolioCenter is a product of Schwab Performance Technologies (SPT). Schwab Advisor Services is a business segment of The Charles Schwab Corporation serving independent investment advisors, which includes the custody, trading, and support services of Charles Schwab & Co., Inc. (Schwab). Schwab and SPT are subsidiaries of The Charles Schwab Corporation. 2. Advent Axys is not affiliated with Schwab. FOR GENERAL INFORMATIONAL PURPOSES ONLY. Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the options disclosure document titled Characteristics and Risks of Standardized Options. With long options, investors may lose 100% of funds invested. Covered calls provide downside protection only to the extent of the premium received and limit upside potential to the strike price plus premium received. Commissions, taxes, and transaction costs are not included in this discussion, but can affect final outcome and should be considered. Please contact a tax advisor for the tax implications involved in these strategies. Supporting documentation for any claims or statistical information is available upon request. Schwab does not provide investment planning, legal, tax, or compliance advice. Consult professionals in these fields to address your specific circumstance Charles Schwab & Co., Inc. (Schwab). All rights reserved. Member SIPC. Schwab Advisor Services serves independent investment advisors and includes the custody, trading, and support services of Schwab. Independent investment advisors are not owned by, affiliated with, or supervised by Schwab. AHA (0216-CWPN) MKT64069 (02/16)