Broker/dealers, custodians and clearing firms are far behind in their preparations for new cost-basis reporting rules that will take effect between January 1, 2011 and January 1, 2013, analysts and tax experts say. Sure, that first deadline is more than a year off. But already, time is short. Selecting an outsource provider or building the appropriate technology in house and integrating it with back office systems is a major, and potentially costly, project, they say.
“I expected everyone in the industry to say ‘Oh, this is a big deal,’ and to start working on it” when the new rule was passed in October as part of the Emergency Economic Stabilization Act, says Sean Cunniff, research director of brokerage and wealth management at Tower Group. “But that didn’t happen. There was so much going on in the industry. Firms were trying to just stay alive,” he says. “In the last eight weeks, it seems like firms are paying a little more attention to it…But I still feel that they might be under-estimating how much work it’s going to take to prepare for it.”
Under the Emergency Economic Stabilization Act passed in October of last year, US b/ds will have to report their clients’ capital gains information on the 1099 forms they provide to clients and the IRS beginning in 2011. The first deadline of Jan.1, 2011 applies to equity shares acquired after that date. By Jan. 1, 2012, they will have to begin reporting capital gains information for mutual funds and dividend reinvestment plan (DRiP) shares. And by Jan. 1, 2013, they will be required to provide reporting for other specified securities, like debt issues, options and private placements. Until now, it has been voluntary, and some of the biggest firms provide this service for their wealthiest clients.
There are positive implications for financial advisors from the rule. For one thing, it should make it easier for them to offer tax-efficient investing strategies, and this could set them apart from other firms in the low-return environment projected for the next several years, says Cunniff in a report he authored in January called Cost Basis Technology for Broker-Dealers. Managed accounts will also be better able to actually offer true tax efficiency, something they have long-promised but seldom delivered. On the other hand, he also expects it could create a lot more customer service demand, as firms that currently offer cost-basis reporting to clients say answering client questions about it is a “substantial cost item.”
For now, many of the outsource vendors—such as, GainsKeeper of Wolters Kluwer Financial Services, Aspire Portfolio Accounting of Broadridge, and Xcitek Cost Basis from IDC—are pushing to get b/ds to start working on the project. “Many of [the vendors] are worried that these firms are going to come to them at the last minute, and they won’t have the people to handle it. So there could be a capacity issue,” says Cunniff.
Among other things, the new rule means firms must have accounting systems that can identify shares bought prior to and after the various effective dates, keep track of certain corporate actions that will affect cost-basis, like spin-offs, mergers and tender offers, and integrate all the new data they will begin to track into accounting and trading platform systems, as well as account setup and client statement technology, says Lori Trezza, vice president of product development at the Depository Trust & Clearing Corporation (DTCC), which also offers a cost-basis technology solution called AccuBasis.
Brokerages and RIAs that rely on a custodian to handle this work only need to worry about whether their custodians are preparing for compliance with the rule. But self-clearing b/ds like Merrill Lynch, LPL and hundreds of smaller b/ds, will have to either build systems, enhance what they've already got, or outsource, as will custodians like Charles Schwab. Cunniff estimates that for firms with 1 million accounts, building a cost-basis engine in house could cost over $5 million up front, plus $500,000 to $750,000 in ongoing maintenance spending. Even those firms who already do cost-basis reporting for some clients will need to make some major enhancements, Cunniff says.
Considering that firms will need to set aside several months to determine the cost of building new technology in house or outsourcing to one of a number of providers, and another several months to test their new systems, the clock is ticking, says Stevie Conlon, tax director at GainsKeeper, a firm that provides cost-basis reporting technology. “Anybody that hasn’t started doing due diligence is really behind,” she says.
One hitch in the process is that the IRS has yet to release the final guidelines. The regulator requested comments on the cost-basis reporting rules in early February, and the comment period closed in early March, but some of the comments are 65 pages long. “The IRS is taking that input and trying to craft guidance they can issue,” says Conlon. “We worry, however, how quickly will the guidance come out? How complete will it be? When people have difficult deadlines, people tend to think, maybe it will get extended. Maybe we can talk the IRS into pushing the deadline back.” But Congress might balk at any attempt to delay the deadline, as the measure is meant to generate $6.7 billion in taxes the government is depending on, she says.
Some of the biggest issues that have yet to be resolved by the IRS are how to identify DRiP stocks, transfer reporting requirements—for which many of the details have been left up to the IRS—and the methods that can be used to calculate cost-basis, like Fifo (first in, first out) and specific ID. Under specific ID, certain lots can be sold instead of first in lots as long as they are tracked.