Pressing Cost Basis Challenges Deserve Close Attention of Mutual Fund Companies

Guest Contributor: Stevie D. Conlon, senior director and tax counsel, Wolters Kluwer Financial Services

With the cost basis reporting law’s next effective date less than six months away, mutual fund companies must closely consider risks and challenges that might result in non-compliance and serious customer service issues.

First and foremost, mutual fund companies that provide Form 1099-B and cost basis information to their investors face a massive new regulatory burden where the potential tax penalty risks are significant. Calculating cost basis correctly will be critical in order to avoid penalties. There are separate penalties for incorrect 1099s provided to the IRS and 1099s provided to taxpayers, and they aggregate to $200 per incorrect 1099 (with an annual maximum of generally $3,000,000 per year before interest).

At the same time, fund companies must address the customer service risks if they cannot adequately explain the impact of the new cost basis reporting rules to their customers. Customers will likely be confused by a number of changes that result from the law, including:

Changes to Form 1099-B – Investors haven’t seen cost basis reported on Form 1099-B before and it is only required to be provided on Form 1099 for mutual fund shares acquired on or after Jan. 1, 2012 (covered shares). The change in the form to include cost basis for covered shares, but not pre-effective date (noncovered) shares, will likely provoke questions. Additionally, investors might expect to see one average basis number, but will generally see two for the same fund—one for covered shares and another for noncovered shares. The law also requires fund companies to correct cost basis information provided on Form 1099-B if it receives updated or corrected information. Customers receiving corrected 1099s might be frustrated because they may worry that they’ll need to file amended tax returns.

Account Election Methods – There are a number of account election methods, such as averaging, highest-in/first-out (HIFO), first-in/first-out (FIFO), and specific ID. Customers will want to know why some shares in mutual funds are eligible for averaging, and others aren’t. Mutual funds that do not educate their customers about tax rules surrounding election methods—and accurately track and retain customer instructions and elections—will likely face problems.

Gifted and Inherited Securities – Special rules must be applied in computing basis and determining the amount of any gain or loss for securities that are transferred as a gift or inheritance.

Exchange Traded Funds (ETFs) and Unit Investment Trusts (UITs) – Mutual funds must be ready to explain why the law doesn’t treat mutual funds, ETFs or UITs consistently for cost basis reporting purposes.

Mutual funds need to have skilled customer service teams in place to handle these inquiries. That means customer services will likely need to be expanded and special training and support will be needed. Mutual fund companies should make sure they have taken these costs and staffing needs into account for planning and budgeting purposes.

For more information on this topic, please refer to a recent whitepaper highlighting the top 10 cost basis issues impacting the mutual fund community.

Check out FTF’s 5th Annual Corporate Actions Processing Conference on October 19th to hear more on this topic from Stevie Conlon!

About Maureen Lowe

President and Founder of Financial Technologies Forum, LLC. Editor-In-Chief of FTF News. Entrepreneur, Jersey Girl that recently returned to Jersey, Loves to Bake, Married to a Kiwi, First Time Mom
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