Tax & Accounting Blog

IRS Proposes Regulations on Broker Reporting of Options and Debt Instruments

ONESOURCE, Tax Information Reporting, Trust Tax February 16, 2012

In 2010, the IRS published Final regs relating to broker reporting of stock. On Nov. 25, 2011, the IRS issued proposed regs that would integrate rules for broker reporting of options and debt instruments into the current final regs that explain how brokers must report stock transactions. However, the proposed regs also would make some changes affecting all securities subject to the reporting rules. For example, broker reporting of gross proceeds would be simplified.

Background. Under Code Sec. 6045(g)(3), a note, bond, debenture, or other evidence of indebtedness acquired on or after Jan. 1, 2013, is a security subject to the broker basis reporting rules. And Code Sec. 6045(h) provides that brokers must report certain information, including gross proceeds, on the sale, exercise, lapse, or other closing transaction of an option on a specified security granted or acquired on or after Jan. 1, 2013.

Purpose of new proposed regs. The new proposed regs would amend the final regs issued in 2010 to require additional information reporting by a broker for a debt instrument acquired on or after Jan. 1, 2013. The proposed regs also would require information reporting for an option granted or acquired on or after Jan. 1, 2013.

Following are some highlights of the substantive changes that the proposed regs would make.

Reporting of options. For purposes of the broker reporting rules, certain options would be added to the definition of a security, specified security, and covered security. In general, an option on one or more specified securities, including an index of such securities or financial attributes of such securities, that is granted or acquired on or after January 1, 2013, would be a covered security. For example, the proposed regs would apply to an option on the S&P 500 Index.

Under the final regs, a compensation-related option is excepted from the general rules for reporting basis for an option. The proposed regs would retain the existing rules for a compensation-related option, but make these rules applicable to all compensation-related options, and not just those granted or acquired before Jan. 1, 2013.

The proposed regulations would update the definitions for the terms “closing transaction” and “sale” to accommodate the reporting of options granted or acquired on or after Jan. 1, 2013. In particular, the cancellation, lapse, expiration, or other termination of an option will be a closing transaction, as will be a cash settlement.

Debt instruments. Under Code Sec. 6045(g), when a debt instrument that is a covered security is sold, a broker must report the adjusted basis of the debt instrument and whether any gain or loss is short-term or long-term. The proposed regs would amend the final regs to include a debt instrument in the definition of a specified security, and a debt instrument acquired for cash in an account on or after Jan.1, 2013, in the definition of a covered security.

If a debt instrument is acquired on or after January 1, 2013, a broker will be required to determine and account for original issue discount (OID), bond premium, acquisition premium, market discount, and principal payments to determine the adjusted basis of the debt instrument and whether any gain or loss upon the sale of the debt instrument is short-term or long-term. Further, a broker will be required to report the amount of any market discount that has accrued as of the date of a sale or transfer of a debt instrument.

Under §1.6045-1(d)(6)(i) of the existing final regulations, a broker is not required to consider elections occurring outside the account. Consistent with this rule, a broker generally is required to calculate amounts relating to OID, bond premium, acquisition premium, and market discount by assuming that the customer has not made any elections with respect to the debt instrument. The proposed regulations, however, provide two exceptions to this general rule: (1) A broker must assume that a customer has elected to use the constant interest rate method under section 1276(b)(2) to determine the amount of accrued market discount; and (2) a broker must assume that the customer has elected under section 171 to amortize bond premium on a taxable debt instrument.

The Treasury Department and the IRS recognize that the amortization election assumption is inconsistent with the rule under section 6049 providing that a payor is not permitted to take premium into account for purposes of reporting a holder’s interest or OID income on Form 1099-INT or 1099-OID each year. However, the Treasury Department and the IRS believe that most holders will make a section 171 election to treat the premium as an offset to ordinary income rather than as a capital loss. Therefore, the Treasury Department and the IRS believe that the section 171 election assumption will result in fewer instances in which a customer will need to reconcile the reported adjusted basis number to the proper number.

Changes affecting all specified securities, including stock. Under the current final regs, a broker may choose to report gross proceeds from the sale of a security as the entire proceeds from the sale or as the proceeds reduced by the commissions and transfer taxes related to the sale. In response to commentators who asked IRS to standardize broker reporting on Form 1099-B and taxpayer reporting on Form 1040, the proposed regs would require brokers to reduce reported gross proceeds by commissions and transfer taxes related to a sale.

More specifically, under the proposed regs, for sales before Jan. 1, 2013, a broker could, but would not be required to, reduce gross proceeds by the amount of commissions and transfer taxes, provided the treatment chosen is consistent with the books of the broker. For sales on or after Jan. 1, 2013, a broker would have to reduce gross proceeds by the amount of commissions and transfer taxes related to the sale of the security.

Under the current final regs, a broker must adjust basis reported for an organizational action taken by an issuer of a security during the period the broker has custody of the security. For a transferred security, the regs exclude adjustments for organizational actions taken on the transfer settlement date. The proposed regs would amend this exclusion to clarify that it applies only to the broker receiving custody of a transferred security. The proposed regs also would require that a broker transferring a security reflect all necessary adjustments for organizational actions taken through and on the transfer settlement date when completing a transfer statement.

Prospective effective/applicability dates. The rules in the proposed regs would be effective when final regs are issued. The rules regarding reporting of basis, and whether any gain or loss on a sale is long-term or short-term under Code Sec. 6045(g), are proposed to apply to debt instruments acquired on or after Jan. 1, 2013. The rules regarding reporting of gross proceeds, basis, and whether any gain or loss on a sale is long-term or short-term under Code Sec. 6045(h), are proposed to apply to options granted or acquired on or after Jan. 1, 2013.