2014 cost basis legislation and tax...
TRANSCRIPT
2014 Cost Basis Legislation and Tax ReportingFixed Income and Options
Advisor Toolkit Volume II
1
Table of Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
NEW Form 1099-B . . . . . . . . . . . . . . . . . . . . . . . . 3
2014 Cost Basis Tax Reporting Requirements For Fixed Income Securities . . . . . . . . . . . . . . . . . 5
NEW Form 1099 Reporting for Fixed Income Securities . . . . . . . . . . . . . . . . . . . . 7
NEW 2014 Form 1099 and Year-End Summary Changes Due to Fixed Income Reporting Requirements . . . . . . . . . . . . . . . . . . . 15
NEW Reporting Requirements for Options . . . . 19
NEW Reporting Requirements for Long Options Expirations . . . . . . . . . . . . . . . . . . 22
Section 1256 Reporting . . . . . . . . . . . . . . . . . . . 24
Year-End Summary Section Updates: Options . . . . . . . . . . . . . . . . . 25
Sample Communication: Inform Your Clients about New Tax Reporting Requirements for Fixed Income Securities and Options . . . . . . . . . 26
Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
2
Introduction
In August, we provided you with Volume I of our Advisor Toolkit . It contains information about cost basis
legislation and the system changes we made to comply with new IRS requirements for Fixed Income
and Options reporting . In November, we’ll be making the remainder of the required system changes in
preparation for year-end tax reporting .
This updated edition highlights the system changes taking place in November and provides a preview of
the changes you and your clients will see on 2014 IRS tax forms .
August Implementation
In August 2014, Schwab made adjustments to its amortization
settings that affected the calculation of whether a bond
purchased at a premium or discount has a gain/loss when sold to
conform to IRS reporting rules:
• The methods used to calculate amortization and accretion
were based on whether a bond is purchased at a premium,
original issue discount, or market discount, and/or if there is a
call or put feature .
• Market discount on a bond purchased on the secondary
market is now calculated using the straight line accounting
method, which is parallel to the IRS default for taxpayers .
• The amount of the market discount is no longer incorporated in
current income or adjusted cost basis until the position has
been sold, matured, or called . Before this change, Schwab
assumed that clients included market discount in their current
income and adjusted cost basis daily .
November Implementation
In addition to the changes made in August 2014 (detailed in
Volume I of the Toolkit), Schwab will be making the following
system changes to conform to IRS reporting rules:
• Closingtransactionsofcoveredfixedincomesecuritiesin
taxable accounts that occurred between January 1, 2014, and
the August 2014 system implementation, will be reprocessed
in November using the IRS broker-required amortization
settings . This may affect a client’s realized gain/loss .
• We will implement system functionality for calculating Yield to
Best for taxable bonds purchased at a premium with a call
feature . Clients holding these types of bonds may see a change
in their adjusted cost basis and unrealized gain/loss .
3
NEW Form 1099-B
1 Consolidated section headings into one
2 QuantityisnowpartofDescriptionfield
3 New location for CUSIP/Symbol
4 New option Symbol display
5 New option activity codes–BC (Buy to Close), SC (Sell to
Close), and X (Expiration)
6 Date of acquisition is now Date acquired
7 Date of sale or exchange is now Date sold or disposed
8 Net proceeds displays only when proceeds were adjusted
for option premium
9 Sales price of stocks, bonds, etc . is now Proceeds
10 Cost or other basis has moved to Box 1e
11 Former Wash sale loss disallowed column is now
1g-Adjustments and 1f-Code, if any:
W = Wash Sale Loss Disallowed
D = Market Discount
C = Collectibles
12 New Realized Gain or (Loss) column is not reported to the IRS
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SomeoftheCostBasischangesmayaffectreportingforallsecuritytypes,othersaremorespecific.InthisToolkit,we’llstartby
highlightingthechangesthatmayaffectallsecurities,andthengointospecificexamplesforFixedIncomesecuritiesandOptions.
4
The Notes for Your Form 1099-B page was updated so that box numbers correspond with box numbers and descriptions on the new
Form 1099-B .
New for 2014
5
2014 Cost Basis Tax Reporting Requirements for Fixed Income SecuritiesThecostbasisoffixedincomesecuritiescanbeaffectedbyaccrualsofincomeaswellastaxelectionstheholderoftheinstrument
makes . Many of the changes made by the IRS align broker reporting on Form 1099-B with taxpayer reporting requirements .
Less Complex Fixed Income: Subject to 1/01/14 Reporting
More Complex Fixed Income: Subject to 1/01/16 Reporting
Fixed Income Excluded from Reporting
Taxable and non-taxable bonds that haveafixedrate,fixedmaturity,andfixedpaymentschedule,eveniftheyarecallable by the issuer . These include:
• Treasury notes and bonds
• Fixed-rate corporate bonds
• Fixed-rate municipal bonds
TheIRSwilladdressfixedincomesecuritiesthat are more complex in terms of calculating adjusted cost basis in 2016 . These include:
• Variable-rate bonds
• Stepped-rate bonds
• Convertible bonds
• Stripped bonds
• Certain tax-credit bonds
• Contingent-payment bonds
•Inflation-indexedfixedincomesecurities
• Foreign-issued bonds or bonds that pay in foreign currency
• Payment-in-kind bonds
• Fixed income securities issued as part of an investment unit
• Fixed income securities for which terms are not reasonably available to brokers within 90 days of acquisition by client
• Fixed income securities evidenced by a physicalcertificatenotheldbyacustodianor clearing agent (physical debt)
TheIRSspecificallyexcludedfixedincome securities described in Section 1272(a)(6) of the IRS regulations from cost basis reporting requirements:
•Certainspecificinterestsinormortgages held by a Real Estate Mortgage Investment Conduit (REMIC)
•Certainotherfixedincomesecuritieswith payments subject to acceleration
•Poolsoffixedincomesecuritieswhose yield may be affected by prepayments
•Short-termfixedincomesecurities(withafixedmaturityratenotmorethan one year from the date of issue) .
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Default Yield Methods
Followingisasummaryofamortizationmethodsthatwillbemodifiedfortaxable/non-taxableaccountswithamortizationenabled.
NEW 2014 Schwab Settings
Bonds A/A Rule Type Yield Method Apply de Minimus Rule?
Original Issue Discount–No Call or Put Feature Constant Yield Yield to Maturity Yes
Market Discount Straight Line N/A Yes
OID–Call Feature Constant Yield Yield to Worst (Lowest Yield) Yes
OID–Put Feature Constant Yield Yield to Best (Highest Yield) Yes
OID with Acquisition Premium Constant Yield Original Yield to Maturity, then apply acquisition premium
Yes
Bond Premium–No Call or Put Feature Constant Yield Yield to Maturity No
Bond Premium–Call Feature Constant Yield Yield to Best (Highest Yield) Taxable Bonds Yield to Worst (Lowest Yield) Tax-Exempt Bonds
No
Bond Premium–Put Feature Constant Yield Yield to Best (Highest Yield) No
Client Instructions that Differ from Broker Default Settings
The new IRS-designated defaults may not coincide with what your
clientshaveusedfortaxfilingpurposesinthepast.ButtheIRS
will allow taxpayers to instruct their brokers to use settings for
taxable bonds that differ from the defaults . They can choose to:
• Accrue market discount using constant yield .
• Include market discount in current income .
• Disable bond premium amortization .
• Treat all interest as OID .
If your client is considering changes to their default settings,
instructions for the 2014 tax year must be submitted in writing to
Schwab by December 31, 2014, and will be retroactive to January
1, 2014 . Schwab will ensure that all forms received by December
31 will be processed in time for 1099 reporting for that tax year .
• The Letter of Authorization (LOA) to Change Fixed Income
Amortization & Accretion Settings form must be signed and
completed by the account holder for each affected account .
Advisors cannot execute the LOA on their client’s behalf .
• Some instructions are not revocable and others require IRS
commissioner approval for revocation .
• Yourclientsarealsoresponsibleforfilingtheappropriate
instructions with the IRS on their tax returns .
• To obtain the Letter of Authorization (LOA) to Change Fixed
Income Amortization & Accretion Settings form, contact the
Client Reporting Services Team at 1-877-762-6446 .
7
NEW Form 1099 Reporting Requirements for Fixed Income Securities
Form 1099-INT Bond Premium-AmortizationLet’s use a simple example to illustrate how bond premium is calculated and reported per new broker defaults .
Example
• On 4/1/2014 you purchased a 10,000 face corporate bond for a purchase price of $10,500
• The bond was issued on 4/1/2005 and matures on 4/1/2015
Form 1099-INT Bond Premium-Amortization ON (Default)
• Schwab will be reporting proceeds, cost basis and market
discountonlesscomplexfixedincomesecuritiesacquiredand
sold after January 1, 2014 to the IRS .
• Schwab will report all principal payments, including partial
principal payments, on the Form 1099-B in the noncovered
securities Cost Basis Is Missing and Not Reported to the IRS
section .
• Annual Bond Premium, if any, will now be reported to the IRS
on Form 1099-INT for covered bonds .
• Acquisition Premium for OID securities will now be reported to
the IRS on Form 1099-OID for covered taxable bonds .
• Market Discount will be reported when a bond is sold or
matured, unless your client provided instructions to include it
in current income . In that case, Schwab will report Market
Discount annually on Form 1099-INT or Form 1099-OID for
covered taxable bonds .
• The amount of bond premium amortization for a tax year can be
reported only up to the stated interest payment on the bond .
Excess amortization will be carried forward to the next tax year .
For tax year 2014, the amount of amortized bond premium from purchase through the 10/1/2014 coupon date of $247.02 ($10,500 Cost Basis at Purchase: $10,252.98 Cost Basis on 10/1/2014) is reported in Box 11-Bond Premium on the Form 1099-INT
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If the election is made to disable bond premium amortization, Box 11-Bond Premium on the Form 1099-INT will show $0.00
Form 1099-INT Bond Premium-Amortization OFF (Election)
Even if your client elects to disable
bond premium amortization, Schwab
will report tax exempt bond premium
in box 11 for covered bonds .
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Let’s use a simple example to illustrate market discount calculated and reported per new broker defaults .
Example
• On 4/1/2014 you purchased a $10,000 face 10% corporate bond for a purchase price of $5,000
• The bond was issued on 4/1/2005 and matures on 4/1/2015
Here is what the purchase looks like on the Schwab Advisor Center Unrealized Gain/Loss screen:
Under the new IRS default, you will always see your original
cost basis for the bond displayed until the bond is sold,
matures or is called away (if applicable) .
Market Discount–Accrued at Disposition
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The original cost basis of $5,000 has been fully adjusted at maturity for the accrued market discount of $5,000. The adjusted cost basis now reflects $10,000.
The original cost basis of $5,000 has been adjusted for the market discount at maturity to $10,000.
The cost basis is only reported on schwaballiance .com
and client statements if an advisor has requested these
reporting preferences .
At maturity, the cost basis is adjusted for the accrued market discount . Here is what the adjusted cost basis looks like on the
Schwab Advisor Center Realized Gain/Loss screen:
Here is what the adjusted cost basis looks like on the schwaballiance .com Realized Gain/Loss screen:
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Here is what the adjusted cost basis looks like on the client statement:
Here is what the adjusted cost basis looks like at maturity on the 2015 Form 1099-B:
Interest Income will show the $500.00 coupon received at maturity on 4/1/2015
Original Cost Basis
Adjusted for Market Discount at maturity
Market Discount is $0.00 since it is not reported in Current Income
Original Cost Basis of $5,000
Market Discount Adjustment
Proceeds-Cost Basis-Adjustments=$0 Realized Gain or (Loss)
Here is what the adjusted cost basis looks like at maturity on the 2015 Form 1099-INT:
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Market Discount–Election to include in Current Income
Under the election to include Market Discount in current income, the cost basis is adjusted daily for the market discount and reports
annually on the Form 1099-INT .
Interest Income will show the $500 coupon received on 10/1/2014
Market Discount will show the $3,736.11 accrued from the 4/1/2014 purchase date through 12/31/2014
Let’s use a simple example to illustrate market discount calculated and reported with the election to include in current income:
Example
• On 4/1/2014, you purchase $10,000 original face of a 10% Corporate Bond
• The bond was issued on 4/1/2005 and matures on 4/1/2015
• The price you paid for the bond on 4/1/2014 is $5,000 total
Here is what the purchase will look like on the schwaballiance .com Unrealized Gain/Loss screen:
Market Discount on the 2014 1099-INT with Election to include in Current IncomeForm 1099 INT
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At maturity, the cost basis has been fully adjusted for the accrued market discount . Here is how it looks on the
schwaballiance .com Realized Gain/Loss screen:
Market Discount with Election to include Current Income (at Maturity) .
The original cost basis of $5,000 has been fully adjusted at maturity for the accrued market discount of $5,000 and the adjusted cost basis now reflects $10,000.
At maturity, the original cost basis of $5,000 has been fully adjusted to $10,000 reflecting the market discount.
At maturity on 4/1/2015, the cost basis has been fully adjusted for the accrued market discount . Here is what the purchase looks like
on the Schwab Advisor Center Realized Gain/Loss screen:
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Here is what it will look like on your client’s statement:
Here is what it will look like on the 2015 Form 1099-INT:
Original Cost Basis
Adjusted for Market Discount at maturity
The $500 coupon payment will be reported in Box 1
Market Discount will show the $1,263.89 accrued from 1/1/2015 to maturity on 4/1/2015
Here is what it will look like on the 2015 Form 1099-B:
1g–Due to the election to include in current income, Box 1g-Adjustments will be blank on 2015 Form 1099-B. Box 1e-Cost or other basis will be adjusted for the amount of Market Discount for an adjusted cost basis of $10,000 resulting in a Realized Gain of $0.00
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NEW 2014 Form 1099 and Year-End Summary Changes Due to Fixed Income Reporting RequirementsForm 1099-INT
Two boxes were added to report Market Discount (if a client election was made to include it in current income) and Bond Premium .
Form 1099-OID
Two columns were added for Market Discount (if a client election was made to include it in current income) and Acquisition Premium .
Two lines were added for Total Market Discount and Total Acquisition Premium .
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Year-End Summary Section–Updates
Under Detail Information of Interest Income, sections were added for Market Discount and Bond Premium .
• Market Discount will display if a position has been sold or has matured, or if a client has elected to include market discount in
current income .
• A detailed breakdown of the market discount and acquisition premium boxes on Form 1099-INT has been added to the Year-End
Summary .
17
Amortization and Accretion for Fixed Income–Updates
There was a complete redesign of the Amortization and Accretion for Fixed Income section of the Year-End Summary .
• The section has been split into taxable and non-taxable sections . • Year-to-Date (YTD) and Life-to-Date (LTD) Bond Premium and
Market Discount have been added . Market Discount will display
only if a position has been sold or has matured, or if a client has
elected to include market discount in current income .
• Added Notes for Your Amortization and Accretion section page .
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Under the Realized Gain/Loss section, there was a change to column headings, and a (–) Market Discount adjustment was added .
• Sales of short-term debt instruments that are no longer reportable to the IRS on Form 1099-B were added here .
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Thelatestcostbasisregulationschangethereportingrequirementsforbrokersforspecificoptionscontractsacquiredinanaccount
on or after January 1, 2014 .
Options Subject to 1/1/14 Reporting Options Subject to 1/1/16 Reporting Options Excluded From Reporting
• Options on a single security
•Optionsonmorethanonespecifiedsecurity, including an index in which the components are considered covered securities
•Optionsonfinancialattributesofspecifiedsecurities,suchasinterestrates or dividend yields
• Warrants or stock rights
• Investment units in which options, stock rights, or warrants are issued together withafixedincomesecurity
• Incentive stock options
• Foreign currency options
• Commodity options
Options acquired prior to January 1, 2014, that were sold or that expired during 2014 are considered noncovered securities and are
not reported by Schwab on Form 1099-B or to the IRS . Noncovered option transactions are displayed in the Realized Gain/Loss
section of the Year-End Summary .
New Reporting Requirements for Options
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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, 2014 . 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 multileg 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:
Opening Trade Closing Trade Resulting Position Premium Adjustment Report on 1099-B?
Buy Call to Open Sell Call to Close — Y
Buy Call to Open Call Expires — Y
Buy Call to Open Call is Exercised Long Underlying Security
OR
Close out existing short position in underlying security
Added to Cost Basis N
Y-The underlying security transaction is reported
Sell Call to Open Buy Call to Close — Y
Sell Call to Open Call Expires — Y
Sell Call to Open Call is Assigned Short Underlying Security
OR
Close out existing long position in underlying security
Add to Sales Proceeds N
Y-The underlying security transaction is reported
Buy Put to Open Sell Put to Close — Y
Buy Put to Open Put Expires — Y
Buy Put to Open Put is Exercised Short Underlying Security
OR
Close out existing long position in underlying security
Subtract from Sales Proceeds
N
Y-The underlying security transaction is reported
Sell Put to Open Buy Put to Close — Y
Sell Put to Open Put Expires — Y
Sell Put to Open Put is Assigned Long Underlying
OR
Close out existing short position in underlying security
Subtract from Cost Basis
N
Y-The underlying security transaction is reported
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Cost Basis Adjustments for Options
There are certain adjustments that brokers are NOT permitted to
make to the original cost basis on options transactions per the IRS .
• Schwab cannot take into account the impact of options
purchases or sales in determining disallowed losses on sales
of the underlying securities . If a client sells shares of XYZ
Corporation at a loss and purchases or sells certain options on
that position, the client is responsible for disallowing the loss
on the sale and tracking the deferred loss for future
transactions . We provide an example in the Wash Sale section
that follows .
• Brokers may not apply Section 1092 straddle rules on options
when reporting adjusted cost basis to the IRS . These straddle
rules affect your basis and holding period for stocks when you
buy and sell options on the same stocks .
– A “straddle” is any set of offsetting positions on personal
property . As an example, a straddle may consist of a
purchased option to buy (long call option) and a purchased
option to sell (long put option) on the same number of shares
of the security, with the same exercise price and expiration
date .
– The IRS only allows deductions on a loss on the disposition
of one or more positions to the extent that the loss exceeds
any unrecognized gain that a client may have on offsetting
losses . Any unrecognized losses must be deferred . Brokers
may not adjust the basis of the remaining position for the
deferred loss .
– A client who has additional questions about Section 1092
straddles should consult his or her tax advisor for more
information .
New Reporting Requirements for
Options Exercise and Assignment
If an option contract is exercised or assigned, brokers will be
required to adjust the cost basis or proceeds of the underlying
position by the option premium . Schwab currently makes this
adjustment, and there will be no change in the client experience .
Seller (Writer) Option Assigned
Buyer (Holder) Option Exercised
Call
Increase sales proceeds on sell of underlying security by option premium received
Increase cost basis on buy of underlying security by option premium paid
Put
Decrease cost basis on buy of underlying security by option premium received
Decrease sales proceeds on sell of underlying security by option premium paid
Call Example: An XYZ 95.00 call trades for $2.00. Later the
buyer exercises the call.
Call Buyer:
Cost basis of underlying stock = $9,500 + $200 option premium
paid ($2 .00 x 100 shares/contract) = $9,700 Adjusted Cost Basis
Call Seller:
Proceeds of underlying stock = $9,500 + $200 option premium
received = $9,700 Total Proceeds
Put Example: An XYZ 95.00 put trades for $4.00. Later the
buyer exercises the put.
Put Buyer:
Sales Proceeds = $9,500 – $400 option premium paid = $9,100
Total Proceeds
Put Seller:
Cost Basis of underlying stock = $9,500 – $400 option premium
received = $9,100 Adjusted Cost Basis
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NEW Reporting Requirements for Long Options Expirations
• Expired long options will show the premium amount as a negative number in the Proceeds column with a cost basis of $0 .00 .
• Realized Gain/Loss sections on the Schwab Advisor Center and schwaballiance .com/statements will also show the premium
amount as a negative number in the Proceeds column with a cost basis of $0 .00 .
• Before expiration, Unrealized Gain/Loss sections will continue to show $0 .00 in the Proceeds column and the amount of the
premium in the Cost Basis column .
Example
• Client buys 10 March calls on 3/14/2014 for $1 .05 each or a total of $1,050 .00
• The calls expire worthless on 3/21/2014 .
Schwab Advisor Center
Here is what it will look like on the Schwab Advisor Center Unrealized Gain/Loss screen:
Realized Gain/Loss sections in the Schwab Advisor Center and schwaballiance .com/statements will show the premium amount as a
negative number in the Proceeds column with a cost basis of $0 .00
Here is what it will look like on the Schwab Advisor Center Realized Gain/Loss screen:
The long option premium amount is in the Proceeds column as a negative number
Cost Basis amount is $0.00 The realized gain/loss amount remains the same
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Here is how it will look on the client’s Form 1099-B:
The Realized Gain/Loss amount is $(1,050)
The long option premium amount is in the Proceeds column as a negative number
Cost Basis amount is $0.00
Reporting Requirements for Broad-Based Index Options (Section 1256 Contracts)Schwab is also required to report on Broad-Based Index Options
acquiredonorafterJanuary1,2014.Thesearedefinedas
“non-equity options” that are marked to market under Section
1256 (i .e ., listed options on non-equity securities and broad-
based stock indexes such as the S&P 500® Index or the Russell
Index) and will be reported under the rules for regulated futures
contracts . Section 1256 contracts are taxed 60% at long-term
capital gains tax rates and 40% at short-term capital gains tax
rates . Section 1256 contracts are reported on Form 6781 and not
onForm8949.ClientswillfindreportingforBroad-BasedIndex
Options on their Form 1099-B in a new section titled Options
Subject to Section 1256 Reporting .
Schwab is required to report the following to the IRS:
• The realized gain/loss on options that were sold during the
tax year
• The unrealized gain/loss for Broad-Based Index Options
positions held open at the end of the previous tax year
• The unrealized gain/loss for Broad-Based Index Options
positions held open at the end of the current tax year
• The aggregate gain/loss on Section 1256 contracts
Please note that for tax year 2014, Schwab will report a $0 .00
amountinBox10–Unrealizedprofit/loss:Open
contracts–12/31/2013, because options purchased before
1//1/2014 are not covered . This may be different from what the
client needs to report . Below we’ve provided an example of the
reporting for Section 1256 contracts and how the aggregate
gain/loss is calculated .
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Section 1256 Reporting
The following example shows how a Section 1256 option contract is reported on the Form 1099-B:
Example
• Buy Broad-Based Index Options contract for $3 during 2014 .
• On 12/31/2014, Options contract is worth $7 .
• On 6/30/2015, sell contract for $9 .
An Options Subject to Section 1256 Reporting section was added to the end of Form 1099-B .
• This section will display if the client has options that are subject to Section 1256 reporting . An instruction page will also display
after the new section .
This amount in box 10 becomes the amount in box 9 in the next year.
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Year-End Summary Section Updates: Options
Investment Activity for Options (Year-End Summary): Description Changed to Option Symbol
• The Option symbol that is displayed comes from enhancements to our security descriptions .
Under the Realized Gain/Loss, there was a change to column headings
• DescriptionchangedtoDescriptionOROptionSymbol(optionsymbolfromItemScreenDisplayfield);DateofAcquisitionchanged
toDateAcquired;DateofSalechangedtoDateSold;CostBasischangedto(–)CostBasis;WashSaleLossDisallowedchangedto
(+)WashSaleLossDisallowed;andRealizedGain/Losschangedto(=)RealizedGain/Loss.Note:thisfollowsthesameformatas
the Form 1099-B .
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Sample Communication:
Inform Your Clients About New Tax-Reporting Requirements for Fixed Income Securities and Options
You may wish to adapt this sample communication as a letter or email to your clients . If you have enabled cost basis reporting
preferences for their accounts, your clients may have seen changes on schwaballiance .com and/or on their monthly statements
starting in August 2014 .
Please note that these sample communications are relevant only if cost basis is displayed on schwaballiance .com or your clients’
statements.Forconfirmationofyourcurrentreportingpreferences,viewyoursettingsundertheCostBasistabon
schwabadvisorcenter .com . Go to the Subscription/Status link for the applicable master account to view schwaballiance .com and
statement settings . You may also contact Client Reporting at 1-877-762-6446 or ascostbasis@schwab .com to obtain this information .
Re: IRS Rule Changes Affecting Fixed Income Securities and Options Reporting for 2014
In August 2014, Schwab made changes to the amortization settings in its cost basis system to conform to new
IRSreportingrules.Fortaxyear2014,SchwabwillreporttotheIRSadjustedcostbasisonlesscomplexfixed
income and select options securities purchased and sold in 2014 . Schwab will also include the adjusted cost
basis for these types of securities on clients’ 2014 tax reports .
In addition, the following changes will be made in November 2014:
Fixed Income Securities
• ClosedfixedincometransactionsthatoccurredinyouraccountbetweenJanuary1,2014,andAugust15,
2014willreflectthenewIRS-requiredamortizationsettings.
• ExistingtaxablebondspurchasedatapremiumwithacallfeaturewillbeupdatedtoreflecttheIRSrequired
yield amortization of Yield to Best .
Options
• Expired Long Options will show any premium amount as negative proceeds, with a cost basis of $0 .00 .
• Wash Sales will be turned off for Broad-Based Index Options (BBIO) . Any existing positions will be updated
to remove Wash Sale adjustments .
Please note that the adjusted cost basis for Fixed Income securities purchased on or after January 1, 2014, will
be reported to the IRS . The Adjusted Cost Basis for Fixed Income securities purchased before January 1, 2014,
will not be reported to the IRS .
If you have any questions or would like to schedule time to discuss these changes, please don’t hesitate to call
to set up a time to talk .
Sincerely,
[Advisor Name]
Independent investment advisors are not owned by, affiliated with, or supervised by Schwab.
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Glossary
Fixed Income
171 Election A taxpayer (a bondholder or client) instruction under Internal Revenue Code Section 171 to amortize bondpremiumonataxablefixedincomesecurity.
Accretion The process of adjusting the purchase price of a bond upward to par . The difference between the price of a bond bought below par and its par value is called the “discount .” When an investor buys a security in the secondary market at a discount (if the security was purchased below par of 100), the purchase price is adjusted upward to 100 over the remaining life of the security until it reaches par on the maturity date .
Acquisition Premium Theexcessofafixedincomesecurity’sadjustedcostbasisimmediatelyafterpurchase,includingpurchaseatoriginalissue,overthefixedincomesecurity’sadjustedissuepriceatthattime.
Amortization The process of adjusting the purchase price of a bond downward to par . The difference between the price of a bond bought above par and its par value is called the “premium .” When an investor buys a security in the secondary market at a premium (if the security was purchased above par of 100), the purchase price is adjusted downward to 100 over the remaining life of the security until it reaches par on the maturity date .
Bond Call Feature Allowstheissuertherighttoredeemthebond,underspecificconditions,priortoitsmaturitydate.
Bond Premium Amount by which your cost basis in the bond right after you buy it is more than the total of all amountspayableonthebondafteryougetit(excludingpaymentsofqualifiedstatedinterest).
Bond Put Feature Allowstheholdertoforcetheissuertorepurchasethesecurityatspecifieddatesbeforematurity.
Constant Yield A method of amortizing bond premium . The constant yield amount is calculated by multiplying the adjustedcostbasisbytheyieldtomaturityatissuanceandthensubtractingthenon-qualifiedstated interest .
Debt Instrument or Fixed Income Security
TheIRSdefines“debtinstruments”(alsoreferredtobySchwabasfixedincomesecurities)asanyinstrument or contractual arrangement that constitutes indebtedness under the general principles of federal income tax law, including notes, bonds, debentures, or other evidence of indebtedness .
De Minimus Under federal tax laws and regulations, for the discount rules to apply to a security, the discount must be at least 0 .25% of the stated redemption price for the bond at maturity, multiplied by the number of full years from the date of original issue for OID securities or purchase date for market discount to maturity . Otherwise, the discount is considered to be zero .
Fixed Income Security or Debt Instrument
TheIRSdefines“debtinstruments”(alsoreferredtobySchwabasfixedincomesecurities)asanyinstrument or contractual arrangement that constitutes indebtedness under the general principles of federal income tax law, including notes, bonds, debentures, or other evidence of indebtedness .
Market Discount The stated redemption price of a bond at maturity minus your cost basis in the bond immediately after you acquire it . Market discount arises when the value of a debt obligation decreases after its issue date .
Original Issue Discount (OID) Theamountbywhichthestatedredemptionpriceatmaturityofafixedincomesecurityismorethanits issue price .
Qualified Stated Interest Ingeneral,qualifiedstatedinterestisstatedinterestthatisunconditionallypayableincashorproperty(otherthanfixedincomesecuritiesoftheissuer)atleastannuallyoverthetermofthefixedincomesecurityatasinglefixedrate(e.g.,bondcouponpayments).
Straight Line Amortization A simple amortization method that spreads out the cost of an asset equally over its lifetime .
Yield to Best— Yield to Highest
The yield that would be realized on a callable bond if it were redeemed on the date that would result in the highest yield .
Yield to Maturity The average annual return on a bond, assuming the bond is held to maturity and all interest payments are reinvested at the same rate . The yield includes an adjustment for any premium or discount from the face value .
Yield to Worst— Yield to Lowest
The yield that would be realized on a callable bond if it were redeemed on the date that would result in the lowest known yield to the holder .
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Options
Assignment An assignment occurs when an options seller’s (writer’s) position is chosen by random lottery conducted by the Options Clearing Corporation . The options seller (writer) is contractually obligated toeitherbuyorselltheunderlyingstockattheoption’sstrikeprice;or,inthecaseofindexoptions,to provide the cash settlement value equal to the difference between the strike price and the set/settlement price .
Broad-Based Index Options Options whose value is determined by reference to a security index that contains stocks from many different industries .
Compensatory Option An option that grants an employee the right to buy shares of the company’s stock at a set price . Stock options are often included in compensation packages . Also known as incentive stock options .
Employer Stock Purchase Plan
An organized program for employees of a company to buy shares of its stock, often at a discount from the current market price .
Exercise Refers to the process whereby an option buyer (holder) converts their option position into a long or short position in the underlying security .
Expiration The date on which an option contract becomes void .
Incentive Stock Options An option that grants an employee the right to buy shares of the company’s stock at a set price . Stock options are often included in compensation packages . Also known as compensatory stock options .
Index Options Optionswhoseunderlyinginstrumentisanindexinsteadofaspecificstock.
Marked to Market The treatment of each Section 1256 contract held by a taxpayer at the close of the year as if it were sold for its fair market value on the last business day of the year .
Narrow-Based Index Options
Options contracts whose underlying instrument is an index that usually consists of fewer than 10 securities and only one industry group .
Options Standardized contracts that give the buyer the right, but not the obligation, to buy or sell a particular asset(theunderlyingsecurityforequityoptions,cashforindexoptions)atafixedpriceforaspecificperiod of time . Options contracts also obligate the seller to meet the delivery terms if the buyer exercises the contract right .
Section 1256 Contract Atypeofinvestmentdefinedasaregulatedfuturescontract,foreigncurrencycontract,Broad-Based Index Options contract, dealer equity options contract, or dealer securities futures contract .
Stock Rights Rights to subscribe to additional shares of stock at a set price, which may be offered to some or all shareholders .
Straddle The purchase or sale of an equal number of puts and calls having the same terms .
Straddle Rules Under Section 1092
Deferred recognition of losses on positions in a straddle where the taxpayer continues to hold gain positions of the straddle that were offsetting the loss positions .
Options carry a high level of risk and are not suitable for all investors. Specific requirements must be met to trade options through Schwab. Please read the options disclosure document “Characteristics and Risks of Standardized Options.”
Futures trading carries a high level of risk and is not suitable for all investors. Specific requirements must be met to trade futures. Please read “Risk Disclosure Statement for Futures and Options” before considering any futures transaction.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors.
For general informational purposes only. Meant for an institutional audience.
Schwab Advisor Services serves independent investor advisors and includes the custody, trading, and support services of Charles Schwab & Co., Inc. (“Schwab”).
Independent investment advisors are not owned by, affiliated with, or supervised by Schwab.
This general information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice and is not intended to be construed as tax advice.
This information cannot be used for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Where specific advice is necessary or appropriate, Schwab recommends consulting with a qualified tax advisor, CPA, financial planner, or investment manager.
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Questions?
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