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Each year, mutual funds and brokerage firms are required to provide the federal government with information, for tax-reporting purposes, pertaining to the sale of securities, including shares of mutual funds. Investors, in turn, are required to report whether a gain or loss was incurred as a result of the sale of the securities.
To date, the responsibility of determining gains or losses resulting from the sale of a security has fallen on the shoulders of the investor—a particularly challenging task because it requires computing the adjusted cost basis of the security (i.e., the amount the investor paid to purchase fund shares adjusted by certain items, such as a tax return of capital or wash sale), gain or loss, and holding period. In October 2008, Congress included mandatory cost-basis reporting by mutual funds and brokerage firms as part of the Emergency Economic Stabilization Act of 2008.
Impact on Shareholders
This change in the tax law requires us to report to both to shareholders and the IRS the cost basis of any mutual fund shares sold during the year. The rule applies to the sale of any shares acquired from January 1, 2012, onward (covered shares). The cost-basis information, which will appear on an investor's year-end tax Form 1099-B, must be used to calculate the gains, losses, and associated income tax on sales of mutual fund shares purchased after January 1, 2012. Lord Abbett shareholders have the ability to designate specific shares to sell or apply one of six cost-basis methods to determine their tax liability:
A shareholder's calculated cost basis may differ depending on the methodology used.
The previous reporting rules still apply to sales of shares purchased prior to January 1, 2012 (noncovered shares). This means that shareholders are responsible for computing and reporting the cost basis to the IRS. However, as a service, we will continue to provide shareholders (not the IRS) with the average cost basis on noncovered shares. Shareholders have the option of using this formulation or another IRS approved method.
The method selected applies only to covered shares. Regardless of the method designated for an account, noncovered shares will always be sold first. Once all noncovered shares are sold, covered shares will be sold in accordance with the designated cost-basis method. If a shareholder prefers to sell covered shares prior to noncovered shares, he or she may do so by specifically identifying shares to sell. To the extent a shareholder takes this approach, Lord Abbett can no longer provide the average cost basis on noncovered shares.
Shareholders should continue to report to the IRS in the same way they have in the past. What's changed is that Lord Abbett is now required to report cost basis to the shareholder and the IRS on covered shares. The reporting of noncovered shares has not changed. See diagram below:
Which Method Should a Shareholder Choose?
The method a shareholder should select depends on each individual's tax situation. We apply the average cost method on both covered and noncovered shares. We believe the average cost method is easy to understand, and we wanted to maintain a consistent approach in methods. However, shareholders can log into their account to estimate the cost basis and resulting gains or losses on a transaction using different methods, and then select their method choice. Once a method is selected and the transaction is submitted, a shareholder may no longer change the method used for that specific transaction. One may, however, change methods for future transactions. Mandatory cost-basis reporting allows shareholders to communicate preferred method of redeeming covered shares and requires us to compute cost basis on their behalf. This provides shareholders with additional options, but with no additional burden.
Additional Questions on Cost Basis?
If you or your clients have additional questions on cost basis, visit our Frequently Asked Questions area focused specifically on cost basis – many common questions are addressed there. If you find you still have questions, please feel free to contact us at 888-522-2388.