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NOVEMBER 2010 Six Noteworthy Changes Issued in the Final Cost Basis Regulations On October 12, 2010, the Internal Revenue Service (IRS) issued final regulations for the cost basis reporting requirements. As you may have read in our previously published educational guides, these requirements are scheduled to be phased in over a three-year period, beginning on January 1, 2011. Although the final regulations are largely similar to the proposed regulations, there are six changes that may impact your firm and your investors. 1. Clarification for when certain types of securities are considered covered The final regulations clarify the timing of coverage for unit investment trusts (UITs), real estate investment trusts (REITs), and exchange-traded funds (ETFs). Essentially, these three types of securities are considered shares of stock in a corporation and thus considered covered securities beginning in 2011. While Fidelity and industry participants recognize that instances arise when ETFs are also considered registered investment companies (RICs), which are eligible for average cost and covered in 2012, we plan to take a conservative position by classifying all ETFs as shares of stock in a corporation and considering them as covered securities beginning on January 1, 2011. 2. No requirement for brokers to offer standing instructions for client accounts The final regulations clarify that although it is allowable, it is not required for brokers to accept standing instructions for alternative cost basis disposal methods (ADMs) for client accounts. While the rules ease platform enhancements for brokers, Fidelity is moving forward with its plans to offer multiple disposition methods for your client accounts, including the following listed below: • Highest Cost • Highest Cost Long-Term • Highest Cost Short-Term • Last In, First Out • Lowest Cost • Lowest Cost Long-Term • Lowest Cost Short-Term • Tax Sensitive Highest Cost is currently available for all client accounts. If you would like to establish this method for accounts that you manage, please contact your Fidelity Client Service Team for instructions. The rollout of the remaining seven methods is scheduled for mid-December. Upcoming Fidelity cost basis operational guides will provide you with further information about establishing these ADMs for your client accounts. 3. Simplified requirements for average cost elections Beginning on January 1, 2011, an average cost election is no longer binding: i.e., taxpayers will no longer be required to obtain written approval from the IRS to change a client account from average cost to another depletion method. Further, the final regulations provide the following rules on how to convert these positions: • If the investor has not sold or transferred the position in the account, then the broker will simply use the basis of the actual purchase when determining the new cost for the security. • If a sale or transfer in the security has occurred, then all existing lots maintain their acquisition date, but each lot takes on cost basis equal to the average cost. Going forward, the basis in any new lots captured in the account will be the actual basis for the lot. 4. New process for determining cost basis for inherited securities The final regulations now require brokers to apply fair market value (FMV) as of the date of death to inherited securities when determining the cost basis for assets transferring from a decedent account. This change makes the transfer process for securities much simpler than the process originally outlined in the proposed regulations. The proposed regulations stated that upon the transfer of assets from a decedent account, brokers would need to proactively reach out to an authorized representative of the account to obtain the updated cost basis for the position, prior to the asset transfer. Industry groups collectively commented to the IRS that this process would place an undue burden on all parties involved and delay the transfer process. Fidelity is pleased to report a favorable change from the IRS on this particular topic. 5. Stringent rules for reporting gifted securities Although the industry requested simplified rules from the IRS, the final regulations continue to require brokers to capture and maintain both the carryover basis (i.e., the donor’s cost basis) and the FMV as of the date of the gift. At the time of the sale, the broker will then evaluate which form of basis to use based on specific IRS rules for gifted securities. 6. Penalty relief for transfers with missing cost basis The final regulations provide penalty relief for transferors through 2011. Essentially, between January 1, 2011 and December 31, 2011, brokers who are not prepared to send cost basis with asset transfers will not incur IRS penalties. In these situations, receiving brokers of transferred assets without cost basis may classify these securities as uncovered. The delivering firm is not under any obligation to transfer updated basis on these positions once their systems are compliant to adhere to the regulations. In instances where positions are transferred without cost basis, advisors may update the cost basis directly through the Fidelity Advisor CHANNEL® website or Fidelity WealthCentral®. Access our resources to learn more Fidelity is committed to providing your firm with ongoing education and support to help you adapt to these new reporting requirements. We have created several resources for principals, compliance, operations and client facing personnel to help you understand these new rules, implement any necessary operational changes, and communicate their impact to your clients. Go to Fidelity’s Cost Basis Resource Center at www.fiws.fidelity.com/costbasis to download our guides and webinars, including a replay of Fidelity’s Special Edition Insight & Outlook Final Cost Basis Reporting Regulations call held October 27, 2010, or contact your Fidelity Relationship Manager for more information. For Investment Professional use only. Not for distribution to the public as sales material in any form. Fidelity Investments is providing this Information as a service to your firm. You are responsible for evaluating you own practice and making appropriate decisions for your firm. Those decisions may be based on these and other factors you deem relevant. This article is not meant to be exhaustive of all possible options you may consider. Fidelity Investments is not responsible for your action or inaction as a result of this service. The information contained above is general in nature, is provided for informational purposes only and should not be construed as legal or tax advice. Fidelity investments does not provide legal or tax advice. Fidelity Investments cannot guarantee that such information is accurate, complete or timely. Laws of a particular state or laws which may be application to a particular situation may have an impact on the applicability, accuracy or completeness of this information. 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