IRS requires firms to report cost basis of trades executed on behalf of clients.

Cost-basis accounting rules imposed by the Internal Revenue Service are having a far-reaching impact on broker-dealers.

The cost-basis legislation states that brokers, custodians and banks have three years to implement system upgrades to track and capture the adjusted cost-basis information for securities transactions that occur for those securities acquired on or after January 1, 2011 or form 1099-B reporting.

Historically, firms reported only the gross proceeds from sales of securities on behalf of clients, according to a white paper by SunGard. However, the accuracy of a reported gain cannot be assured or confirmed if the investment base’s starting point or cost basis is uncertain, unadjusted or unknown.

As a result, Congress in 2008 passed legislation that makes cost-basis reporting mandatory for all brokers executing transactions that involve publicly-traded securities.

Under the law, firms must track and report the cost basis of stocks, bonds, mutual funds and other securities sing choices that include the first-in, first-out method, specified lot processing or the average cost method for mutual funds, according to SunGard.

Since August 2011, Shadow Financial Systems has included new functionality that handles cost-basis accounting in its ShadowSuite real-time clearing platform. “ShadowSuite’s cost-basis functionality provides the automation that streamlines the tax reporting requirements for cost-basis accounting for these financial intermediaries,” Don Marino, CEO of Shadow Financial Systems, told Markets Media. “Cost-basis accounting represents one of the most complicated tax reporting challenges facing the industry.”

ShadowSuite is a real-time, exceptions based solution for middle and back-office post-trade multi-currency, multi-asset class and multi-entity securities processing, reconciliation, clearance, settlement, treasury and accounting, Marino said.

Many firms are focusing their energy on the back-office aspects of cost-basis reporting, but clients and the front office need attention as well, the SunGard paper noted.

“With the added complexity of cost basis rules, clients are going to need extensive help to understand the changes firms will be introducing,” said SunGard.

Questions may center on why some firms choose to report uncovered securities on 1099-B forms, yet others do not, and why some security types are showing, but others are not (e.g., equities are required for 2011, but other security types are not required until later).