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Cost basis reporting is a financial concept related to investment and taxtation. In 2008, the United States (US) passed a series of laws related to economic recovery in response to a lingering recession. One of these bills introduced the concept of cost basis reporting. Under cost basis reporting laws, all investment firms and brokerage houses must submit client earning reports to the Internal Revenue Service (IRS). These laws were designed to help the IRS more accurately assess tax returns, and to reduce tax losses associated with fraud or underreporting by individual taxpayers.
Through 2008, many investment brokers issued quarterly or annual statements to investors. These statements outlined gains and losses, as well as current value. While brokers were required to submit records to the IRS, these records were only expected to list the sale price of investment instruments. This made it difficult for the IRS to compare statements received from brokers with tax returns submitted by individuals. Some taxpayers took advantage of this by underreporting earnings, resulting in a lower tax payment.
In 2008, the US Congress passed the Emergency Economic Stabilization Act of 2008. This law included a clause that enacted cost basis reporting laws for all investment firms and brokerages. The bill was designed to improve the accuracy of capital gains and losses reporting. It also included provisions that would help the IRS spot short term gains from the sale of investments, which are taxed at a higher rate than long term gains.
Under cost basis reporting laws, brokerages must inform the IRS how much an investor paid for a stock, mutual fund, or other investment. The report is also required to show the sale price, as well as any stock splits or other events that influenced the price of the investment. Firms are required to follow cost basis reporting laws for stocks starting in January 2011, with reporting for mutual funds and other types of investment instruments to follow in January 2012.
Firms that fail to follow cost basis reporting standards are subject to significant fines and financial penalties. Simple errors can net fines as high as $350,000 US Dollars (USD), while fraud can result in unlimited penalties. Taxpayers who accidentally or intentionally misrepresent investment earnings also face fines and other penalties. Under cost basis reporting laws, taxpayers who make errors when reporting earnings can pay fines of up to $1,000 USD, while those who commit fraud can be fined up to $5,000 USD.