In T.D. 9750, the IRS has issued final regulations on information reporting by brokers for transactions involving debt instruments and options under Sections 6045, 6045A and 6049. The regulations update the rules on reporting market discount, require brokers to report original issue discount (OID) on tax-exempt obligations, and provide relief for brokers who must perform basis reporting for tax-exempt and foreign obligations where the necessary information is not readily available. These final regulations finalize and modify, in part, rules issued in 2013 and 2015.

Background

Section 6045, as amended in 2008, provides that, when a customer of a broker sells securities and the broker reports the gross proceeds on Form 1099-B, in certain cases, the broker must also report the adjusted basis of the securities that were sold. To assist brokers, Section 6045A requires that a broker who transfers customer securities to another broker must provide a "transfer statement" with information to help the receiving broker compute adjusted basis. Section 6049 generally requires brokers to report payments of interest (including tax-exempt interest) and accruals of OID on debt instruments, but the IRS historically did not require brokers to report accruals of OID on tax-exempt obligations.

In March 2015, the IRS issued new final, temporary and proposed regulations under Sections 6045, 6045A and 6049. Primarily, the 2015 temporary and proposed regulations included changes to how brokers were to compute accruals of market discount and required brokers to commence reporting of OID on tax-exempt obligations under Section 6049. See Tax Alert 2015-558 for a discussion of the 2015 final, temporary and proposed regulations.

2016 regulations

Constant yield election for market discount

When basis reporting was extended to certain debt instruments, the regulations required brokers to report the market discount that accrued while the seller held the instrument. The rules originally required brokers to assume that taxpayers had elected to accrue market discount on a straight-line basis (which is the default rule under substantive law) unless the customer notified the broker that the customer had elected under Section 1276(b)(2) to accrue market discount on a constant yield basis. The Section 1276(b)(2) election is generally more advantageous, and one would expect that well-informed customers would make it.

The 2015 temporary regulations stated that, for debt instruments acquired on or after January 1, 2015, brokers must assume that a customer will elect to compute accrued market discount using the constant yield method unless the customer notifies the broker otherwise. The 2016 final regulations generally adopt this rule. In response to comments, the final regulations also permit, but do not require, a broker to apply the default constant yield method to a debt instrument acquired on or after January 1, 2014, and before January 1, 2015 — provided the broker was not informed that the customer had made a Section 1278(b) election to include market discount in income currently and there were no principal payments on the debt instrument during the 2014 calendar year.

Transfer statement reporting for "nonequity options"

Options over equities, including listed options, acquired after 2013 are in scope for basis reporting. Listed options over certain broad-based equity indices are marked to market at the end of every year under Section 1256 (Section 1256 options). Commenters pointed out that since a prior marking to market would affect the customer's basis, transferee brokers needed transfer statements for Section 1256 options.

The 2015 temporary and proposed regulations extended transfer reporting to transfers of Section 1256 options that occur on or after January 1, 2016, and listed the data specific to Section 1256 options that must be reported. The 2016 final regulations adopt these rules without substantive change. These final regulations apply to a transfer of a Section 1256 option that occurs on or after January 1, 2016.

Reporting of OID on tax-exempt obligations

The 2015 temporary regulations specified that a payor must report accruals of OID and acquisition premium on tax-exempt obligations acquired on or after January 1, 2017. The 2016 final regulations adopt this rule.

However, for instruments acquired before 2017, this same information was not permitted to be reported, even though it was necessary for basis reporting on Form 1099-B beginning in 2014. This left a gap where if a customer purchased an instrument in 2014, 2015 or 2016, he or she would receive a Form 1099-B that takes into account OID and acquisition premium on a tax-exempt obligation in computing basis, but would receive a 1099-OID omitting those items. On the other hand, if the instrument was acquired in 2017 or later, both the Form 1099-B and 1099-OID would take into account OID and acquisition premium. As a result, in response to comments, for tax years beginning after December 31, 2016, the final regulations provide that a broker may, but is not required to, report OID and acquisition premium for a tax-exempt obligation acquired before January 1, 2017, that is within the scope for basis reporting.

Treatment of certain debt instruments with information not readily available

Brokers must report basis for simple debt instruments acquired after 2013. For certain complex debt instruments (e.g., contingent payment debt instruments and debt instruments issued by non-US issuers), basis reporting is required only for debt instruments acquired on or after January 1, 2016. Certain commenters expressed concerns that brokers may not have the information necessary to comply with the information reporting rules for some of these "complex" instruments.

The IRS agreed that brokers may not always be able to obtain the necessary information in the case of two types of debt instruments: (1) tax-exempt obligations issued before 2014 and (2) those issued by non-US issuers. Accordingly, the final regulations state that these two types of instruments will be treated as non-covered securities (that is, not subject to basis reporting under Section 6045) if the terms of the debt instrument are not reasonably available to the broker within 90 days of the date the debt instrument was acquired by the customer. Presumably, a broker would have to show that it made a reasonable attempt to acquire the necessary information but was not successful.

This rule applies to debt instruments acquired on or after February 18, 2016, but may be relied upon for debt instruments acquired prior to that date.

Implications

The 2016 final regulations, once again, indicate the IRS's willingness to listen to comments in the basis reporting space. The changes to the market discount rules are sensible, because they align Form 1099 reporting of market discount with the elections that a well-informed investor would make and allow brokers generally to apply such changes to debt instruments acquired during 2014. The relief from basis reporting when the necessary information is not readily available is helpful, although not as broad as some might have wished.

Other than the relief granted for certain foreign currency debt instruments, the 2016 final regulations do not provide relief or guidance regarding complex debt instruments, which generally are subject to basis reporting if acquired on or after January 1, 2016. There are many unresolved complexities with complex debt instruments, notably with respect to foreign currency denominated debt, contingent payment debt instruments and reverse exchangeable securities. Accordingly, brokers must still grapple with many of these issues.

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