Notice 2011-56

A stakeholder suggested that, when a taxpayer changes from a broker’s default average basis method to the cost basis method, the basis of the shares should revert to the cost basis under certain circumstances.

Section 6045(g)(2)(B)(i)(II) provides that, for purposes of broker reporting, the adjusted basis of RIC or DRP stock is determined by a broker’s default method unless a taxpayer elects another method. Section 1.1012-1(e)(2)(i) provides that, unless a taxpayer elects another method, the basis of RIC or DRP stock is determined by the broker’s default method.

Section 1.1012-1(e)(9)(i) provides that, beginning in 2012, a taxpayer elects the average basis method by notifying a broker in writing. Under § 1.1012-1(e)(9)(iii), a taxpayer that wants to revoke its average basis method election must revoke the election within one year after making the election or, if earlier, by the date of the first disposition of the stock. A broker may extend the one-year period but not beyond the first disposition of the stock. After a revocation, the basis of the stock reverts to the cost basis.

After the revocation period has expired, a taxpayer may change from the average basis method to the cost method at any time, but only for stock acquired after the date of the change (the change is prospective). After the change, the basis of the stock that was averaged remains averaged. Section 1.1012-1(e)(9)(iv).

Section 1.1012-1(e)(9)(i) provides that a taxpayer has not made a basis election if (1) the taxpayer fails to choose a basis determination method, and (2) basis is determined by a broker’s default method. Section 1.1012-1(e)(9)(v), Example 2, illustrates that, because averaging under a broker’s default method is not a taxpayer’s election, a taxpayer’s change from a broker’s default averaging method to the cost method is prospective and stock acquired before the change retains the averaged basis.

To provide consistency between revoking a taxpayer’s average basis election and changing from a broker’s default average basis method, the proposed regulations are expected to provide that, when a taxpayer changes from a broker’s default averaging method for RIC or DRP stock to the cost basis method, the basis of the stock reverts to the cost basis if the taxpayer requests the change by the earlier of (1) one year after receiving notice of the broker’s default method, or (2) the date of the first sale, transfer, or other disposition of the stock. A broker may extend the one-year period, but not later than the date of the first sale, transfer, or disposition of the stock.

To determine the beginning of the one-year period, a broker using the average basis method as a default method must use reasonable means to notify taxpayers. Reasonable means may be mailings, circulars, or electronic mail sent separately or included in a taxpayer’s account statement, or other means reasonably calculated to provide actual notice. The notice must identify the securities subject to the broker’s default average basis method.

Under § 1012(d)(4)(A), a DRP is an arrangement under which dividends are reinvested in identical stock. Section 1.1012-1(e)(6)(i) provides that a plan, arrangement, or program qualifies as a DRP if the written plan documents require that at least 10 percent of every dividend on any share of stock is reinvested in identical stock.

A stakeholder asked if a plan that pays only cash in lieu of fractional shares meets the 10 percent requirement if the dividends on some shareholders’ stock are insufficient to acquire at least one whole share of identical stock. For example, if a shareholder in a plan receives a dividend of $30.00 but the price of one share of stock exceeds $30.00, the shareholder will not be able to reinvest 10 percent and will receive the dividend in cash.

It is expected that the proposed regulations will clarify that a DRP does not fail the 10 percent reinvestment requirement because it pays cash in lieu of fractional shares when the amount of a dividend is insufficient for some shareholders to acquire stock.

Section 1012(c)(1) provides that the “conventions” prescribed in the § 1012 regulations apply to stock disposed of after certain dates on an account-by-account basis. The legislative history identifies these “conventions” as first-in, first-out (FIFO), specific identification, and average basis. H. Rep. No. 606, 110^th Cong., 2d Sess. 62 (2008). However, § 1.1012-1(e) provides account-by-account rules only for averaged stock. The proposed regulations are expected to clarify that the lot selection methods, such as FIFO and specific identification, also apply on an account-by-account basis.