Covered Securities for Income Tax Reporting
For tax purposes, a covered security refers to any investment security for which a broker is required to report the asset's cost basis to the Internal Revenue Service and to the owner. This covers several types of stocks, notes, bonds, commodities, and mutual fund shares. Covered securities include:
- Any stock in a corporation that was acquired on or after January 1, 2011
- Any mutual fund shares that were acquired on or after January 1, 2012
- Stock in a corporation that was purchased through a dividend reinvestment plan acquired on or after January 1, 2012, and
- Notes, bonds, and commodities, as well as derivatives or contracts based on commodities, that were acquired on or after January 1, 2013
Non-covered securities are those that were acquired prior to these dates.
A Little Legislative History
The concept of covered securities was first introduced by the National Securities Market Improvement Act of 1996. It refers to classes of securities that are exempt from state regulations under federal law. Then additional legislation was passed in 2011 that required brokers to report the adjusted basis of these securities on Form 1099-B for tax purposes.
Brokers became obligated to indicate whether gains or losses realized on the sale of covered securities were short-term or long-term. Investment firms had no such reporting obligations prior to this time, and this often left taxpayers grappling to identify the underlying information necessary for filing accurate tax returns. Firms were only required to report gross proceeds before the 2011 legislation took effect.
Covered Securities and Form 1099-B
Investment brokers are first tasked with indicating whether an investment is a covered security on Form 1099-B. This is a tax document that reports the sale of stocks, bonds, mutual funds, and other investment securities. A check in box 3 of Form 1099-B indicates that the broker is reporting the cost basis to the IRS, which means that this is a covered security. The cost basis of such an asset is typically its original value plus adjustments for things like capital distributions and stock splits.
Covered Securities and Form 8949
Investment sales are also segregated into covered and noncovered securities using Form 8949. This is a tax form that itemizes details regarding the sales of stocks, bonds, and other capital investments. Form 8949 reports three subgroupings:
- Transactions of securities reported on Form 1099-B showing that basis was reported to the IRS. All covered securities get reported here. Code A is used for short-term holdings and code D is used for long-term holdings.
- Transactions of securities reported on Form 1099-B showing that basis was not reported to the IRS. Non-covered securities are usually reported here using code B for short-term holdings and code E for long-term holdings.
- Transactions not reported on Form 1099-B. These are also non-covered securities. Code C is used for short-term holdings and code F is used for long-term holdings.
Tax laws change periodically and the above information may not reflect the most recent changes. Please consult with a tax professional for the most up-to-date advice. The information contained in this article is not intended as tax advice and it is not a substitute for tax advice.