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What are the top 6 broker tax reporting issues for 2021?

Nelson Suit
Nelson Suit
Tax Compliance Officer

For tax reporting professionals, the year-end is often busy as operations teams ramp up for the Form 1099 and Form 1042-S filing season that begins at the start of the new year. However, consideration should also be given to significant tax developments that may occur in the coming year that could impact the tax reporting function.

  1. Even as tax reporting season begins in earnest, thought should be given to intermediate and longer-term issues that may affect a broker’s tax reporting function.
  2. Among issues to monitor for the coming year are rules relating to broker withholding and reporting on sales of publicly traded partnerships, tax information reporting for crypto assets, and tax changes that may come with a new administration in Washington.
  3. Brokers should also be aware of coming tax form changes and changes that may impact tax information reporting for IRAs and pensions.

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A number of tax reporting issues has the potential to significantly affect broker tax withholding and reporting functions in 2021. We list below the top six issues that we are monitoring.

1. Broker withholding and reporting on PTP transfers

The IRS issued final section 1446(f) regulations in October 2020, which will require brokers to withhold on transfers of publicly traded partnership (PTP) interests by non-U.S. persons. Withholding is generally on 10 percent of proceeds from sale, unless one of several exceptions apply. These regulations are effective for transfers occurring on or after 1 January, 2022.

These regulations mean that brokers who handle PTP trades will need to assess and update their due diligence processes and withholding and tax reporting systems to accommodate PTP trades.

The systems will also need to be adjusted for distributions from PTPs because certain distributions can also be subject to these withholding rules. Updates to systems and processes will need to occur during 2021, so that they are ready for trades made in 2022.

Due diligence processes will need to account for documentation from other brokers that may be facilitating PTP trades, as well as documentation from customers that may be modified due to the section 1446(f) regulations. Intermediary and non-U.S. partnership accounts will be most impacted.

Withholding systems will need to distinguish PTP trades from trades of other securities and determine appropriate tax withholding based on payee tax profile and the applicability of withholding exceptions allowed under the section 1446(f) regulations. Such determinations may require looking at treaty eligibility or qualified notices issued by PTPs.

Tax reporting on Form 1042-S will be required on PTP transfers subject to section 1446(f). It’s important to note that portions of distributions from PTPs may be subject to withholding under current section 1446(a), and other portions (e.g., return of capital amounts) may be subject to section 1446(f) withholding. And the tax rates for each are different.

Readying systems to be section 1446(f)-compliant will require significant efforts and monitoring in 2021.

Refinitiv Maxit, the industry’s only end-to-end tax information reporting solution, allows firms to focus on their core business without the cost and distraction of managing multiple vendors and large operations teams

2. Accommodating new Form W-8 updates

Largely due to section 1446(f) regulations, tax forms within the Form W-8 series are expected to be updated in the coming year. In particular, updates are expected to Form W-8IMY and instructions, but may extend to Form W-8ECI and Form W-8BEN-E instructions and/or forms.

Moreover, proposed regulations relating to the qualified foreign pension exemption to section 1445 withholding issued last year may mean an update to Form W-8EXP form and instructions as well.

Due diligence systems will need to be updated to handle validation of updated Forms W-8 and/or instructions. This is a critical aspect for accurate withholding and tax reporting because proper validation of tax certificates provide the tax profile used to determine tax withholding and the necessary recipient and exemption codes utilized ultimately for tax reporting.

3. Crypto tax reporting

As revealed in a recent TIGTA report, there is a recognition that third-party tax information reporting is a key piece in the IRS’s enforcement effort to have taxpayers comply with virtual currency taxes. The IRS Priority Guidance Plan for 2020-21 includes, as it did last year, a regulatory project under section 6045 on tax reporting for virtual currencies.

Brokers facilitating crypto trading will need to monitor developments in this regard because it may require systems changes and enhancements to accommodate new tax reporting rules. In the meantime, such brokers will need to make their own determinations as to appropriate tax reporting based on their own circumstances.

4. Section 871(m) guidance

Early this year, Notice 2020-2 extended the transition relief for section 871(m) regulations for another two years. Transition rules, which generally exclude non-delta one transactions from the application of section 871(m) provisions, apply though the end of 2022.

Between now and the beginning of 2023, brokers and other withholding agents will need to assess systems capability to handle non-delta one derivative transactions. Further guidance is expected from the IRS in the meantime on some of the more complicated aspects in the application of these rules.

We continue to monitor developments in section 871(m) for 2021 because any such guidance will inform systems changes that may need to be made prior to the end of the transition period in 2022.

5. IRA-related reporting

The CARES Act passed earlier in 2020 contains several tax provisions that could affect withholding and reporting for retirement plans. In particular, the act allows a penalty-free early withdrawal from retirement arrangements and tax-free rollovers of these withdrawals over three years. Likely impacts are to Form 1099-R and Form 5498 reporting.

Moreover, the SECURE Act passed at the end of 2019 may continue to have an impact. The adjusted RMD requirements that were waived in 2020 due to the CARES Act will come into play again in 2021.

Also, the SECURE Act had contained a penalty-free withdrawal provision for qualified birth and adoption events that, like the COVID-related withdrawal provisions of the CARES Act, allow for re-contribution at a later time.

6. New tax law changes

With a new administration in Washington in January, new tax law proposals will likely emerge. While it is still uncertain at this point which party will control the U.S. Senate in 2021 and whether administration tax proposals may come to fruition, such proposals will need to be monitored.

Among tax proposals advanced by President-Elect Biden during the campaign that may affect brokers and investors are the following: Taxation of long-term capital gains and dividends at ordinary income rates for taxpayers with income greater than $1 million; phasing out of the section 199A deduction for filers with income greater than $400,000; and taxing carried interest from partnerships at ordinary income tax rates.

Refinitiv Maxit, the industry’s only end-to-end tax information reporting solution, allows firms to focus on their core business without the cost and distraction of managing multiple vendors and large operations teams

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