[Code of Federal Regulations] [Title 26, Volume 13] [Revised as of April 1, 2004] From the U.S. Government Printing Office via GPO Access [CITE: 26CFR] [Page 256-260] TITLE 26--INTERNAL REVENUE CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY (CONTINUED) Procedure and Administration--Table of Contents Sec. 1.6045-2 Furnishing statement required with respect to certain substitute payments. (a) Requirement of furnishing statements--(1) In general. Any broker (as defined in paragraph (a)(4)(ii) of this section) that transfers securities (as defined in Sec. 1.6045-1(a)(3)) of a customer (as defined in paragraph (a)(4)(iii) of this section) for use in a short sale and receives on behalf of the customer a substitute payment (as defined in paragraph (a)(4)(i)) shall, except as otherwise provided, furnish a statement to the customer identifying such payment as being a substitute payment. (2) Special rule for transfers for broker's own use. Any broker that borrows securities of a customer for use in a short sale entered into for the broker's own account shall be deemed to have transferred the stock to itself and received on behalf of the customer any substitute payment made with respect to the transferred securities, and shall be required to furnish a statement with respect to such payments in accordance with paragraph (a)(1) of this section. (3) Special rule for furnishing statements to individual customers with respect to payments in lieu of dividends--(i) In general. Except as otherwise provided in paragraph (a)(3)(ii) of this section, for taxable years beginning before January 1, 2003, a broker that receives a substitute payment in lieu of a dividend on behalf of a customer who is an individual (``individual customer'') need not furnish a statement to the customer. (ii) Reporting for certain dividends. Any broker that receives on behalf of an individual customer a substitute payment in lieu of-- (A) An exempt-interest dividend (as defined in paragraph (a)(4)(vii) of this section); (B) A capital gain dividend (as defined in paragraph (a)(4)(vi) of this section); (C) A distribution treated as a return of capital under section 301(c)(2) or (c)(3); or (D) An FTC dividend (as defined in paragraph (a)(4)(viii) of this section) shall furnish a statement to the individual customer identifying the payment as being a substitute payment as prescribed by this section, provided that the broker has reason to know not later than the record date of the dividend payment that the payment is a substitute payment in lieu of an exempt-interest dividend, a capital gain dividend, a distribution treated as a return of capital, or an FTC dividend. (4) Meaning of terms. The following definitions apply for purposes of this section. (i) The term substitute payment means a payment in lieu of-- (A) Tax-exempt interest, to the extent that interest has accrued on the obligation for the period during which the short sale is open; (B) A dividend, the ex-dividend date for which occurs during the period after the transfer of stock for use in a short sale, and prior to the closing of the short sale; or (C) Any other item specified in a rule-related notice published in the Federal Register (provided that such items shall be subject to the rules of this section only subsequent to the time of such publication). For purposes of this section original issue discount accruing on an obligation (the interest upon which is exempt from tax under section 103) for the period during which the short sale is open shall be deemed a payment in lieu of tax-exempt interest. (ii) The term broker means both a person described in Sec. 1.6045- 1(a)(1) and a person that, in the ordinary course of a trade or business during the calendar year, loans securities owned by others. (iii) The term customer means, with respect to a transfer of securities for use in a short sale, the person that is the record owner of the securities so transferred. (iv) The term dividend means a dividend (as defined in section 316) or a distribution that is treated as a return of capital under section 301(c)(2) or (c)(3). (v) The term tax-exempt interest means interest to which the exception in section 6049 (b)(2)(B) applies. [[Page 257]] (vi) The term capital gain dividend means a capital gain dividend as defined in section 852(b)(3)(C) or section 857(b)(3)(C). (vii) The term exempt-interest dividend means an exempt-interest dividend as defined in section 852(b)(5)(A). (viii) The term FTC dividend means a dividend with respect to which the recipient is entitled to claim a foreign tax credit under section 901 (but not by virtue of taxes deemed paid under section 902 or 960). (5) Examples. The following examples illustrate the definition of a substitute payment in lieu of tax-exempt interest found in paragraph (a)(4)(i)(A) of this section. Example (1). On September 1, 1984, L, a broker, borrows 200 State Q Bonds (the interest upon which is exempt from tax under section 103) held in street name for customer R and transfers the bonds to W for use in a short sale. The bonds each have a face value of $100 and bear 12% stated annual interest paid semiannually on January 1 and July 1 of each year. The bonds were not issued with original issue discount. On November 1, 1984, W closes the short sale and returns State Q Bonds to L. On January 1, 1985, L receives a $1200 interest payment (6%x$100x200 bonds =$1200) from State Q with respect to R's bonds. Four hundred dollars (2 months the bonds were on loan/6 months in the interest period =\1/3\x$1200=$400) of the interest payment represents accrued interest on the obligations for the period during which the short sale was open and is a substitute payment in lieu of tax-exempt interest within the meaning of paragraph (a)(4)(i)(A) of this section. L must furnish a statement under paragraph (a) of this section to R for calendar year 1985 with respect to the $400 substitute payment. Example (2). Assume the same facts as in Example (1), except that W closes the short sale on February 1, 1985. On January 1, 1985, L receives a $1200 payment from W with respect to R's bonds. Eight hundred dollars (4 months the bonds were on loan prior to January 1, 1985/6 months in the interest period =\2/3\x$1200=$800) of the payment represents accrued interest on the obligation for the period during which the short sale was open and is a substitute payment in lieu of tax-exempt interest. On July 1, 1985, L receives a $1200 payment from State Q. Two hundred dollars (1 month the bonds were on loan after December 31, 1984/6 months in the interest period =\1/6\x$1200=$200) of the payment represents accrued interest on the obligation for the period during which the short sale was open and is a substitute payment in lieu of the tax-exempt interest. Because both payments are received by L in 1985, L must furnish a statement under paragraph (a) of this section to R for that year with respect to both payments. (b) Exceptions--(1) Minimal payments. No statement is required to be furnished under section 6045(d) or this section to any customer if the aggregate amount of the substitute payments received by a broker on behalf of the customer during a calendar year for which a statement must be furnished is less than $10. (2) Exempt recipients--(i) In general. A statement shall not be required to be furnished with respect to substitute payments made to a broker on behalf of-- (A) An organization exempt from taxation under section 501(a); (B) An individual retirement plan; (C) The United States, a possession of the United States, or an instrumentality or a political subdivision or a wholly-owned agency of the foregoing; (D) A State, the District of Columbia, or a political subdivision or a wholly-owned agency or instrumentality of either of the foregoing; (E) A foreign government or a political subdivision thereof; (F) An international organization; or (G) A foreign central bank of issue, as defined in Sec. 1.6049- 4(c)(1)(ii)(H), or the Bank for International Settlements. (ii) Determination of whether a person is described in paragraph (b)(2)(i) of this section. The determination of whether a person is described in paragraph (b)(2)(i) of this section shall be made in the manner provided in Sec. 1.6045-1(c)(3)(i)(B). (3) Exempt foreign persons. A statement shall not be required to be furnished with respect to substitute payments made to a broker on behalf of a person that is an exempt foreign person as described in Sec. 1.6045-1(g) (c) Form of statement. A broker shall furnish the statement required by paragraph (a) of this section on Form 1099. The statement must show the aggregate dollar amount of all substitute payments received by the broker on behalf of a customer (for which the broker is required to furnish a statement) during a calendar year, and such other information as may be required by Form 1099. A statement shall be [[Page 258]] considered to be furnished to a customer if it is mailed to the customer at the last address of the customer known to the broker. (d) Time for furnishing statements. A broker must furnish the statements required by paragraph (a) of this section for each calendar year. Such statements shall be furnished after April 30th of such calendar year but in no case before the final substitute payment for the calendar year is made, and on or before January 31 of the following calendar year. (e) When substitute payment deemed received. A Broker is deemed to have received a substitute payment on behalf of a customer when the amount is paid or deemed paid to the broker (or as it accrues in the case of original issue discount deemed a payment in lieu of tax-exempt interest). (f) Identification of customer and recordkeeping with respect to substitute payments--(1) Payments in lieu of tax-exempt interest and exempt-interest dividends. A broker that receives substitute payments in lieu of tax-exempt interest, exempt-interest dividends, or other items (to the extent specified in a rule-related notice published pursuant to paragraph (a)(4)(i)(C) of this section) on behalf of a customer and is required to furnish a statement under paragraph (a) of this section must determine the identity of the customer whose security was transferred and on whose behalf the broker received such substitute payments by specific identification of the record owner of the security so transferred. A broker must keep adequate records of the determination so made. (2) Payments in lieu of dividends other than exempt-interest dividends--(i) Requirements and methods. A broker that receives substitute payments in lieu of dividends, other than exempt-interest dividends, on behalf of a customer and is required to furnish a statement under paragraph (a) of this section must make a determination of the identity of the customer whose stock was transferred and on whose behalf such broker receives substitute payments. Such determination must be made as of the record date with respect to the dividend distribution, and must be made in a consistent manner by the broker in accordance with any of the following methods: (A) Specific identification of the record owner of the transferred stock; (B) The method of allocation and selection specified in paragraph (f)(2)(ii) of this section; or (C) Any other method, with the prior approval of the Commissioner. A broker must keep adequate records of the determination so made. (ii) Method of allocation and selection--(A) Allocation to borrowed shares and individual and nonindividual pools. With respect to each substitute payment in lieu of a dividend received by a broker, the broker must allocate the transferred shares (i.e., the shares giving rise to the substitute payment) among all shares of stock of the same class and issue as the transferred shares which were (1) borrowed by the broker, and (2) which the broker holds (or has transferred in a transaction described in paragraph (a)(1) of this section) and is authorized by its customers to transfer (including shares of stock of the same class and issue held for the broker's own account) (``loanable shares''). The broker may first allocate the transferred shares to any borrowed shares. Then to the extent that the number of transferred shares exceeds the number of borrowed shares (or if the broker does not allocate to the borrowed shares first), the broker must allocate the transferred shares between two pools, one consisting of the loanable shares of all individual customers (the ``individual pool'') and the other consisting of the loanable shares of all nonindividual customers (the ``nonindividual pool''). The transferred shares must be allocated to the individual pool in the same proportion that the number of loanable shares held by individual customers bears to the total number of loanable shares available to the broker. Similarly, the transferred shares must be allocated to the nonindividual pool in the same proportion that the number of loanable shares held by nonindividual customers bears to the total number of loanable shares available to the broker. (B) Selection of deemed transferred shares within the nonindividual pool. The broker must select which shares within the nonindividual pool are deemed [[Page 259]] transferred for use in a short sale (the ``deemed transferred shares''). Selection of deemed transferred shares may be made either by purely random lottery or on a first-in-first-out (``FIFO'') basis. (C) Selection of deemed transferred shares within the individual pool. The broker must select which shares within the individual pool are deemed transferred shares (in the manner described in the preceding paragraph) only with respect to substitute payments as to which a statement is required to be furnished under paragraph (a)(2)(ii) of this section. (3) Examples. The following examples illustrate the identification of customer rules of paragraph (f)(2): Example (1). A, a broker, holds X corporation common stock (of which there is only a single class) in street name for five customers: C, a corporation; D, a partnership; E, a corporation; F, an individual; and G, a corporation. C owns 100 shares of X stock, D owns 50 shares of X stock, E owns 100 shares of X stock, F owns 50 shares of X stock, and G owns 100 shares of X stock. A is authorized to loan all of the X stock of C, D, E, and F. G, however, has not authorized A to loan its X stocks. A does not hold any X stock in its trading account nor has A borrowed any X stock from another broker. A transfers 150 shares of X stock to H for use in a short sale on July 1, 1985. A dividend of $2 per share is declared with respect to X stock on August 1, 1985, payable to the owners of record as of August 15, 1985 (the ``record'' date). A receives $2 per transferred share as a payment in lieu of a dividend with respect to X stock or a total of $300 on September 15, 1985. H closes the short sale and returns X stock to A on January 2, 1986. A's records specifically identify the owner of each loanable share of stock held in street name. From A's records it is determined that the shares transferred to H consisted of 100 shares owned by C, 25 shares owned by D, and 25 shares owned by F. The substitute payment in lieu of dividends with respect to X stock is therefore attributed to C, D and F based on the actual number of their shares that were transferred to H. Accordingly, C receives $200 (100 shares x $2 per share), and D and F each receive $50 (25 shares each x $2 per share). A must furnish statements identifying the payments as being in lieu of dividends to both C and D, unless they are exempt recipients as defined in paragraph (b)(2) of this section or exempt foreign persons as defined in paragraph (b)(3) of this section. Assuming that A had no reason to know on the record date of the payment that the dividend paid by X is of a type described in paragraphs (a)(3)(ii)(A) through (D) of this section, A need not furnish F with a statement under section 6045(d) because F is an individual. (However, A may be required to furnish F with a statement in accordance with section 6042 and the regulations thereunder. See paragraph (h) of this section.) By recording the ownership of each share transferred to H, A has complied with the identification requirement of paragraph (f)(2) of this section. Example (2). Assume the same facts as in example (1), except that A's records do not specifically identify the record owner of each share of stock. Rather, all shares of X stock held in street name are pooled together. When A receives the $2 per share payment in lieu of a dividend, A determines the identity of the customers to which the payment relates by the method of allocation and selection prescribed in paragraph (f)(2)(ii) of this section. First, the transferred shares are allocated proportionately between the individual pool and the nonindividual pool. One-sixth of the transferred shares or 25 shares are allocated to the individual pool (50 loanable shares owned by individuals/300 total loanable shares-\1/6\; \1/6\x150 transferred shares=25 shares). Assuming A has no reason to know by the record date of the payment that the payment is in lieu of a dividend of a type described in paragraphs (a)(3)(ii)(A) through (D) of this section, no selection of deemed transferred shares within the individual customer pool is required. (However, A may be required to furnish F with a statement under section 6042 and the regulations thereunder. See paragraph (h) of this section.) Five-sixths of the transferred shares or 125 shares are allocated to the nonindividual pool (250 loanable shares owned by nonindividuals/300 total loanable shares=\5/6\; \5/6\x150 transferred shares=125 shares). A must select which 125 shares within the nonindividual pool are deemed to have been transferred. Using a purely random lottery, A selects 100 shares identified as being owned by C, and 25 shares identified as being owned by D. Accordingly, A is deemed to have transferred 100 shares and 25 shares owned by C and D respectively, and received substitute payments in lieu of dividends of $200 (100 shares x $2 per share) and $50 (25 shares x $2 per share) on behalf of C and D respectively. A must furnish statements to both C and D identifying such payments as being in lieu of dividends unless they are exempt recipients as defined in paragraph (b) (2) of this section or exempt foreign persons as defined in paragraph (b) (3) of this section. A has complied with the identification requirement of paragraph (f)(2) of this section. (g) Reporting by brokers--(1) Requirement of reporting. Any broker required to furnish a statement under paragraph (a) of this section shall report on Form 1096 showing such information as may [[Page 260]] be required by Form 1096, in the form, manner, and number of copies required by Form 1096. With respect to each customer for which a broker is required to furnish a statement, the broker shall make a return of information on Form 1099, in the form, manner and number of copies required by Form 1099. (2) Use of magnetic media. For information returns filed after December 31, 1996, see Sec. 301.6011-2 of this chapter for rules relating to filing information returns on magnetic media and for rules relating to waivers granted for undue hardship. A broker or barter exchange that fails to file a Form 1099 on magnetic media, when required, may be subject to a penalty under section 6721 for each such failure. See paragraph (g)(4) of this section. (3) Time and place of filing. The returns required under this paragraph (g) for any calendar year shall be filed after September 30 of such year, but not before the final substitute payment for the year is received by the broker, and on or before February 28 (March 31 if filed electronically) of the following year with any of the Internal Revenue Service Centers, the addresses of which are listed in the instructions for Form 1096. (4) Cross-reference to penalties. For provisions relating to the penalty provided for failure to file timely a correct information return required under section 6045(d) and Sec. 1.6045-2(g)(1), including a failure to file on magnetic media, see Sec. 301.6721-1 of this chapter. For provisions relating to the penalty provided for failure to furnish timely a correct payee statement required under section 6045(d) and Sec. 1.6045-2(a), see Sec. 301.6722-1 of this chapter. See Sec. 301.6724-1 of this chapter for the waiver of a penalty if the failure is due to reasonable cause and is not due to willful neglect. (h) Coordination with section 6042. In cases in which reporting is required by both sections 6042 and 6045(d) with respect to the same substitute payment in lieu of a dividend, the provisions of section 6045(d) control, and no report or statement under section 6042 need be made. If reporting is not required under section 6045(d) with respect to a substitute payment in lieu of a dividend, a report under section 6042 must be made if required in accordance with the rules of section 6042 and the regulations thereunder. Thus, if a broker receives a substitute payment in lieu of a dividend on behalf of an individual customer and the broker does not have reason to know by the record date of the payment that the payment is in lieu of a dividend of a type described in paragraphs (a)(3)(ii)(A) through (D) of this section, the broker must report with respect to the substitute payment if required in accordance with section 6042 and the regulations thereunder. (i) Effective date. These regulations apply to substitute payments received by a broker after December 31, 1984. With regard to paragraph (g)(2) of this section, see section 6011(e) of the Internal Revenue Code for information returns required to be filed after December 31, 1989, and before January 1, 1997; and see paragraph (g)(2) of this section for information returns required to be filed after December 31, 1996. [T.D. 8029, 50 FR 23677, June 5, 1985, as amended by T.D. 8683, 61 FR 53060, Oct. 10, 1996; T.D. 8734, 62 FR 53480, Oct. 14, 1997; T.D. 8770, 63 FR 35519, June 30, 1998; T.D. 8895, 65 FR 50407, Aug. 18, 2000; T.D. 9010, 67 FR 48758, July 26, 2002; T.D. 9103, 68 FR 74848, Dec. 29, 2003]