This document is designed to provide guidance with some of the fundamental processes

and procedures affecting the cost basis of investments.

Cost

Basis Procedures at Schwab

2

Contents

Overview of Cost Basis Regulations……………………...……. 2

Cost Method Selection………………………………………….…… 2

Lot instruction deadlines ................................................... 2

Reconciling data ................................................................. 3

Lot mismatch ...................................................................... 4

Missing cost basis on form 1099 ....................................... 5

Cost basis edits .................................................................. 5

Transferring cost basis ....................................................... 6

Step up cost basis to date of death .................................. 7

Gifting.................................................................................. 8

Return of capital ................................................................. 8

Cash/stock mergers—368(a) .............................................. 9

Cash in lieu (CIL) of fractional shares ............................... 9

Wash sales and disallowed losses ................................. 10

Closing a Short Position Reporting Requirements……….11

Options exercises and assignments................................ 12

3

Overview of Cost Basis Regulations

The Emergency Economic Stabilization Act of 2008 was created to ensure that investors

accurately report investment gains and losses in their annual tax filings. To achieve this

objective, custodians and brokers are required to report the adjusted cost basis of

covered securities (including whether the gain or loss is short or long term) to taxpayers

and the IRS on Form 1099-B.

Cost basis reporting effective dates by security type

Accounting Method Selection Use the Cost Basis Enrollment and Preferences Form to provide accounting

methods selections. Please note that new accounting methods take effect on a

going-forward basis only. Existing Charles Schwab accounts linked to your firm’s

master account will retain their previously selected accounting methods. To change

the accounting methods on these accounts, please submit a new Cost Basis

Enrollment and Preferences Form.

Lot instruction deadlines The Advisor has the option to provide specific lot instructions as opposed to using the

default cost basis method on account. Lots can be specified online through web trading

for equities and mutual funds or by completing the Cost Basis Lot Specification Form.

Trades • Complete online through web trading.

• Upload instructions with the trade file.

At time of trade or post-trade prior to

settlement date

Gifts* • Include instructions on the Charitable Gift Transfer LOA form. At time of gift

* Lots cannot be specified for mutual funds if the cost basis is being averaged.

The Tax Lot Optimizer™ option only applies to sells; any other disposition of shares, including transfers or journals, will use the High-Cost method.

Type How to specify lots Deadline

Journals* • Attach instructions to the Check and Journal Request form. At time of journal

• Lot instructions must be received by your Service Team no later

than the same day the request was processed.

Transfers* • Use the gifting form.

• Include instructions with the Letter of Authorization for

transfer outside Schwab.

At time of transfer request

4

Reconciling data Advisors should reconcile daily to ensure that the firm data and Schwab data are in sync. If a

portfolio management system (PMS) is being used, a tool may be available to automatically

reconcile the two data sources. Reconciling data can also be performed manually by using

Excel. Schwab is working with various PMS providers to incorporate this functionality into the

application. Fixed income positions should be reconciled against original cost basis, not

current cost, which could be adjusted due to amortization/accretion.

• PortfolioCenter®1—PortfolioCenter will use the Daily UGL file at the lot level for taxable

accounts. Position- level data will continue to be provided as it is today. PortfolioCenter

has added a new reconciliation report to help advisors reconcile between PortfolioCenter

and Schwab. The output from PortfolioCenter is a report showing any discrepancies between

Schwab and your firm’s data. Please see the PortfolioCenter website for more details.

• Axys2—Advent Axys will use the Daily UGL position file for taxable accounts to post and

reconcile cost basis. Please see the Advent website for more details.

• Other PMS vendors—Schwab has provided file specifications to third-party PMS

vendors. Contact your vendor for specifics on how to reconcile data files.

• Excel—Although advisors cannot view the cost basis data files in the existing

SchwabLink®Desktop or Schwab Data Delivery® viewers, they will be able to view

these files in Excel.

To open cost basis files in Excel, take the following steps:

1. Open Excel.

2. Select “Open.”

3. Select “All Files” from the Files of Type drop-down.

4. Navigate to the folder where download files are stored and select a file to open.

5. In the Text Import Wizard, select “Delimited” for the Original File Type.

6. In step 2 of the Text Import Wizard, select “Other” for the Delimiter and enter a

pipe character ( | ).

7. Click “Finish.”

Please note: Excel will automatically drop zeroes from numeric values. Additional

column formatting will be needed in order to line up decimals for dollar amounts or

other variables.

View detailed file specifications on the Schwab resource page.

Once the data files have been downloaded, review the cost basis details to verify the

cost basis instructions submitted were processed.

5

Lot mismatch If specified lots are not available or not received after settlement date, a Cost Basis Lot

Instructions Alert will be generated which will indicate that the account’s default

accounting cost basis method was used to fulfill the sell.

This alert may be received under two circumstances:

• Partial match: If a portion of the specified lots do not match Schwab’s records, an

alert will be generated providing information of a partial match. In this case, Schwab

will apply the lots able to be matched first, and then apply the remainder using the

account’s default cost basis method.

• No match: If we cannot match lots to the lot instructions provided, the alert will

indicate that we could not match the lot instructions. Because we could not identify

the lots specified, we will use the account’s default cost basis method to fulfill the sell

instead.

Lot instructions can be adjusted as long as it is communicated to us before the

settlement date of the trade.

If you would like Schwab to adjust the lots prior to the settlement date:

1. Log in to Schwab Advisor Center® and launch web trading.

2. Find trade in the Order Status via the Trading tab.

3. Highlight the order.

4. Click the Specify Lots button. This will launch an overlay that will allow the advisor

to add or edit lot instructions.

5. Use the Specified Lot Trading functionality to submit the lot specification.

Alternatively, advisors can complete the Cost Basis Lot Specification Form. Forward

completed form by settlement to Advisor Services Client Reporting Team using “Service

Requests” on SchwabAdvisorCenter.com and select “Cost Basis” and attach instructions, or

by phone at 877-762-6446.

Please note: Regulations do not allow changes to lot instructions after the settlement

date. If instructions are not received by settlement date, an adjustment to the PMS must

be made to match Schwab data.

If Schwab data is correct:

To correct advisor data, take the following steps:

1.Adjust the data in the PMS to match Schwab’s data. The software may have a tool to import

data from the Schwab data files, or corrections may need to be made manually.

2. Contact the PMS vendor for specific details on how to import data.

After correcting a lot mismatch within either system, review the data files the next day to

ensure that the systems are in sync.

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Missing cost basis

on Form 1099-B

Schwab will display cost basis on Form 1099 Composite for covered and non-covered

securities. Cost basis for non-covered lots will not be reported to the IRS. Form 1099-

B includes a missing cost basis section for long- and short-term holdings. This

emphasizes the need to update missing cost basis. Cost basis may be missing

because the security was transferred from another financial institution and Schwab

does not have the necessary information to determine cost basis.

You can determine whether your clients’ accounts have missing cost basis by the

following methods:

• You can view status on individual accounts through the Cost Basis tab on

Schwab Advisor Center. The account will indicate “missing” in the cost basis

column.

• To view status at the master level, use the daily download file, sort the Excel

spreadsheet by cost and all the masters showing zero cost will appear together.

• Send a request via “Service Requests” from the Cost Basis tab on Schwab Advisor

Center, provide the master numbers, and request a missing cost basis report.

Please allow two to three days to receive the report.

To determine missing cost basis information, you can take the following steps:

• Determine where the security was purchased.

• Review original statements or confirmations or request them from the purchasing broker.

• Check past statements and trade confirmations for the original purchase dates and prices.

• Contact the broker who transferred the securities to Schwab, or search online

services such as NetBasis, to obtain the data.

Provide Schwab missing cost basis using one of the following methods:

• Edit missing cost basis using the online tool at schwabadvisorcenter.com.

• Complete a Cost Basis Edit Form and fax to your service team. If you have the data in

a format such as Excel, email the file through the secure ‘Service Requests’ link on

schwabadvisorcenter.com. Direct the email to the attention of Cost Basis

7

Cost basis edits The legislation places limitations on cost basis editing. Schwab will be able to change

unrealized, non-covered cost basis data. Schwab is also able to update missing unrealized

and realized cost basis as this is also considered non-covered.

Schwab cannot change cost basis on realized positions after settlement date. The IRS

regulations require that lot specifications be made by settlement date. Cost basis that is

considered covered by the legislation cannot be changed by Schwab, whether the position is

unrealized or realized unless for a Date of Death Step-up.

Transferring cost basis IRS code 6045(a) provides that any applicable person (such as a broker) that

transfers custody of a covered security to a receiving broker, must furnish a

transfer statement that allows the receiving broker to satisfy the cost basis

reporting requirements of section 6045(g).

This requires all applicable persons (i.e. brokers, transfer agents, mutual fund companies) to

transfer cost basis on covered lots only. If a position or tax lot is non-covered, and we receive

the cost basis we will display the basis received on the clients’ account.

The transfer statement must be furnished to the receiving broker within 15 days after

the date of transfer. Schwab will send out a request for a cost basis transfer

statement for taxable accounts on the 16th day after settlement of the transfer if cost

basis transfer statements are not received.

Most firms do not provide cost basis for Qualified (nontaxable accounts) since these

account types are not covered by the cost basis legislation. The client will need to submit

cost basis to Schwab on these account types if it is not provided by the previous custodian.

Schwab participates in the Cost Basis Reporting Service (CBRS), which is used in conjunction

with transfers of securities to pass cost basis information to other CBRS participating firms,

regardless if it is an ACAT or NON-ACAT transfer. Firms that do not participate in CBRS, will

send cost basis information via written format. Cost basis received from non-CBRS firms may

take longer to update due to manual processing. Please note: The CBRS process is completely

separate from the ACAT/NON-ACAT process.

For incoming transfers, please make sure that the delivering firm has been contacted

prior to settlement if there are specific tax lots to be transferred in to Schwab. Contra

firms are may not be willing to send corrected records if they did not have lot

instructions on file prior to the transfer.

Additional Information

DRIP plans/securities held at transfer agents—Most transfer agents only maintain and

keep track of cost basis for covered tax lots. Schwab may only receive partial cost basis

information, which would leave lots unknown/missing cost basis. The client will need to

reach out to the transfer agent to request historical information.

Transfers directly from mutual fund companies—Similar to transfer agents, most mutual

fund companies will only track and maintain lots that are bought and reinvested the

year mutual funds started to become covered securities (2012). In the event that

Schwab receives partial information, please have the client provide historical

information to update cost basis.

For large transfers of multiple accounts (or if the advisor is currently onboarding

accounts to Schwab), contact the AS Client Reporting team so we can help facilitate the

transfers of cost basis from the contra firm to eliminate potential issues with

reconciliation.

Step up cost basis

to date of death

Under the cost basis legislation, the IRS has requirements for brokers on inherited shares.

• Rules require that if Schwab processes an estate and assets are distributed from an

account fully owned by the decedent that Schwab step up the basis 100% to the date

of death automatically. Inherited tax lots will be tagged as such and the holding period

will be long term.

• If the decedent was a partial owner of an account ( i.e., JT TEN or Trust account),

Schwab will not proactively step up the basis because the percentage owned by the

decedent is not known and thus the percentage of tax lots to be stepped up is not

known. If a step up is required, submit a request using Schwab’s new Step Up Cost

Basis to Date of Death Request Form, a copy of the client’s Death Certificate and

forward to your service team.

• When inherited shares are transferred between accounts, brokers must identify and flag

the individual security as inherited. Inherited tax lots are treated as Long Term,

regardless of the date purchased by the decedent, the date the securities were received

from the estate, or the date the securities were sold by the owner.

• If an inherited security is transferred, the transfer statement will indicate it as

such.

If the inherited security is Covered, the transfer statement must provide the following:

• The Date of Death (DOD) as the acquisition date

• Adjusted basis equal to the fair market value (FMV) of the security on the DOD,

unless the broker received instruction to use an alternate date (exactly six months

from DOD).

Equities

• If DOD falls on a trading day, the FMV is calculated using the average of the high/low of

the DOD.

• If DOD falls on a non-trading day ( i.e., weekends or holidays), the FMV is calculated using

the average of the high/low of the trading day PRIOR to and the average price of the of

the high/low of the trading day AFTER the DOD.

Example:

• Weekends—Use the average of Friday’s average price and Monday’s average price.

• Holidays—Assuming Monday is a holiday, use the average of Friday’s average price

and Tuesday’s average price.

Mutual Funds

• If DOD falls on a trading day, the FMV is calculated using the Net Asset Value of the DOD.

• If DOD falls on a non-trading day ( i.e., weekends or holidays), the FMV is calculated

using the Net Asset Value of the trading day PRIOR to the DOD.

Fixed Income

• If DOD falls on a trading day, the FMV is calculated using the average of the high and

low price on the DOD.

• If DOD falls on a non-trading day ( i.e., weekends or holidays), the FMV is calculated

using the average of the closing price of the trading day PRIOR to and the trading day

AFTER the DOD.

7

8

Gifting When calculating cost basis for gifts, Schwab maintains the following information:

• The donor’s cost basis as of the gift date

• The donor’s original acquisition date

• The FMV as of the gift date

• The date of the gift

To calculate the gain/loss at the time of sale for shares received as a gift, refer to the guidelines

below:

• If the FMV is equal to or greater than the donor’s cost basis, the donor’s cost basis

is retained to calculate the gain/loss.

• If the FMV is less than the donor’s cost basis, the proceeds amount must be

considered when determining the cost basis.

• If the total proceeds are greater than the donor’s cost basis ( i.e., gain), the donor’s

cost basis is retained to calculate the gain.

• If the total proceeds are less than the FMV (i.e., loss), the FMV is used to calculate the

loss.

• If the total proceeds are less than the donor’s cost basis and greater than the

FMV, there is no gain or loss. The cost basis will be equal to the proceeds.

The holding period is determined by whether the FMV or the donor’s cost basis is used to

calculate gain/loss. If FMV is used, the holding period begins on the date of the gift. If the

donor’s cost basis is used, the holding period is determined by the donor’s original

acquisition date.

Unless Schwab is instructed otherwise, we will identify shares that move from one owner to

another as gifted.

Return of capital A return of capital event occurs when Schwab receives an updated file from our third- party

vendor informing us that an issuer has reclassified income previously paid as a dividend to

return of capital. When this happens, Schwab will decrease the cost basis by the amount of

the return of capital. A Cost Basis Adjustment Alert will be generated after the cost basis has

been adjusted. The cost basis adjustment amount should match the amount reported as

return of capital on the client’s 1099-DIV.

Your PMS provider may have a tool that allows you to adjust cost basis for return of capital in

your system. Please contact them for further details.

Note: Return of capital is not automatically applied to non-taxable accounts.

9

Cash/stock

mergers—368(a)

The cost basis legislation has resulted in a change of how we determine cost basis on

some cash/stock mergers. Section 368 of the Internal Revenue Code recognizes three

types of corporate acquisitions that may qualify under 368(a) reporting.

368(a) mergers, in which a gain limit is applied, will require the FMV price of the distributed

security (child security). Each individual tax lot of the parent security will need to be calculated

separately to determine the total value being distributed per lot. The total proceeds used to

determine the overall gain/loss will be the child security’s FMV plus the cash received. The

gain/loss limit will adjust the realized gain/loss that is actually being reported.

Gain/loss limit rules result in three possible realized gain/loss outcomes:

To Calculate Gain/Loss for each lot: FMV of shares received + Cash Received - Original

Cost Basis

1. Gain is limited to the cash received—Total proceeds minus cost basis results in a gain

greater than the cash received in the cash/stock merger. Only the cash received will be

reported as a gain.

2. Full gain—Total proceeds minus the cost basis results in a gain less than the cash

received in the cash/stock merger. The full difference between proceeds and cost basis

will be reported as a gain.

3. No loss—Total proceeds minus cost basis results in a loss. The IRS does not allow a loss to

be claimed. Schwab will report the cost basis equal to proceeds, resulting in a gain/loss of

zero.

The amount of cost basis reported in realized gains and losses (RGL) will be deducted from

the cost basis of the child security.

Each tax lot could have a different outcome, resulting in the cost basis being adjusted

differently in the unrealized gain/loss for the child security, and the realized gain/loss for the

parent security.

To adjust your data, contact your PMS provider.

Cash in lieu (CIL) of

fractional shares

Schwab’s corporate action department delivers whole shares into an account during a corporate action. The fractional shares are not credited to the account, but the cash received as payment for the fractional shares is received into the account as CIL. When processing corporate actions, the cost basis system credits the fractional shares to the account, and they are subsequently sold off according to the accounting method for the account when the cash is received for the CIL. This causes a temporary “out of balance” between the share quantity shown under the positions tab vs. the quantity on the cost basis tab until the CIL payment is received. Once the quantity discrepancy is adjusted, the fractional shares will be displayed as a realized transaction on the realized gain/loss tab with the proceeds equaling the CIL credited to the account.

10

10/3/2010 Sell Proceeds ($400.00) - Cost ($500) = <$100.00 $97.50

Wash sales and

disallowed losses

A wash sale occurs if you sell securities at a loss and buy substantially identical replacement

shares within 30 days before or after the sale. The wash sale period for any sale at a loss

consists of 61 days: the day of the sale, the 30 days before the sale, and the 30 days after the

sale. The wash sale rule postpones losses on a sale if replacement shares are bought during the

61 day wash sale period. Schwab tracks and adjusts for wash sales at the individual account

level, not across all taxpayer accounts.

If a wash sale occurs, all or a portion of the loss incurred on the original sale is disallowed. The

disallowed loss amount is added to the cost basis of the replacement security. The holding

period for the replacement shares you acquire in a wash sale includes the period you held the

old stock or securities.

To calculate the adjusted realized gain/loss, you need to determine:

1. The wash sale disallowed loss %

total # of wash sale shares (shares repurchased) / total # of shares sold

2. The disallowed loss amount

= wash sale disallowed loss % × original loss amount

3. The adjusted realized gain/loss

= original loss amount – disallowed loss amount

To calculate the adjusted holding period date, start with the closed lot acquisition date

and add the number of days the position was not held. That is, the acquisition date is

adjusted on the new lot to equal the closed lot acquisition date plus any days that it was

not held.

Lots are chosen based on the default accounting method assigned to the account or

specified instructions given at the time of trade

How does a wash sale work?

Transactions over a 30-day period, beginning with a flat position, are being used for this example:

9/30/2010 Buy 100L ABC $1,000.00

10/3/2010 Sell 50S ABC $400 Wash sale triggered

10/16/2010 Buy 1.250L ABC $15.60

Realized Gain/Loss

New Lots for ABC

9/30/2010 Buy 50L ABC $500.00

10/13/2010 Buy 1.250L ABC $18.10

2. The cost is adjusted on the replacement shares by the disallowed amount

which is the total amount of the loss on the sale ($15.60 + $2.50 =

$18.10).

3. The acquisition date is adjusted on the lot to equal the closed

lot acquisition date plus any days it was not held (9/30/10 + 13

days).

1. A portion of the loss is disallowed; the dividend reinvestment of 1.250 shares is considered

a purchase. A loss of $97.50 is the amount that can be claimed because it is the loss on the

shares that were not repurchased.

11

Closing a Short Position Reporting Requirements

Due to IRS regulation, brokerages are required to report closing transactions on short positions based on the settlement date of the

shares that were bought to cover the short sale, not the trade date. For example, if you are covering a short position in 2014 for

2014 tax reporting, then you need to ensure the shares bought to cover settles in 2014.

12

Year-End Reporting Requirements for Options Schwab is required to report adjusted cost basis and proceeds for sales transactions on IRS Form 1099-B for options that are acquired on or after January 1, 2014. We will report sale date, acquisition date, proceeds, cost basis, and Wash Sale disallowed loss data to the IRS, as we do for all other covered securities. Please note that if you trade multi-leg options strategies such as spreads, straddles, and strangles, Schwab will report the individual legs of the strategy as separate transactions. The following chart illustrates the reporting requirements for opening option transactions:

13

Example: Short Call Assignment

In a short call assignment, the proceeds are adjusted by the option premium.

• Bill Blevins held 100 shares of ABC Corporation, which he bought for $120 per share.

• He sold (wrote) 1 ABC Oct $130 call @ $5, and he received a premium of $500.

proceeds $13,000

– cost of underlying stock - 12,000

=

+

realized gain or loss

option premium

=

+

1,000 (realized gain)

500

= adjusted realized gain or loss = $1,500 (adjusted realized gain)

• The call was assigned, which means the call option holder exercised the right to

purchase the security.

• Mr. Blevins sold 100 shares of ABC at $130 per share. He received $13,000 (100 × $130) in

proceeds from the option holder.

proceeds $13,000

+ option premium + 500

=

-

adjusted proceeds

cost

=

-

13,500 (adjusted proceeds)

12,000

= adjusted realized gain or loss = $1,500 (realized gain)

When fulfilling an option assignment, the seller adds the premiums received to the proceeds of

the underlying stock. The closing date of the underlying security is the effective date of the

exercise. Since the premium received from the option is “bundled” with the proceeds of the

underlying stock, a separate option transaction will not be displayed.

The call option holder who exercises the right to purchase the security adds the premium paid

to the cost basis of the shares. The opening date of the underlying security is the effective date

of the exercise. Since the premium paid for the option is “bundled” with the cost basis of the

underlying stock, a separate option transaction will not displayed.

Example: Long Put Exercise

In a long put exercise, the proceeds are adjusted by the option premium.

• Bill Blevins held 200 shares of XYZ Solutions, which he bought for $5 per share.

• He bought 2 XYZ Nov $7 put @ $1.50 and paid a premium of $300.

• Mr. Blevins exercised the put, which means he had the right to sell the security to the

option writer. Mr. Blevins sold 200 shares of XYZ at $7 per share. He received $1,400

(200 × $7) from the option seller.

Put option buyers (holders) pay a premium for the option. When the underlying security is sold,

they subtract the premium amount from the proceeds of the sale of the underlying security. The

opening date of the underlying security is the effective date of the exercise. Since the premium

paid for the option is “bundled” with the proceeds of the underlying stock, a separate option

transaction will not be displayed.

Put option sellers (writers) subtract the premium received from the cost basis of the underlying

shares purchased through the option. The closing date of the underlying security is the effective

date of the exercise. Since the premium received from the option is “bundled” with the cost basis

of the underlying stock, a separate option transaction will not be displayed.

proceeds $1,400

– option premium - 300

=

-

adjusted proceeds

cost

=

-

1,100 (adjusted proceeds)

1,000

= realized gain or loss = $100 (realized gain)

Long option expirations will be displayed as zero proceeds with the premium paid reported

as the cost basis.

The closing and acquisition dates of the closed short option positions will be changed to the

settlement date of the closing buy-to- cover transactions.

These changes will be visible to advisors on Schwab Advisor Center and to clients on the

Realized Gain/Loss page on SchwabAlliance.com, monthly statements and the Form 1099

Composite.

DISCLAIMERS

1. PortfolioCenter®is a product of Schwab Performance Technologies®(SPT). Schwab Advisor Services™ is a business segment of The Charles Schwab Corporation serving independent investment advisors, which includes the custody, trading, and support services of Charles Schwab & Co., Inc. (Schwab). Schwab and SPT are subsidiaries of The Charles Schwab Corporation.

2. Advent Axys is not affiliated with Schwab.

FOR GENERAL INFORMATIONAL PURPOSES ONLY.

Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the options disclosure document titled “Characteristics and Risks of Standardized Options.”

With long options, investors may lose 100% of funds invested. Covered calls provide downside protection only to the extent of the premium received and limit upside potential to the strike price plus premium received.

Commissions, taxes, and transaction costs are not included in this discussion, but can affect final outcome and should be considered. Please contact a tax advisor for the tax implications involved in these strategies.

Supporting documentation for any claims or statistical information is available upon request.

Schwab does not provide investment planning, legal, tax, or compliance advice. Consult professionals in these fields to address your specific circumstance.

© 2016 Charles Schwab & Co., Inc. (Schwab). All rights reserved. Member SIPC.

Schwab Advisor Services™ serves independent investment advisors and includes the custody, trading, and support services of Schwab. Independent investment advisors are not owned by, affiliated with, or supervised by Schwab.

AHA (0216-CWPN) MKT64069 (02/16)