By Brad McCaffrey, Scottrade Senior Tax Reporting Specialist

For holders of publicly traded securities organized as grantor trusts (this includes mortgage-backed securitiesand some exchange-traded funds and unit investment trusts), the Internal Revenue Service (IRS) has tightened up its enforcement of regulations that change the way you need to report income, expenses and gains for the 2010 tax season. You will commonly hear these groups of securities called Widely Held Fixed Investment Trusts, or WHFITs.

What Are WHFITs?

WHFITs are fixed investment trusts (meaning the original holdings of the trust are not changed or rebalanced) that are held by at least one third party rather than the owner of the trust. Some examples of these, as mentioned above, include mortgage-backed securities (MBS) and some exchange-traded funds (ETF) and unit investment trusts (UIT).

The broader WHFIT umbrella has two separate and unique subcategories: Widely Held Mortgage Trusts (WHMTs) as well as Non-Mortgage Widely Held Fixed Investment Trusts (NMWHFITs) that do not contain any underlying mortgage-related assets in their portfolio.

The official definition of a WHFIT, from an Internal Revenue notice (Internal Revenue Bulletin 2008-40, Notice 2008-77) follows:

A WHFIT is an arrangement classified as a trust under • 301.7701-4(c), provided that: (i) the trust is a United States person under • 7701(a)(30)(E); (ii) the beneficial owners of the trust are treated as owners under subpart E, part I, subchapter J, chapter 1 of the Code; and (iii) at least one interest in the trust is held by a middleman. See • 1.671-5(b)(22). A WHMT is a WHFIT the assets of which consist only of mortgages, regular interests in a REMIC, interests in another WHMT, reasonably required reserve funds, amounts received with respect to these assets, and during a brief initial funding period, cash and short-term contracts to purchase these assets. See • 1.671-5(b)(23).

WHFIT Tax Reporting

The reporting regime for WHFITs was enacted in the final days of 2006, but up to this point, had largely been granted penalty relief for non-compliance.

The most fundamental concept to consider is that these types of securities are organized as a grantor trust; the trustee creates the trust to hold a fixed portfolio of underlying assets. Therefore, since the securities are a form of trust, the income and proceeds flow through to the underlying trust interest holder (TIH) on a pro rata basis, meaning each TIH receives an equal portion of the earnings.Further, the pro rata TIH not only owns the income and proceeds that they can see being paid into their account, but now also essentially takes tax ownership of a larger portion of all the asset activity occurring behind the scenes at the "master trust" level as the trustee redeems tendered TIH units, receives principal prepayments from underlying assets, levies its fees, etc.

Receipt-Based Reporting

This aspect of the WHFIT process is a new step and requires an accompanying understanding of the concept of "receipt-based" reporting versus "distribution-based" reporting, the system that had long endured for reporting grantor trust securities up to this point.

What this entails is reporting based on when the master trust booked in (i.e., received) payments from underlying assets, not when a TIH is paid the income disbursed from the master trust. Investors traditionally are used to seeing on a 1099 whatever amount it was that they were paid as individuals, when it was paid to the account. This is no longer the requirement; nominees (meaning your brokerage firm, Scottrade) must now report to individuals and the IRS the pro-rata share of amounts received or recognized by the master trust on an individual's behalf at the time it was received by the master trust-information that had been largely invisible to the individual investor up to this point.

How WHMTs Are Affected

The largest sub-sector of securities these regulations will affect is the WHMTs, which include pass-through mortgage-backed security (MBS) pools issued by agencies such as Fannie Mae, Ginnie Mae and Freddie Mac.

The new regulations require reporting on a more granular level those items of gross interest (as opposed to the net interest paid), principal factors, expense and market discount fraction to be used in calculating bond premium amortization and market discount accrual.

Please Note:For WHMTs, Scottrade will issue a separate Widely Held Mortgage Trust statement to affected investors by March 15, 2013, in accordance with IRS regulations.Holders of these securities will be sent a composite tax statement by February 15, 2013, that includes a disclaimer that the subsequent March 15 document will be forthcoming.Please consider this fact before filing your individual tax return at a date earlier than March 15.

How NMWHFITs Are Affected

Some of the different types of NMWHFITs (non-mortgage WHFITs) are unit investment trusts (UITs) organized as grantor trusts; royalty trusts (oil and gas); commodity trusts that hold gold, silver or other precious metals or commodities; and HOLDRS trusts. These types of WHFITs historically have always had Form 1099 reporting for any dividends (1099-DIV), interest (1099-INT), royalty income (1099-MISC), original issue discount (1099-OID) and/or sales proceeds (1099-B). These were all based on the prior methodology of distribution-based reporting.

As discussed earlier in this article, the new receipt-based reporting requires a much deeper detail and level of granularity that may cause many investors confusion as to what is being reported on their behalf. The NMWHFITs largely require income gross up to account for accompanying trust expense and/or fees, and in the case of commodity trusts, inclusion of trust-level sales of commodities to fund trust expenses. An individual TIH assumes a pro-rata portion of these periodic sales, as well as an offsetting expense amount.All available information will be passed on to the individual TIH by Scottrade prior to the required March 15 date for these securities.

How the IRS Describes WHFIT Tax Reporting

From page 3 of the 2012 General Instructions for Forms 1099, 1098, 3921, 3922, 5498, and W-2G:

Widely held fixed investment trusts (WHFITs). Trustees and middlemen of WHFITs are required to report all items of gross income and proceeds on the appropriate Form 1099. For the definition of a WHFIT, see Regulations section 1.671-5(b)(22). A tax information statement that includes the information provided to the IRS on Forms 1099, as well as additional information identified in Regulations section 1.671-5(e) must be furnished to trust interest holders (TIHs).

Items of gross income (including OID) attributable to the TIH for the calendar year including all amounts of income attributable to selling, purchasing, or redeeming of a trust holder's interest in the WHFIT must be reported. Items of income that are required to be reported including non pro-rata partial principal payments, trust sales proceeds, redemption asset proceeds, and sales of a trust interest on a secondary market must be reported on Form 1099-B. See Regulations section 1.671-5(d).

Safe harbor rules for determining the amount of an item to be reported on Form 1099 and a tax information statement with respect to a TIH in a non-mortgage WHFIT (NMWHFIT) and a widely held mortgage trust (WHMT) are found in Regulations sections 1.671-5(f) and (g) respectively.

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Due date exception and other requirements for furnishing statement to TIH. The written tax information for 2012 furnished to the TIH is due on or before March 15, 2013. For other items of expense and credit that must be reported to the TIH, see Regulations section 1.671-5(c).

There is no reporting requirement if the TIH is an exempt recipient unless the trustee or middleman backup withholds under section 3406. If the trustee or middleman backup withholds, then follow the rules in part N on page 11. An exempt recipient for this purpose is defined in Regulations section 1.671-5(b)(7).

How Scottrade Can Help

If you hold WHMT securities, you will see a notice on your composite tax statement from Scottrade, sent by February 15, 2013. This will be followed by a Widely Held Mortgage Trust statement before March 15, which will contain all the information you need to accurately complete your individual tax return.

Additional tax information about NMWHFITs you may hold will be provided in the Supplemental section of your 1099 (sent by February 15, 2013) or in a subsequent "corrected" 1099 if the trustee supplies Scottrade with this data after your 1099 has already been provided to you.

If you have questions about any of these documents, please contact your local branch office for further assistance.

Scottrade does not provide tax advice. This material is for informational purposes only. Please consult your tax or legal advisor(s) for questions concerning your personal tax or financial situation.