Covered Security

A covered security refers to a class of securities that enjoys federally imposed exemptions from state restrictions and regulations. Most stocks traded in the U.S. are covered securities.

A covered security is also known as a "federal covered security."

Covered securities were developed to standardize security regulations and filings across the United States. Rather than having individual companies register, file and comply with the differing regulations in all the states, a uniform set of rules was created.

Provisions of the National Securities Market Improvement Act clarified what constitutes a covered security. This also granted federal regulators superseding authority over this class of security rather than state-level laws.  

According to the federal legislation, a covered security is a security that is listed or authorized for listing on the New York Stock Exchange and comparable stock exchanges. That includes the American Stock Exchange, the Nasdaq National Market, or a national securities exchange with similar listing standards to those other exchanges. This would cover any exchanges established in the future that meet these criteria.

Stock traded on specific tiers of the Pacific Exchange, the Philadelphia Stock Exchange, and the Chicago Board Options Exchange are classified as covered securities. Options listed on the International Securities Exchange have received covered security designation as well.

Covered securities also include securities issued by an investment company that is registered or has filed a registration statement under the Investment Company Act of 1940. The designation of covered securities extends to the sale of those securities to qualified purchasers as defined by the Securities and Exchange Commission.

Designation of covered securities plays a role in reporting taxes. Brokers must report to the Internal Revenue Service the adjusted costs basis when those securities are sold. This must be reported on Form 1099-B. Taxpayers who sold covered securities must also report the transactions with their tax filings.

In this context, other criteria come into play. Company stock acquired starting in 2011, as well as shares of stock in a dividend reinvestment plan and mutual fund shares purchased as of 2012, are designated as covered securities. This means that. Many bonds, notes, commodities, and options bought from 2013 onwards are also classified as covered securities. Securities originally purchased prior to these dates are non-covered securities and the adjusted costs basis is not reported when they are sold.

Even if covered securities and non-covered securities are within the same investment account, they will be treated separately for tax purposes.