In investing, the "cost basis" of an investment is simply the original purchase price paid for the investment, although in some cases this price gets adjusted for commissions paid, options premiums paid or received, reinvested dividends, stock splits and return of capital distributions.
The cost basis of an investment is used to calculate the capital gain (or loss) netted if/when the investment is eventually sold, which is important to know for tax purposes.
Until recently, the burden of keeping track of cost basis fell onto the individual taxpayer, which often resulted in nightmare scenarios of trying to adjust for multiple stock splits and dozens of dividend payouts across multiple decades of owning a stock. It was an impossible task unless the investor kept meticulous records. In practice, this often meant that investors were forced to report imagined cost bases to the IRS (generally erring on the side of less tax owed), and the IRS had almost no way to verify these numbers.
However, as part of the Emergency Stabilization Act of October 2008, brokerages and issuers are now required to track cost bases for their clients and report them to the IRS, starting with equities for the 2011 calendar year, and phasing in mutual funds and dividend reinvestment plans in 2012, and other financial instruments such as debt securities, options, and private equity starting in 2013.
This much needed reform shifts the burden of tracking cost bases to institutions with computerized databases who are in a much better position to maintain accurate records over decades than individual investors. It will boost tax receipts for the IRS by reducing cost basis reporting fraud (both intentional and accidental), while at the same time saving individual taxpayers who want to do the right thing and pay their full taxes a lot of headache.