Bonds

<div class="Section1"><br /> <br /> When a taxpayer makes a gift of a taxable bond issued after July 18, 1984, or a taxable bond issued on or before July 18, 1984, and purchased after April 30, 1993, or a tax-exempt bond purchased after April 30, 1993, any of which the taxpayer acquired at a market discount and that has appreciated in value at the time of the gift, he or she must include in gross income an amount equal to the market discount accrued to the date of the gift, but limited to the amount of gain that would have been realized had the taxpayer received fair market value on making the gift.<a href="#_ftn1" name="_ftnref1">¹</a> The amount is treated as interest income (but not for withholding at the source).<a href="#_ftn2" name="_ftnref2">²</a> Discount is considered to have accrued on a ratable basis, or, if the taxpayer elects (irrevocably), at a constant interest rate, just as if he or she had sold the bond (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7645">7645</a>). Had the taxpayer previously elected to include market discount in gross income as it accrued (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7644">7644</a>), no accrued discount would be includable as a result of the gift.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> If a bond was issued on or before July 18, 1984, and purchased before May 1, 1993, or if the bond is a tax-exempt issue purchased before May 1, 1993, no accrued market discount is included in income.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 1276.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. General Explanation&ndash;TRA &rsquo;84, p. 94.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect; 1278(b).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. TRA &rsquo;84, &sect; 44(c)(1). See IRC &sect;&sect; 1276, 1277, and 1278.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> According to IRS Publication 550, if a child is the owner of an E, EE, or I bond, the election to report interest annually may be made by the child or by the parent. The choice is made by filing a return showing all the interest earned throughout the year and stating that the child is electing to report interest each year. The child then does not have to file another return until he or she has enough gross income during a year to require filing.<br /> <br /> A child could elect to change from annual to deferred reporting under Revenue Procedure 89-46. This provision is not included in the current revenue procedure governing such elections.<a href="#_ftn1" name="_ftnref1">¹</a> However, Publication 550 states that neither the parent nor the child can change the way that interest is reported unless permission from the IRS is requested (in accordance with the procedures outlined in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7679">7679</a>). Thus, it appears that a child may make such election. If the election is available, the parent of a child making such an election may sign Form 3115 on behalf of the child. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="679">679</a> for an explanation of the taxation and filing requirements of children under age 14.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. See Rev. Proc. 2002-9, 2002-1 CB 327.<br /> <br /> </div></div><br />

<div class="Section1">If, on conversion of a market discount bond issued after July 18, 1984, or issued on or before July 18, 1984, and purchased after April 30, 1993, a taxpayer receives stock in the issuer of the bond, the amount of market discount accrued to the date of exchange must be treated as ordinary interest income upon sale or disposition of the stock, unless the taxpayer had elected to include in income market discount on the bond as it accrued.<a href="#_ftn1" name="_ftnref1">¹</a><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect;&sect; 1276(c), 1278(b).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> A REMIC is a &ldquo;real estate mortgage investment conduit.&rdquo; In general, a REMIC is a fixed pool of real estate mortgages that issues multiple classes of securities backed by the mortgages and that has elected to be taxed as a REMIC. It can issue several different classes of &ldquo;regular interests&rdquo; and must issue one (and only one) class of &ldquo;residual interests.&rdquo;<a href="#_ftn1" name="_ftnref1">¹</a> A regular interest is a debt obligation (or is treated as one) and a &ldquo;residual interest&rdquo; participates in the income or loss of the REMIC.<a href="#_ftn2" name="_ftnref2">²</a> A REMIC is not treated as a separate taxable entity (unless it engages in certain prohibited transactions); instead, the income is taxable to the interest holders as explained in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7694">7694</a>.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> Generally, entities that do not qualify as REMICs, but that issue multiple maturity debt obligations, the payments on which are related to payments on the mortgages and other obligations held by the entity, are classified as Taxable Mortgage Pools (TMPs).<a href="#_ftn4" name="_ftnref4">⁴</a> (Domestic building and loan associations are not considered TMPs.) TMPs are taxed as corporations.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 860D.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect;&sect; 860B, 860C.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect;&sect; 860A, 860F(a)(1).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. IRC &sect; 7701(i)(2); Treas. Reg. &sect; 301.7701(i)-1(b).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. IRC &sect; 7701(i)(1).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <p class="PA"><span style="letter-spacing: .1pt">Treasury bills (T-bills) are obligations of the United States government, generally issued with 4-, 13-, 26-, and 52-week maturity periods. Treasury bills are issued in minimum denominations of $100 with $100 increments thereafter. Treasury bills are issued without interest and on a discount basis (that is, they are issued at a price that is less than the amount for which they will be redeemed at maturity). The price is determined at auction (13- and 26-week bills are generally auctioned on Monday of each week; four-week bills are generally auctioned on Tuesday of each week; 52-week bills are generally auctioned every four weeks on Tuesday).</span></p><br /> <br /> </div><br />

<div class="Section1"><br /> <br /> The Service will disallow amortization in situations that lack economic substance.<a href="#_ftn1" name="_ftnref1">¹</a> A deduction for amortization was disallowed where sales were not bona fide sales;<a href="#_ftn2" name="_ftnref2">²</a> and where an individual who put up no margin, signed no note, and intended to sell the bonds to cover his liability, was ruled not to be the owner of the bonds for purposes of deducting a part of the premium.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> Amortization of premium on tax-exempt bonds is discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7664">7664</a>.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. Rev. Rul. 62-127, 1962 CB 84. With the 2010 codification of the economic substance doctrine, see IRC &sect; 7701(o), many transactions must pass scrutiny under this doctrine to be honored.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. <em>Lieb v. Comm.</em>, 40 TC 161 (1963).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. <em>Starr v. Comm.</em>, 46 TC 450 (1966), <em>acq.</em> 1967 CB 3.7.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> The IRS released regulations relating to the proper timing and source of income from fees received to induce the acquisition of noneconomic residual interests in REMICS. The regulations provide that an inducement fee must be included in income over a period reasonably related to the period during which the applicable REMIC is expected to generate taxable income (or net loss) allocable to the holder of the noneconomic residual interest. Under a special rule applicable upon disposition of a residual interest, if any portion of an inducement fee received with respect to becoming the holder of a noneconomic residual interest has not been recognized in full by the holder as of the time the holder transfers (or otherwise ceases to be the holder for federal income tax purposes) that residual interest in the applicable REMIC, the holder must include the unrecognized portion of the inducement fee in income at that time.<br /> <br /> The regulations set forth two safe harbor methods of accounting for inducement fees, and contain a rule that an inducement fee is income from sources within the United States.<a href="#_ftn1" name="_ftnref1">¹</a> The Service also released the procedures by which taxpayers can obtain automatic consent to change from any method of accounting for inducement fees to one of the two safe harbor methods.<a href="#_ftn2" name="_ftnref2">²</a> The Service reached a settlement with two entities that purportedly brokered noneconomic residual interests in a manner based on what the IRS perceived to be an overly aggressive interpretation of the tax laws.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. See Treas. Reg. &sect;&sect; 1.446-6, 1.860C-1(d), 1.863-1(e), 1.863-1(f), 69 Fed. Reg. 26040 (5-11004).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. See Rev. Proc. 2004-30, 2004-1 CB 950.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. See IR004-97 (July 26, 2004).<br /> <br /> </div></div><br />

<div class="Section1">Deduction of interest paid on amounts borrowed by a taxpayer to purchase or carry Treasury bills or short-term taxable corporate obligations may be subject to limitation and deferral. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8045">8045</a> for details.<a href="#_ftn1" name="_ftnref1">¹</a> Certain short sale expenses (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7529">7529</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7530">7530</a>) may be treated as interest within this rule.<a href="#_ftn2" name="_ftnref2">²</a> Any deductible interest expense will also be subject to the general limit on otherwise allowable investment interest expense deductions (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8040">8040</a>).<div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 1282(a).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 1282(c).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> An individual who owns any fully tax-exempt interest bearing bond (or debenture, note, certificate, or other evidence of indebtedness) <em>must</em> amortize any premium paid for the bond, but the part of the premium allocable to the year is not deductible.<a href="#_ftn1" name="_ftnref1">¹</a> (The premium paid, in effect, reduces the annual interest; therefore, because the tax-free interest received each year represents in part a tax-free return of premium, the premium is not deductible.) Regulations in effect for bonds acquired before March 2, 1998 (or held before a taxable year containing March 2, 1998) provided substantially similar rules. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7665">7665</a> for an explanation of the effective date for final regulations under IRC Section 171. The individual <em>must</em> reduce his or her basis each year by the amount of premium allocable to the year.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> For an explanation of how the annual amount of amortization is calculated, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7665">7665</a>.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 171; Treas. Reg. &sect; 1.171-1(c).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 1016(a)(5).<br /> <br /> </div></div><br />

<div class="Section1">No, it is a capital payment taxable as capital gain.<a href="#_ftn1" name="_ftnref1">¹</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7663">7663</a> if the bond was originally issued at a discount. For the treatment of capital gains and losses, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="702">702</a>.<div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. Rev. Rul. 72-587, 1972 CB 74; GCM 39309 (118-84); see also Rev. Rul. 74-172, 1974-1 CB 178; <em>District Bond Co. v. Comm.</em>, 1 TC 837 (1943); <em>Bryant v. Comm.</em>, 2 TC 789 (1943), <em>acq.</em> 1944 CB 4.<br /> <br /> </div></div><br />