OID Coupon vs OID bond on a US Strip Treasury

OID Coupon vs OID bond on a US Strip Treasury

How is a US Strip Treasury OID taxed for Coupon and Bond portions.

I am looking at a Schwab statement that has as description “US Treasury Strip O%26” and in box 8 of the 1099 INT is $3,037. So the idea is that some bright financier has purchase the whole bond and strip it into 2 components. The annual interest portion or the “Coupon” bond and then a second part the “Principal” bond.

For example: Bond pays 2.5% interest for 10 years before being split.

Principal Bond portion of Strip 80,000 (2016 FMV) —– 100,000 (2026 payout)                     OID is 20,000.

Coupon portion 20,000 (2016 FMV) [ 2,500 X 10 years] —– 25,000 (2026 payout)            OID is 5,000.
Keep in mind  with the Coupon portion you dont actually get 2,500 in cash each year, rather you get 25,000 in cash 10 years from now.

So the Schwab statement says the OID is $3,037 but I have no idea if the client owns the coupon bond portion of the Strip or the principal bond portion of the Strip. And I have concluded it does not matter.

If you look at IRS publication 1212 you get the following info:

“If you strip one or more coupons from a bond and then sell or otherwise dispose of the bond or the stripped coupons, they are treated as separate debt instruments issued with OID. The holder of a stripped bond has the right to receive the principal (redemption price) payment. The holder of a stripped coupon has the right to receive an interest payment on the bond. The rule requiring the holder of a debt instrument issued with OID to include the OID in gross income as it accrues applies to stripped bonds and coupons acquired after July 1, 1982.  So the OID rule applies to both stripped bond portion and stripped coupon portion of the bond.”
The IRS goes on in Pub 1212,
“The amount shown in box 8 of the Form 1099-OID you receive for a stripped bond or coupon may not be the proper amount to include in income.”   The IRS is confusing in its instructions.  You can have US stripped bonds,  state and city stripped bonds, and private stripped bonds. If you include in Box 8 then this is for state and city OID.  In other words box 8 is  for state and city bonds with OID that  are tax exempt at the federal level but taxable at the state level if the bond is not a bond from your state ( an out of state bond).  However interest on a federal obligation like a US Treasury Bill or Note or US Strip Treasuryies are  taxable at the Federal level, but not at the state level.  So the US OID has to be entered in Box 3.
I am going to pick up the OID as taxable federal and not taxable state. The question comes to mind why not just buy a treasury bond? Why would I want to recognize interest income and have no cash to show for it?

The other thought is that this US Strip Treasury bond is in a child’s name and with the time I spend figuring out the Kiddie tax form on 2 children’s 1040s and my cost and time does it really do the family any benefit investing in these US Strip Treasury obligations.  The Kiddie tax on the 1st $1,050 of income is $0, so the savings in not including the US Strip Treasury interest is the parents rate at 25% or $262.50.  The child’s rate is used on the interest income from $1,050 to $2,100 so that rate is 10% vs the parent rate leaves a savings of $157.50.  On any income earned on the instrument from $2,100 to $3,037 is tax at the parents rate and so no benefit.  So the total benefit is $420 and I charged $400 to do the child’s return.

Now IRS form 8814 allows the parent to elect to report the children’s interest and dividends on their tax return and thus avoid having to prepare a separate return and related cost for the child’s tax return preparation.   The problem here is that once there is a stock or bond sale of one of the child’s investment a schedule D is required and then the parent cannot elect to use the 8814 form reporting of income and the child has to have a separate tax return prepared on their behalf.

 

Here is an example from Wikepedia:

 

Example Original Issue Discount

Bond Issuance Price $7,462
Bond Redemption Price $10,000
Original Issue Discount $2,538

Most loans require interest payments. Loans that require inadequate or no interest payments bear original issue discount. Whether interest is adequate is determined with reference to the applicable federal rate (AFR). Under the Internal Revenue Code, original issue discounts on debt instruments are taxed each year, even though the debt may not be repaid until a later date. The tax system will impute an interest rate on the loan. The rules for calculating the original issue discount utilize a compounding interest formula, with the principal recalculated every six months. Section 1272(a) of the tax code requires that the Original Issue Discount is includible in the lender’s taxable income at the end of each tax year, or part of the tax year if the loan was not owned for the full year.[1]

The daily portion of the discount uses a compounded interest formula with the principal recalculated every six months. The following table illustrates how to calculate the original issue discount for a $7,462 bond with a $10,000 repayment and a three-year maturity date:[2]

Period Adjusted Issue Price Yield Original Issue Discount
1 $7,462 .05 $373
2 $7,835 .05 $392
3 $8,227 .05 $411
4 $8,638 .05 $432
5 $9,070 .05 $454
6 $9,524 .05 $476
Redemption $10,000

This is a general tax discussion.  You need to consult your own tax preparer before taking any action on this discussion above.  I hope this has been helpful on OID Coupon vs OID bond on a US Strip Treasury treatment.

A solution to the traffic problem

A solution to the traffic problem.

 
Here is a solution to the traffic problem.  A tax credit of $5,000 for you to move to be within 1 mile of your job, or get a new job within 1 mile of where you live. For example, a Mary lives in Vienna and works in Bethesda for Marriott as an accountant. Bob lives in Silver Spring and works in Falls Church for IBM as an technician. Everyday they head in opposite directly on 495 and cross at the American Legion Bridge.
 
If Mary loves Virginia and would never think of moving to MD., fine, Mary can get a new job within a mile of her home in Virginia and get the credit. Bob says I love my job with IBM, fine, Bob can find a new residence within a mile of his existing employer IBM and get the 5,000 credit. We have just gotten 2 people off the expressway without having to pour one more foot of concrete.
 
Think of the amount of billable productive hours that are sitting on the highways, the cost of the autos, the cost of the fuel. This is an idea to alleviate the traffic problem. Keep in mind, right row, if you move for Arlington, where you work, to more than 50 miles to start a new job you get a tax deduction for the move on your 1040. Is $5,000 the right number? Maybe it has to be adjusted to income or geographic location where traffic is the worst.

Renewal energy credit

ENERGY TAX CREDIT FOR RESIDENCES 2016

Thinking about energy credit for your home? Let’s look at the restrictions and limits. All of the improvements for windows, insulation, roofs, doors and skylights are limited to 10% of costs.

There is a further limit to a maximum of $500 for certain improvements. The total credit allowed is cumulative for all years since 2005 through to today in the amount $500 for windows, insulation, roofs, doors, skylights, stoves, furnaces, central air, and water heaters.

So the 1st question you have to ask is how many people have kept track of what they have spent after 2005 – 11 years ago on energy improvements. And certainly the IRS has no way of knowing what you spent in 2006 for insulation, etc.

You may have already taken full advantage of the credits listed for for windows, insulation, roofs, doors, skylights, stoves, furnaces, central air and water heaters. However it is always worth reviewing, especially for new home owners. Congress should reset the time clock. I am sure that with wear and tear on homes in the last 10 years, homeowners should be given an incentive to get up in the attic and put some insulation down, etc. to make their homes more energy efficient.

The good news is for geothermal, wind, fuel cells, and solar energy units there is not dollar limit, and the credit is 30%.

RESIDENTIAL ENERGY PROPERTY COSTS

A. For an existing home that is your principal residence here are the items that you are entitled to a 10% of the money spent towards a energy credit

For example, if you spent $2,500 for energy efficient windows, that cost is limited to $2,000, and if you spent $450 for insulation and another $200 on your roof. Then the total credit would be $265 ($2,000 + $200 + 450 = 2,650 X 10%)

And limited to the following CUMULATIVE since 2005

OVER ALL CREDIT LIMIT $500

LIMIT for Window credit $200

LIMIT for advanced main air circulating fan credit $50

LIMIT for ALL BOILERS & FURNACES credit is $150

LIMIT for Bio Mass stoves, heat pumps, central air conditioning, and hot water heater credit is $300.

If you think about the cost of a water heater being approx $700, then this is a very good credit, but for a furnace that may cost $7,000 a $150 credit is paltry.
Energy-efficient building property Bio Mass Stoves, Heat Pumps, Central Air Conditioning, and Hot Water Heaters

Biomass Stove (burns plant derived fuel to heat your home or hot water) Although wood and wood pellet stoves are most common, biomass fuels includes renewable forms such as corn or even aquatic plants.

Bio mass stove
Air Source Heat Pumps. This device absorbs heat in one place and releases it as another either to cool or heat the house.

 

Heat Pump

 

Central Air and Water heater

 

Maximum credit for Natural Gas, Propane, Oil, and Hot Water Furnaces or Boilers is $150. If there is an advance main air circulating fan then a credit is limited to $50.
Natural Gas, Propane, Oil Furnace or Hot Water Boilers

Boiler 1

 

Gas Propane and Oil Furnaces and Fans

Boler 2

QUALIFIED ENERGY EFFICIENCY IMPROVEMENTS – ROOFS, WINDOWS, SKYLIGHTS, AND DOORS. Remember costs are multiplied by 10% to calculate credit.

Insulation
Insulation

 

 

Roof
Roofs
Must meet
Energy Star req.

 

Window Doors

Windows, Doors & Skylights

Must meet Energy Star requirements

Maximum cost is $2,000 X .10 is $200.

RESIDENTIAL ENERGY CREDITS
B. For principal residence for either new or existing construction the following

Credit is 30% of cost with no limits

Fuel Cells. A machine that creates electricity by the interacting of hydrogen and oxygen.

Fuel cell

There is a limit to the lower of 30% of the cost or the Kilowatt capacity X 1,000. So if you buy a Fuel cell system for 10,000 and it has a Kilowatt capacity of 2. The lower amount will be 2 X 1,000 or $2,000 and not the 3,000 amount ($10,000 X 30%)
C. For both new homes and existing homes qualify – and principal residence and 2nd homes qualify.
30% of cost with no limit on the following:

Geothermal
Geothermal Heat Pumps

Small Wind Turbines (Residential)

Windmill

Solar Panel
Solar Energy Systems (Water or Heating)
The IRS form to claim a credit is form 5695. As typical these credits are subject to almost yearly renewal. So you may want to do energy conservation in 2016 because you don’t know is Congress will renew. The one exception is for Geothermal, Wind, and Solar the 30% credit is through 12/31/19, and then is reduced to 26% for 2020,and then drops to 22% in 2021 the final year.

Using a C Corporation to income average

 

Using a C Corporation to income average as compared to an S corporation.

A C corporation can be used for income averaging.

Let’s talk about the concept of using a C corporation to income average.  The example below give you an idea of the tax savings available. Three things to keep in mind.

1. The C corporation will get the tax back via a refund when the NOL is carried back, but, of course there is a cash flow issue. During the period the IRS has the tax money pending the NOL carryback, there is a cost of money. In our example below, the federal corporate taxes on $160,000 is $45,650. So this money would be unavailable to the Taxpayer for a year. At 10% interest the cost of funds would be $4,565. So there is still an overall savings.

2. The example below is just for 2 years. Keep in mind that the NOL can be carried back 2 years. So you could have a loss in Year 3, and carry back the NOL to Years 1 and 2. This would allow for even more income averaging.

3. Also the pension benefit allowed would be greater with the C corp example. Let’s say the S corp had a SEP retirement plan that allows for 25% of salary. So you might assume you could make a $75,000 contribution ($300,000 X .25%). But the limit per year in 2016 is $53,000 ($59,000 if 50 years of age or over). So, the SEP contribution is limited. Not so with the C corporation example below because the salary is spread over two years. You get to contribute money and enjoy the tax savings on the additional contribution. The additional SEP contribution would be $22,000 ($75,000 – $53,000), and you get a tax deduction on the $22,000 at 39% or $8,580.

4. So in our example, there is a $16,091 tax benefit less the cost of money of $4,565, plus the tax savings on the ability to make an additional SEP contribution of $8,580 for a total savings of $20,106.

See the example of the benefits of using a C corporation to income average.

Income_Averaging_C_Corp

Can a 1041 tax return fiscal year filing end on any day of the year?

Can an Estate choose any day of the year to end its fiscal year  in filing the 1041 tax return?

An Estate can choose a fiscal year for a year end.  But can an Estate choose any day of the year for a year end  What if you are trying to close the estate in one year and not have to incur the cost of preparing a second 1041 tax return?

For example, the death occurs on February 22, 2015, and the client is on February 15th  of 2016 just finishing selling stock, collecting dividends, and making the final distributions. Can I elect a February 21, 2016 year end?  If not, I would have to choose January 31, 2016, and then a second 1041 would have to be filed.

IRS Publication 559 states, “The estate’s
first tax year can be any period that ends on the
last day of a month and does not exceed 12
months.”

So unfortunately, the estate will have to have a January 31st year end, and a second 1041 tax return will have to be filed for the activity in February.

Also 26 USC §441(e) also answers this same question,

“For purposes of this subtitle, the term “fiscal year” means a period of 12 months ending on the last day of any month other than December.”

When is a debt discharged in bankruptcy?

When is a debt discharged in bankruptcy?

108(1)(1) talks about the exclusion from gross income by reason of discharge of indebtedness of the taxpayer.

The issue is what is the date of the discharge of the indebtedness in a Chapter 7 liquidation. For a large corporate bankruptcy the litigation of whether there is a legitimate debt may go on over a number of years while the corporation is in bankruptcy. Even though the corporation filed in year 1, the ultimate determination of whether the debt is legitimate, and what amount will actually be collected may be many years later. The Trustee may have preference action and fraudulent transfer litigation that goes on for years in trying to collect moneys for the creditors.

Even with a secured debt, the amount of COD may not be known until the Trustee’s final report is approved. For example, a secured creditor, ABC Mortgagee, has a Deed of Trust on a hotel worth 100,000,000. The property is foreclosed on in year 2 at a FMV of 80,000,000. Is the COD 20,000,000? The ABC Mortgagee is unsecured in the amount of 20,000,000. What if there are other assets in the corporation that are being liquidated by the Trustee and in year 4 the Trustee is able out of the remaining liquidated assets to pay the ABC Mortgagee 15,000,000 as an unsecured creditor. Now the COD is only 5,000,000. So what is the date of the discharge of the indebtedness. Year 4? Yes if Year 4 is the final year of the Corporation administration and all the assets have been abandoned, foreclosed, sold, collected, adjudicated, and admin expenses paid. The determination of what moneys are available for all claims is determined only upon the approval of the Trustees final report in year 4 of this example. There is no way of knowing what the final payouts will be until year 4.

In general, a debt is considered discharged at the point when it becomes clear that the debt will never have to be paid. Cozzi v. Commissioner, 88 T.C. 435, 445 (1987). The test for determining that point requires a practical assessment of all the facts and circumstances surrounding the likelihood of repayment of the debt. Id. Any “identifiable event” which fixes the loss with certainty may be taken into consideration. Id. (citing United States v. S.S. White Dental Mfg. Co., 274 U.S. 398 (1927)). The commencement of a bankruptcy proceeding is not an identifiable event. See Friedman v. Commissioner, 216 F.3d 537 (6th Cir. 2000), aff’g T.C. Memo. 1998-196; Alpert v. United States, 481 F.3d 404 (6th Cir. 2007), aff’g 430 F. Supp. 2d 682 (N.D. Ohio 2006). Private Letter Ruling 144654-10.
This issue is critical because under 108(b)(4) the attribute reduction Ordering Rules are made AFTER the year of the taxable year of the discharge. (108(b)(4) uses the word “discharge”, which I believe means “discharge of the indebtedness”, which is a separate issue from the discharge of a debtor and of course corporations never obtain a discharge 11 USC 727(a)(1).)

Reg Sec. 1.6050P-1(b)(2)(i) clarifies the date of discharge and the identifiable event under (b)(2)(i)(A), see below. This section again returns back to the issue of the actual date that it become clear that the debt will not be paid.
b) Date of discharge –

(1) In general. Solely for purposes of this section, except as provided in paragraph (b)(3) of this section, indebtedness is discharged on the date of the occurrence of an identifiable event specified in paragraph (b)(2) of this section.

(2) Identifiable events –

(i) In general. An identifiable event is –

(A) A discharge of indebtedness under title 11 of the United States Code (bankruptcy);

(B) A cancellation or extinguishment of an indebtedness that renders a debt unenforceable in a receivership, foreclosure, or similar proceeding in a federal or State court, as described in section 368(a)(3)(A)(ii) (other than a discharge described in paragraph (b)(2)(i)(A) of this section);

(C) A cancellation or extinguishment of an indebtedness upon the expiration of the statute of limitations for collection of an indebtedness, subject to the limitations described in paragraph (b)(2)(ii) of this section, or upon the expiration of a statutory period for filing a claim or commencing a deficiency judgment proceeding;

(D) A cancellation or extinguishment of an indebtedness pursuant to an election of foreclosure remedies by a creditor that statutorily extinguishes or bars the creditor’s right to pursue collection of the indebtedness;

(E) A cancellation or extinguishment of an indebtedness that renders a debt unenforceable pursuant to a probate or similar proceeding;

(F) A discharge of indebtedness pursuant to an agreement between an applicable entity and a debtor to discharge indebtedness at less than full consideration;

(G) A discharge of indebtedness pursuant to a decision by the creditor, or the application of a defined policy of the creditor, to discontinue collection activity and discharge debt; or

(H) In the case of an entity described in section 6050P(c)(2)(A) through (C), the expiration of the non-payment testing period, as described in § 1.6050P-1(b)(2)(iv).

When is a debt discharged in bankruptcy for a plan of reorganization?

For entities with an approved Chapter 11 plan of reorganization where for example a certain class will not be paid at all, then it is clear the debt will not be paid and the tax attributes will be reduced in the following year. If the approved Chapter 11 plan of reorganization is based on a percentage, then there is still a question on what that exact amount will be. Further, even if the plan allows for a fixed percentage or an amount certain, approximately 90% of all chapter 11 plans are eventually converted to a chapter 7 plan. And of course with the conversion to a chapter 7 plan the amount a creditor may receive can be reduced. Also the amount received can be reduced by the chapter 7 administrative expenses. For a secured creditor the issue would be whether they will have to wait under the chapter 11 plan until all the payments are made, or alternatively whether the plan will default and the secured creditor will be able to obtain a relief from stay and foreclose, and then at what price and when.

So when is a debt discharged in bankruptcy? Certainty in bankruptcy is elusive.

Please see your attorney or tax advisor for your specific legal issues and situation. The above should not be consider legal advice.

Can a “responsible person” take a deduction for trust fund liabilities paid?

When a company is not doing well, the withholding taxes are often not paid. The IRS in such cases can assess the “responsible person” for personal liability. The question becomes whether upon payment by the individual held responsible if that individual can take a deduction on their 1040 for trust fund liabilities.

So, an IRS agent will interview the people at the company who could have paid the withholding tax ( and instead paid suppliers, etc.) and make a determination of who is going to be held personally responsible for not having made the IRS payroll withholding deposits.

That “responsible person” is personally liable for the employee withholding taxes that were not paid. Collection action is then taken by the IRS against that individual.

And assuming the “responsible person” actually makes the payment, the question arises: can the responsible person take a tax deduction on their 1040?

Or, in the alternative, if not allowed an immediate tax deduction, can the responsible person, who is also a shareholder or partner, increase their basis in their stock or partnership interest by the amount of the payment?

A couple of practical points:

1. Most likely the corporation has already taken this same deduction and thus the “responsible person” is attempting taking the same deduction again.

How so? When the business made the entry for payroll it most likely looked like this example:

 

example

A. Even a cash basis taxpayer will be on an modified accrual method for payroll and thus accruing the payroll withholding taxes.

B. So in our example, the 20,000 is never paid by the business, and assuming all of the 20,000 is trust fund liability, then the responsible person would be liable.

So, when the “responsible person” tries to deduct the 20,000, the problem is the 20,000 was already included as part of the 100,000 salary deduction taken by the business.

C. The other point is that if the “responsible person”, who is a shareholder or partner, contributed the cash to pay the withholding tax liability of 20,000 before it got to the point of the IRS assessing the individual with the trust fund liability, then the shareholder/partner basis would be increased.

2. The IRC 162(f) specifically denies certain deductions:

(f) Fines and penalties

No deduction shall be allowed under subsection (a) for any fine or similar penalty paid to a government for the violation of any law.

3. Here is a case below where the responsible person argued that he could take a deduction personally as a business bad debt (this would be limited to 3,000 a year or offsetting capital gains) because the corporation agreed to indemnify him.

The Tax Court in Elliott V. Commissioner, 73 T.C.M. 3197 (1997), T.C. Memo 1997-294 states,

Petitioner is not entitled to deduct any portion of this amount. Even if we were to assume that EPC was required to indemnify petitioner for this payment, an assumption which we do not find as a fact, petitioner would be unable to deduct this amount because he paid it in settlement of amounts assessed against him under section 6672. Amounts paid for section 6672 assessments are nondeductible. See sec. 162(f); sec 1.162-21(b), Income Tax Regs; see also Arrigoni v. Commissioner [Dec. 36,758], 73 T.C. 792 (1980); Patton v. Commissioner [Dec. 35,589], 71 T.C. 389 (1978); Smith v. Commissioner [Dec. 24,365], 34 T.C. 1100 (1960), affd. per curiam [61-2 USTC ¶ 9686] 294 F.2d 957 (5th Cir. 1961); Duncan v. Commissioner [Dec. 49,222(M)], T.C. Memo. 1993-370, affd. [95-2 USTC ¶ 50,547] 68 F.3d 315 (9th Cir. 1995).

The answer is “No”, a “responsible person” cannot take a deduction on their 1040. The answer can be “Yes” if a “responsible person” makes the capital contribution to the cash account and pays the taxes before the trust fund liability penalty is assessed.

Please see your attorney or CPA for answers to your particular situation.

Have you changed your name? This will affect the processing of your tax return.

Did you know that a name change could impact your taxes? Here’s what you need to know:

1. Report Name Changes. Did you get married and are now using your new spouse’s last name or hyphenate your last name? Did you divorce and go back to using your former last name? In either case, you should notify the SSA of your name change. That way, your new name on your IRS records will match up with your SSA records. A mismatch could unexpectedly increase a tax bill or reduce the size of any refund.

2. Make Dependent’s Name Change. Notify the SSA if your dependent had a name change. For example, this could apply if you adopted a child and the child’s last name changed. If you adopted a child who does not have a Social Security number, you may use an Adoption Taxpayer Identification Number on your tax return. An ATIN is a temporary number. You can apply for an ATIN by filing Form W-7A, Application for Taxpayer Identification Number for Pending U.S. Adoptions, with the IRS.

3. Get a New Card. File Form SS-5, Application for a Social Security Card, to notify SSA of your name change. You can get the form on SSA.gov or call 800-772-1213 to order it. Your new card will show your new name with the same SSN you had before.