I was just looking at my 2022 Fidelity Form 1099 and noticed that Fidelity has included the "Accrued Interest Paid on Purchases" on secondary market purchases in the interest I earned for 2022. e.g.; I bought UNITED STATES TREAS NTS NOTE 2.75000% 11/15/2023 (CUSIP: 912828WE6) in the secondary market on 10/15/2022 and paid five months of the accrued interest to the seller. Coupon is paid every six months on Nov 15 and on May 15. I was expecting Fidelity to report on my 2022 Form 1099 a one month interest (i.e., six month coupon I received on 11/15/2022 minus the five months of accrued interest I paid to the seller) but Fidelity reported the full coupon I received on 11/15/2022 as "Interest on U.S. Savings Bonds and Treas. Obligations" on line 3 of my 2022 Form 1099-INT. Worse case, I would have been fine Fidelity accruing and reporting 2.5 months of the interest income (10/15 -12/31/2022) on my Form 1099.
(The Note is not an OID bond and I did not make any elections w/r/t market discounts and premiums with Fidelity.)
I would appreciate forum members sharing their experience of how their brokerage reported on their Form 1099-INT w/r/t Treasury Obligations with coupons purchased on the secondary market. (I plan to dispute Fidelity's reporting but wanted to check with you guys about your experience.)
Also, if anybody had purchased Treasury notes / bonds (not Bills) with market discount mature in 2022, please share with us if Fidelity reported the receipt of the par amount minus the principal you paid to purchase the Treasuries as an additional interest income or as capital gain. (Capital gains can be subject to State income tax while interest income on Treasury obligations is exempt from State income tax.)
(I am assuming Fidelity is reporting interest income correctly on (zero coupon) Treasury Bills.)
Thank you.
A
Comments
Five months interest was paid in your name that belonged to the seller. You are the "nominee" for this payment. Declare the full amount on Sched B, line 1, and at the bottom of that line you subtract the accrued interest paid to the seller as a "Nominee Distribution".
https://www.irs.gov/instructions/i1040sb#en_US_2022_publink100059769
Your: "Declare the full amount on Sched B, line 1, and at the bottom of that line you subtract the accrued interest paid to the seller as a "Nominee Distribution"."
I have to subtract the accrued interest paid to the seller as "Accrued Interest" and not as "Nominee Distribution."
(If it were a Nominee Distribution, I will be required to issue a Form 1099-INT to the person I paid the accrued interest. I have no way of knowing the seller. The word Nominee has a legal connotation and I have not undertaken to be or function as a nominee for the seller.)
Looking at the instructions to form 1099-INT, the brokerage (in this case) is required to report on a Form 1099-INT issued to the seller the amount of accrued interest received from me upon sale of their bond.
(Not looking for a comment but just noting the reality - The issue discussed here is a trap for the unwary created by the reporting rules convenient for the IRS and the financial intermediaries, who always aspire to do the least amount of perceived work possible and the IRS on the other hand would rather have more income reported than require (fight) the financial intermediaries to report on the buyer's Form 1099-INT only the amount of interest beneficially received by the buyer (coupon received minus accrued interest paid to seller).
Good thing I caught this before filing my tax return. I checked with some friends and family and they all filed without taking a deduction for the accrued interest paid over to the seller. Good for the IRS, some of them do not want to spend the time to file an amended return to get a refund.
P.S.: 2022 is the first year I bought bonds in my taxable account. I have purchased bonds in the IRA going as far back as post GFC.
Thank you.
I hope to remember to post when I figure that out but if any of you have an experience with this, please share.
@yogibearbull For sure ! I thought that was part of his problem. Also , now I'm wondering why Preparer didn't catch this.
It's your option whether to declare the imputed interest from market discount annually or upon sale/redemption. https://www.thetaxadviser.com/issues/2007/oct/taxtreatmentofmarketdiscountbonds.html
IRC 1278(b)
Sample form (from TIAA) for notifying broker of election
Baird has a nice seven-pager on tax treatment of market premium and market discount.
Note that despite the ratable method being the default method for calculating accrued interest, the IRS presumes you are using the constant yield method unless you explicitly declare otherwise. The instructions for box 10 on the 1099-INT explain how this works.
Form 1099-INT with instructions
The constant yield method works to your advantage, as it represents compounding of interest. So interest accrues more slowly at first and then faster as it compounds. The ratable acccrual method is linear - the fraction of the time to maturity that you hold the bond is the fraction of the discount that you accrue as interest.
Also "It's your option whether to declare the imputed interest from market discount annually or upon sale/redemption. " Does that hold for notes ?
Just an FYI for others, the Constant Yield Method vs Ratable Method are relevant only if the Treasury Obligation is sold before maturity. That is, one does not need to worry about these if held to maturity.
I looked at only the first 1/2 page of Baird write up @msf linked and can say that it is a very good write up for anybody interested in learning / refresher about Bonds / Notes, even if the tax issues mentioned in this thread are not relevant for you.
It seems I can take a deduction for Accrued Interest in the year paid (and not wait until the next year in which related coupon payment was received.)
https://www.irs.gov/pub/irs-pdf/p538.pdf see Expense Paid In Advance under Cash Method on page 8.
I paid Accrued Interest on some bonds in 2022 but the first coupon was not paid to me until 2023. This created more Accrued Interest paid than Interest Income from Treasury obligations in 2022. It seems I can take a deduction for all the Accrued Interest paid in 2022. My overall interest income is higher than Accrued Interest paid and so Line 2, Schedule B will not be negative.
Initially, I was planning to take a deduction only when the related interest income (coupon) was taken into account because that provides better matching of income and deduction. But as a cash basis taxpayer it felt weird to defer the deduction of Accrued Interest paid to the following year. Taking a deduction in the year paid also did not harm the IRS or any taxpayer. Yr 1, Seller reports income, Buyer reports the deduction for the same amount, and the IRS receives the tax on coupon in Yr 2 when it would have received if the seller did not sell the bond.
What would you do - when would you take the deduction for the accrued interest paid?
Thanks.
"Market discount on a tax-exempt security is includible in taxable income as interest
income."
See the last sentence under Line 10 instructions to recipient of Form 1099-INT - https://www.irs.gov/pub/irs-pdf/f1099int.pdf
It was inconceivable to me that the IRS (i.e., tax rules) would make a distinction between new vs previously issued tax exempt securities in the total amount of taxable income recognition. I must be missing something here because this would artificially depress secondary market for tax-exempt securities, leading to more liquidity issues. May be just like the bank stress tests, the tax rules are myopic and assume that market discount is created by credit events and not by interest rate changes.
Form 1099-INT instructions for the payer. https://www.irs.gov/pub/irs-pdf/i1099int.pdf
The payer instructions do not tell me where on Form 1099-INT the brokerage reports market discount on a Treasury obligation accrued at maturity (i.e., no election to include annually is made). My Fidelity account currently shows the market discount paid to me in 2023 under Total Realized Gain / Loss (Tax Info (Year-to-Date)). I am guessing this Accrued Market Discount received will be reported on Form 1099-B under item 1(f). I had asked a Fidelity rep about Form 1099 reporting of Accrued Market Discount and he said it will be reported on Form 1099-INT just like interest on Treasury Bills is reported.
https://thismatter.com/money/bonds/bond-income-taxation.htm
It has a section entitled US Treasuries that starts: "US Treasuries are taxed like other bonds and notes." It goes on to say that T-bills, being short-term debt (maturing in a year or less) are taxed at maturity, with the "gain" being taxed as ordinary income.
That "tax at maturity" rule for short-term debt is the reason why you don't have to pay tax on CDs of a year or less until maturity. But you have to declare interest annually on longer term CDs.
@BaluBalu - cash basis accounting is just the way most people naturally operate. Think of it as "checkbook accounting", or "cash flow accounting."
https://www.shopify.com/blog/what-is-cash-basis-accounting
As an example, one December I did some consulting cross country. I incurred my expenses in December and declared them on that year's tax return. The business mailed me a check between Christmas and New Years' and booked its expense that year. I received the check in the mail in early January. I declared the income the year I received the check, not the year I earned the income.
Cash basis accounting is not a way to magically transform investments into operating expenses. When you purchase a bond at a premium, part of each coupon payment is considered return of principal. If you pay $110 for a $100 bond, you don't get to deduct the premium when you make the investment. You reduce the taxable amount of each interest payment as the premium amortizes.
Same thing here - you're paying up front for a higher cash flow down the road. Not advice, only describing the way I would treat it.
Thank you for your time, Derf
"Expense paid in advance. An expense you pay in advance is deductible only in the year to which it applies, unless the expense qualifies for the 12-month rule.
Under the 12-month rule, a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of
the following.
• 12 months after the right or benefit begins, or
• The end of the tax year after the tax year in which payment is made."
Page 8 Publication 538 (January 2022)
One of the benefit of taking a deduction in the year Accrued interest is paid to the sellers is it eliminates for me accrued interest deduction recording keeping on a bond by bond basis. Less chance of making a mistake and over or under reporting the deduction. Accelerating deductions is not important to me because I always have tons of tax overpayment which I always roll all of it into the next year estimated taxes. It is more important for me to get my tax returns done right so I do not have to revisit them in audits.
I was only asking what you would do so I may know the benefits of your choice that I may not have thought through. No need to answer.
Here's the 12 month rule for intangibles: 26 CFR § 1.263(a)-4
You can go reading through all the exceptions and draw a legal conclusion, or you can apply some common sense. Virtually all bonds with coupon payments make payments at least annually. So if you buy a bond between interest dates, it is nearly certain that there will be a coupon payment within a year that more than covers any accrued interest you paid to the seller.
Consequently, if we assume that the 12-month rule applies to your bond, then it applies to virtually all bonds bought with accrued interest. So it is curious that the Sched B instructions say only that you can declare prepaid interest there if you get a 1099-INT. https://www.irs.gov/pub/irs-prior/i1040sb--2022.pdf
I don't think you can willy nilly enter items on a tax Schedule when there's no instruction for it. You can't decide that you'll put your capital losses on Schedule B, though that would reduce your taxes. Instructions say what you can or must put on a schedule. They don't say what you can't or mustn't include. That's just common sense.