Download March 2015 Financial Planning Bulletin

March 2015 Financial Planning Bulletin
Bond Premium Amortization - 2014 tax reporting dilemma
The Emergency Economic Stabilization Act of 2008 included a series of phased tax reporting requirements that
dramatically change the way taxpayers and investment custodians manage cost basis, gain/loss and interest income
reporting. Beginning with calendar year 2014 (Form 1099s that were just received), new IRS rules instructed
custodians to change how they report fixed income securities purchased at a premium or discount. Thus, you will
notice a new section on your Form 1099 Composite called Amortization and Accretion for Fixed Income.
Adding some confusion to the situation created by IRS Regulations and instructions to firms, custodians like
Charles Schwab and TD Ameritrade are only required to calculate this bond premium interest offset for bonds
acquired in 2014 forward called "covered bonds." Thus, the bond premium interest figure you see on your Form
1099 does not include any premium amortization from existing bonds in your portfolio acquired in earlier years,
which are considered "noncovered bonds" by the IRS. These calculations would need to be completed by your CPA
or tax preparer. Finally, fixed income instruments deemed more complex (variable rate, convertible, foreign or
inflation adjusted bonds) have further reporting requirements to begin no later than calendar year 2016.
Background Information: With interest rates dropping significantly since the financial crisis height of 2009, most
bonds that Frontier purchases for clients are existing issues in the secondary market. Many of these bonds were
issued at a point in time when coupon rates averaged 5 - 6%. Thus, we typically have to pay a premium (can be up
to 10% range) to acquire such bonds. But doing so allows us to control duration (average maturity) and avoid
unnecessary interest rate risk. When you pay a premium to buy a bond, the premium is part of your basis in the
bond. If the bond yields taxable interest, you can choose to amortize this premium only by filing an IRC Section
171 statement with your tax return. This generally means that each year, over the life of the bond, you use a part
of the premium to reduce the amount of interest includible as income. If you make this election, you must reduce
your basis in the bond by the amortization amount for the year.
If the bond yields tax-exempt interest, you must amortize the premium. This amortized amount is not deductible in
determining taxable income. However, each year you must reduce your basis in the bond (and tax-exempt interest
otherwise reportable on Form 1040) by the amortization for the year. In some cases, bondholders have been known
to buy and sell bonds specifically to recognize capital gains (at reduced tax rates) that increase the cost basis of the
investment and/or allow the bondholder to deduct the amortized premium (marginal tax rates) of a bond with
above-par market value from taxable interest income.
Specific action items required
1) Forward this alert along with your custodian Form 1099s to your CPA or tax preparer.
2) Have your CPA advise you of the Section 171 election and whether it would be worth the extra steps and
expense in your particular case.
3) Be advised that further clarification on these new reporting rules are being sought by numerous CPA
associations and reporting laws could change again in the near future.
Eric Kordsmeier, CFP®, AEP®, Director - Financial & Estate Planning
Frontier Investment Management Company does not offer tax or legal advice. Please consult with your Attorney and/or CPA for
specific tax or legal matters and to implement any strategies discussed herein.