Treasury Direct (no TIPS or Series I) and taxes

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marcos123
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Treasury Direct (no TIPS or Series I) and taxes

Post by marcos123 »

I am thinking about diversifying my US portfolio with individual USG notes and bonds (no TIPS or Series I) with semi-annual interest payouts via Treasury Direct. This would be in my taxable account, and my other key objective is to absolutely continue to keep my US tax reporting simple. My question is: if I make all purchases via their web site, and hold to maturity, never buying or selling on the secondary market, would I just report Interest Income on Schedule B from 1099s to be received that reflect the year's interest payouts; or would I still have to contend with potentially amortizing premiums and accreting discounts, and that attendant tax reporting headache as well? Apologies if this is overly simplistic - but KISS is really important to me from a tax perspective for my US portfolio. (Somewhat ironically I found the tax tab on their site unhelpful and did run a search here first.) Thanks for any insights.
stlutz
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Re: Treasury Direct (no TIPS or Series I) and taxes

Post by stlutz »

A few comments. Please read the whole post before my comment #1 scares you off. :D

1) You would still have amortization and [less likely] OID to worry about. Because the bonds are auctioned, they are not sold at exactly par. For discount bonds, you have to pay OID if the discount is more than .25% per year. If not, you'll pay capital gains tax on the difference at maturity.

These are the examples the IRS uses in Pub 550.
Example 1.

You bought a 10-year bond with a stated redemption price at maturity of $1,000, issued at $980 with OID of $20. One-fourth of 1% of $1,000 (stated redemption price) times 10 (the number of full years from the date of original issue to maturity) equals $25. Because the $20 discount is less than $25, the OID is treated as zero. (If you hold the bond at maturity, you will recognize $20 ($1,000 − $980) of capital gain.)

Example 2.

The facts are the same as in Example 1 , except that the bond was issued at $950. The OID is $50. Because the $50 discount is more than the $25 figured in Example 1, you must include the OID in income as it accrues over the term of the bond.
With amortization, you would want to amortize any premium as that is most advantageous from a tax perspective.

#2) With the cost basis regulations that took effect in 2014 for "simple" fixed income like regular T-notes, your broker/intermediary has to track all of this for you. So, if there is amortization it will be on your 1099. If there is market discount, it will be included as interest income on your 1099. If there is a capital gain, they will report the cost basis to you just as if it was a mutual fund/ETF/stock. You don't have to manually track any of this yourself.

#3) If you want to do this, you should not use Treasury Direct. Their reputation around here for customer service is poor. Many brokers let you buy *and* sell Treasuries both at auction and in the secondary market for no commission (Note: you couldn't sell for free at Treasury Direct if you needed/wanted to). You can participate in the exact same action and get the exact same price at Fidelity as at TD and get good customer service to go with it. Again, they have to keep track of all of the tax stuff for you, so you just have to enter numbers from your 1099 into your tax software/tax form and that's it.
Coles
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Re: Treasury Direct (no TIPS or Series I) and taxes

Post by Coles »

stlutz wrote:1) You would still have amortization to worry about.
There's a fairly small likelihood that an auction will result in a price above par. The auction yield on notes/bonds would need to be less than 0.125%. Although the 2-yr did get close to that a couple of years ago.
dbr
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Re: Treasury Direct (no TIPS or Series I) and taxes

Post by dbr »

I personally have chosen not to operate with the addition of TD as another agent holding assets just to be able to carry individual treasury bonds. I didn't like their approach to account management and customer interaction. Maybe they are different now but when they mailed out that plastic card gimmick that you needed to get on your account that was the end for me.
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#Cruncher
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Re: Treasury Direct (no TIPS or Series I) and taxes

Post by #Cruncher »

stlutz in [url=https://www.bogleheads.org/forum/viewtopic.php?p=2393417#p2393417]this post[/url] wrote:1) You would still have amortization and [less likely] OID to worry about. Because the bonds are auctioned, they are not sold at exactly par. For discount bonds, you have to pay OID if the discount is more than .25% per year. If not, you'll pay capital gains tax on the difference at maturity.
As long as you buy at the initial auction and as long as the yield is 1/8% or more (as Coles says), you won't have to worry about either amortization or OID. This is because the price will always be at par or with a discount less than the 0.25% per year de minimis amount mentioned in this IRS publication. This is because at the initial auction the Treasury first determines the yield the issue will earn and then sets the coupon equal to or less than the yield in 1/8% increments. The biggest discount will be when the coupon is 0.124% points less than the yield as shown in this table:

Code: Select all

                                   Max      de min-
Term   Yield    Coupon   Price   Discount  imis OID
----   -----    ------   ------  --------  --------
   2   0.624%   0.500%   997.54     2.46      5.00
   3   0.999%   0.875%   996.34     3.66      7.50
   5   1.499%   1.375%   994.05     5.95     12.50
   7   1.749%   1.625%   991.86     8.14     17.50
  10   1.999%   1.875%   988.81    11.19     25.00
  30   2.624%   2.500%   974.36    25.64     75.00
In all cases the discount is less than half the de minimis amount. Thus you won't have to report OID each year. You'll only have to report the discount as a capital gain at maturity. However, if you purchase at a reopening rather than an initial auction, the price can be at either a premium or a discount to par, and can exceed the de minimis amount.

Other points:
  • In many cases you pay a small accrued interest even for a purchase made at an initial auction. To reduce your taxes, you'll want to list this as a negative amount on your tax return for the year of purchase. You can avoid this is by buying Treasury bonds where the Issue date is the same as the Dated date. These will have no accrued interest.
  • If you want to minimize tax accounting, consider either "EE" or "I" type Savings Bonds. You only have to report interest in the year you redeem them.
  • I would only use TreasuryDirect for Savings Bonds. For marketable Treasury bonds, I concur with stlutz and dbr and suggest using a broker -- like Fidelity, Schwab, or Vanguard.
Iorek
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Re: Treasury Direct (no TIPS or Series I) and taxes

Post by Iorek »

dbr wrote:I personally have chosen not to operate with the addition of TD as another agent holding assets just to be able to carry individual treasury bonds. I didn't like their approach to account management and customer interaction. Maybe they are different now but when they mailed out that plastic card gimmick that you needed to get on your account that was the end for me.
They are long past that. Aside from a few small things, such as don't try to click "back" on their website and you need to remember to download your 1099, I find TD to be easy and not a problem at all to use. YMMV.
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marcos123
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Re: Treasury Direct (no TIPS or Series I) and taxes

Post by marcos123 »

Many thanks for all the responses - very helpful.
stlutz wrote:
With amortization, you would want to amortize any premium as that is most advantageous from a tax perspective.
Understood.

But just for simplicity sake, instead of amortizing the premium:

- I could still opt to use the default option, right, with the purchase price as cost basis, and then take a capital loss on the premium when the bond matures at face value (or if I sell the bond for less than the cost basis)? And there certainly would be no non-compliance or tax penalty for not amortizing the premium, right? (On the contrary, I would expect, given the increased taxes!)
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marcos123
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Re: Treasury Direct (no TIPS or Series I) and taxes

Post by marcos123 »

bump - Could one of the fixed income experts just confirm my understanding above? Many thanks in advance.
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Re: Treasury Direct (no TIPS or Series I) and taxes

Post by #Cruncher »

marcos123 in [url=https://www.bogleheads.org/forum/viewtopic.php?p=2397981#p2397981]this post[/url] wrote:But just for simplicity sake, instead of amortizing the premium: I could still opt to use the default option, right, with the purchase price as cost basis, and then take a capital loss on the premium when the bond matures at face value ...? And there certainly would be no non-compliance or tax penalty for not amortizing the premium, right?
The word "choose" in the following quote from Bond Premium Amortization in IRS Pub 550 Chapter 3 implies that you are correct and do not have to amortize bond premium:
If 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 the premium. (emphasis added)
it makes sense that the IRS would give you this option, since it is to its benefit if you don't amortize the premium.

However, it may be different if you purchase the bond at a discount. As I stated in my previous post, if you buy a Treasury bond at the initial auction and its coupon is at least 1/8%, the price will be at a discount and the discount will be small enough (de minimis) that it's OK not to accrue it every year. However, if you purchase at a reopening auction, it's possible that the price might be at a discount that is not de minimis. If the the IRS considers this to be an original issue discount, you're required to accrue it each year. However if the IRS considers this to be a market discount, it appears from the word "choose" in this quote in Market Discount in IRS Pub 550 Chapter 1 that you need not accrue it:
When you buy a market discount bond, you can choose to accrue the market discount over the period you own the bond and include it in your income currently as interest income. (emphasis added)
Topic Author
marcos123
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Re: Treasury Direct (no TIPS or Series I) and taxes

Post by marcos123 »

Many thanks #Cruncher!
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