Reporting taxes for TIPS bonds in taxable account

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dual
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Reporting taxes for TIPS bonds in taxable account

Post by dual »

[edited title to clarify this was about TIPS bonds - moderator prudent]

I am trying to understand how much of a hassle it is to buy and hold tips in a taxable account. To be specific I’d like to use the example of buying the five-year tips at the upcoming June 23, 2022 auction in my Schwab account. Here’s a scenario from my reading on tips. Please correct any mistakes. If you make a correction I would appreciate your reference to the correction.

Although I am interested in questions about the tax efficiency of doing this, that is not the topic of this thread. The topic is the mechanics of paying and reporting the taxes.

I will assume that there is no deflation during the period when I own the bond.

Cost basis of the bond: Although the purchase price will include effects of changing interest rates and the inflation adjustment, I assume that from the point of view of taxes this will be my basis.

Annual taxable interest. Every year starting with tax year 2022 and continuing through tax year 2027, I will receive a 1099int for the interest and a 1099 OID for the inflation adjustment during that year. Both are taxed by the federal government as ordinary income but they are state tax free.

Taxes due at maturity. When the bond matures on April 15, 2027, Schwab will issue a 2027 1099B for the amount I receive from the Treasury. I will also receive interest and an OID adjustment in 2027 and those will be reported on 2027 1099int and 1099 OID. I will include those in my 2027 income.

I will need to keep track of the OID payments over the years and I get to add them to the 2027 1099B basis to determine the taxable amount

Questions: is the difference between the amount I receive at maturity and the sum of the purchase price plus the OID payments taxed as a long-term capital gain or is it interest? Is it taxable by my state?

Record keeping. It looks like I have to keep track of my initial purchase price plus the annual OID payments.

Comments and corrections welcome.
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HueyLD
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Re: Reporting taxes for tips in taxable account

Post by HueyLD »

IRS Pub 1212 has a section on TIPS taxation and it is very good.

https://www.irs.gov/publications/p1212# ... 1000206402

Some quotes:

“In general, if you hold an inflation-indexed debt instrument, you must report as OID any increase in the inflation-adjusted principal amount of the debt instrument that occurs while you held the debt instrument during the tax year. You must include the OID in gross income whether or not you hold the debt instrument as a capital asset. Your basis in the debt instrument is increased by the OID you include in income.

Inflation-indexed debt instruments acquired on or after January 1, 2016, are “covered securities.” Dispositions of covered and noncovered securities must be reported on Form 8949.
….
Form 1099-OID. The amount shown in box 8 of the Form 1099-OID you receive for an inflation-indexed debt instrument may not be the correct amount to include in income. For example, the amount may not be correct if you bought the debt instrument other than at original issue or sold it during the year. If the amount shown in box 8 is not correct, you must figure the OID to report on your return under the following rules.

Stated interest. Under the coupon bond method, you report any stated interest on the debt instrument under your regular method of accounting. For example, if you use the cash method, you generally include in income for the tax year any interest payments received on the debt instrument during the year.

Deflation adjustments. If your calculation to figure OID on an inflation-indexed debt instrument produces a negative number, you do not have any OID. Instead, you have a deflation adjustment. A deflation adjustment is generally used to offset interest income from the debt instrument for the tax year. Show this offset as an adjustment on your Schedule B (Form 1040 or 1040-SR) in the same way you would show an OID adjustment.“

Etc. etc.
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dual
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Re: Reporting taxes for tips in taxable account

Post by dual »

Thanks. Here are some other information sources I have come across:

TIPS: Tax Considerations
https://www.treasurydirect.gov/indiv/r ... s_tax.htm
——
TIPS: FAQs
https://www.treasurydirect.gov/indiv/r ... s_faq.htm
——
TreasuryDirect, TIPS and the dreaded 1099-OID
Posted on March 28, 2013 by Tipswatch
https://tipswatch.com/2013/03/28/treas ... 1099-oid/
—-
Original Issue Discount (OID) – Form 1099-OID
https://www.hrblock.com/tax-center/irs ... ount-oid/
FactualFran
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Re: Reporting taxes for tips in taxable account

Post by FactualFran »

dual wrote: Thu Jun 16, 2022 11:17 am Questions: is the difference between the amount I receive at maturity and the sum of the purchase price plus the OID payments taxed as a long-term capital gain or is it interest? Is it taxable by my state?
It depends on the unadjusted price determined by the auction. It is likely that the unadjusted price will be less than 100 because the real yield on that security is now positive. It is likely that the discount (price less than 100) will large enough that the discount should be accrued on the income tax return of each year you own the TIPS. The accrued discount will be taxed as income from the U.S. Government.

As HueyLD mentioned the TIPS are "covered" securities. The broker should provide you with amounts to be reported on your income tax returns without any adjustments by you. A possible exception is that the broker will not adjust the taxable income of the first interest payment for the accrued interest included in the settlement amount. You may need to report an accrued interest adjustment on your income tax return.
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dual
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Re: Reporting taxes for tips in taxable account

Post by dual »

Another issue is bond premium amortization. This occurs when you buy a bond with a coupon rate above the market rate and you have to pay a price that's above the par amount. You can amortize the premium to reduce the taxes you owe on the interest. To me it's not worth the hassle. The alternative is to treat the premium paid as a capital loss to reduce taxes when the bond matures. I assume the broker gives you information to compute the loss with the 1099B.
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HueyLD
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Re: Reporting taxes for tips in taxable account

Post by HueyLD »

dual wrote: Wed Jun 22, 2022 10:12 am Another issue is bond premium amortization. This occurs when you buy a bond with a coupon rate above the market rate and you have to pay a price that's above the par amount. You can amortize the premium to reduce the taxes you owe on the interest. To me it's not worth the hassle. The alternative is to treat the premium paid as a capital loss to reduce taxes when the bond matures. I assume the broker gives you information to compute the loss with the 1099B.
Where do you hold TIPS?

I think each brokerage provides its own basis amortization, accretion and similar adjustments. For example, Fidelity provides the following:

“ Adjusted cost basis information is shown where this indicator is displayed. Adjusted cost basis reflects any cumulative original issue discount, premium, or acquisition premium (including any year-to-date amount).

It assumes such amounts were amortized or accrued for tax purposes from the acquisition date through the disposition date. Premium amortization was calculated using the yield-to-maturity method. Acquisition premium was calculated using the ratable accrual method. Any market discount accretion for this position was calculated using the constant yield method unless a different fixed income election has been made and, if applicable, recognized upon disposition.

Gain/loss displayed for this transaction is calculated using the cost basis adjustments, as described above. The adjusted cost basis used here may not reflect all adjustments necessary for tax purposes (such as wash sale adjustments) and may not apply if you are using an alternative amortization calculation method. Refer to IRS Publication 550, Investment Income and Expenses, for additional information.”
Hyperchicken
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Re: Reporting taxes for tips in taxable account

Post by Hyperchicken »

The title is a bit misleading. "TIPS" and "tips" are both a thing and are very different.
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dual
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Re: Reporting taxes for tips in taxable account

Post by dual »

It assumes such amounts were amortized or accrued for tax purposes from the acquisition date through the disposition date. Premium amortization was calculated using the yield-to-maturity method. Acquisition premium was calculated using the ratable accrual method. Any market discount accretion for this position was calculated using the constant yield method unless a different fixed income election has been made and, if applicable, recognized upon disposition.
Does Fidelity report the annual amortization amount with the 1099int and 1099OID?

I wonder if the IRS will flag my return if I use a different cost basis than the one computed by Fidelity?
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dual
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Re: Reporting taxes for tips in taxable account

Post by dual »

Hyperchicken wrote: Wed Jun 22, 2022 10:54 am The title is a bit misleading. "TIPS" and "tips" are both a thing and are very different.
The first two sentences of the original post make it clear that I am discussing individual bonds. The taxation of a tips exchange traded fund is also an interesting topic and worthy of its own thread. For example, the state taxability depends on the laws of each individual state.
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HueyLD
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Re: Reporting taxes for tips in taxable account

Post by HueyLD »

dual wrote: Wed Jun 22, 2022 1:21 pm Does Fidelity report the annual amortization amount with the 1099int and 1099OID?

YES.

I wonder if the IRS will flag my return if I use a different cost basis than the one computed by Fidelity?

SEE INSTRUCTIONS FOR FORM 8949 re: How To Complete Form 8949, Columns (f) and (g)
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AerialWombat
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Re: Reporting taxes for tips in taxable account

Post by AerialWombat »

dual wrote: Wed Jun 22, 2022 1:27 pm
Hyperchicken wrote: Wed Jun 22, 2022 10:54 am The title is a bit misleading. "TIPS" and "tips" are both a thing and are very different.
The first two sentences of the original post make it clear that I am discussing individual bonds. The taxation of a tips exchange traded fund is also an interesting topic and worthy of its own thread. For example, the state taxability depends on the laws of each individual state.
I think Chicken was referring to potential confusion between TIPS and tip income, as a waiter or cab driver would receive.
This post is a work of fiction. Any similarity to real financial advice is purely coincidental.
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