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Level 4

Question

Accrued Market Discount on Treasury Bonds State Taxability

Forum|Forum|2 years ago
September 20, 2023
10 replies
40 views

This thread is specifically to discuss how to get Turbotax to handle accrued market discount on Treasury bonds relative to preserving the state tax exemption on Treasury interest.

This year Turbotax picked up the accrued market discount all by itself from the downloaded 1099 from my brokerage. It showed as interest for each bond it found, itemized separately, nicely written out on Sched B and supplemental forms.

Then TT also did the trick of showing it as cap gain and then adjusting it out, so the effect on cap gains is zero. So far so good.

But it did not offer a way to get the Treasury accrued market discount onto Schedule CA column B subtractions, which is where in California you exempt your Treasury interest from state taxes.

My CPA, using different software, put it in Schedule CA column z, "Other Income". When I tried this the California number was right, but it also increased my Federal income, so no go.

I then tried overriding Line 2 Schedule CA, and this seems to work. Don't know if TT would let me file with this override, though.

I realize my post has been specific to California, but it must be a common issue for all states.

Any other ideas? Let's limit the discussion to those of us who believe that accrued market discount on Treasuries is non-taxable to states, just like interest, as per Pub 550.

Anonymous_

Level 15

Contact Support.

How do I contact TurboTax? (intuit.com)

bluepost22Author

Level 4

You must have had very different experiences with Support. Others have tussled with this, hoping to see if anybody cracked it.

Greg Brown

Level 3

Did you ever get this resolved? I have exactly the same issue with my Hawaii taxes, using TurboTax 2024. I've tried to call support 3 times now and have had no success resolving it.

DetroitRick

Level 2

Just wanted to say, I'm having the exact issue you describe (but for Michigan vs. Cali.). My issue occurs with Notes vs. Bonds, but this is the same exact Accrued Market Discount issue as you referenced.

Solutions I've read elsewhere, essentially recommending creation of a fictious 1099INT with all Treasury-related fields combined into Box 3 (Interest on .. Treasury Obligations), didn't work. So Accrued Market Discount on Notes would be combined with periodic interest payments on Notes, plus purchase discounts on any Bills. Unfortunately, the Accrued Market Discount field is populated anyway from the adjustments on our broker's 1099-B (yours and mine, apparently), resulting in a doubling of that particular "Interest" component on Federal. So it didn't work.

My Plan B, unless I can find a fix for this, is to override the Treasury subtraction (one field) on my state form as you mentioned, increasing it by the amount of Accrued Market Interest, not properly deducted. It works in the sense that my numbers are then reported correctly and TT reviews complete just fine. I've posted elsewhere to see whether that override on the state return will preclude state efiling, as it supposedly would for Federal.

Plan C is just to override the field and file my state return on paper.

As you probably know, not every state preparer will run into this since some states don't allow this subtraction (I've heard Illinois, but haven't confirmed). But both California and Michigan do allow it. I'm surprise more people, given the current bond market, aren't raising the issue.

Glad you posted. Hope someone can answer. I am NOT calling TT suport...

Greg Brown

Level 3

FWIW, I think it *might* be a conscious decision on the part of Intuit to not transfer the Accrued Market Discount to state returns. I read in one place where a tax expert said Accrued Market Discount is not the same as interest paid by the government. This seems completely wrong to me, as Fidelity even reports it directly as box 3 interest on the 1099-INT in the case of zero coupon T-bills. I called my local tax office in Hawaii and spoke to an auditor who told me it was deductible, so I have no concerns. Bottom line, it seems like there's a lot of uncertainty around how to properly handle Accrued Market Discount.

In my situation, I had already e-filed both federal and state returns when I discovered the problem. This is my first year doing state income tax (HI) in over 15 years, having previously lived in a state (WA) without income tax. So, what I did was amend my return in TurboTax, removing the capital gains entries and adding the Accrued Market Discount amount as 1099-INT box 3 entries on the federal return. You'll notice in doing this that the federal amount owed/refund does not change, as it should be. I went on to amend the state return, which now pulled the US government interest in correctly. I'm having to file the amended state return by mail.

Pammy2

Level 2

I am having the same problem for Nebraska. Planning to call the NE Dept of Revenue tomorrow to be sure the Accrued Market Discount on Treasuries is not taxed in Nebraska. If so, I too do not know how to handle it it TT. Very frustrating! Hope not to have to file NE by paper.

CKONDO

Level 2

This is a post from Bogleheads.org that mirrors the position my tax advisor gave me when reviewing my TT returns:

OID from a government entity is treated as tax-exempt interest for federal tax purposes. Market discount interest is not. The position of the Treasury is that OID is (equivalent to) interest paid directly to the government entity, whereas the market discount is NOT paid to the government entity, but to the after-market seller of the bond.

Although I haven't been able to locate any specific references, I'm certain that the state tax authorities will take the identical position in respect to U.S. treasury bonds, i.e. OID is tax-exempt, market-discount is not.

bluepost22Author

Level 4

In my original post I asked if we could limit the discussion to "how-to", and leave "whether-to" aside.

However, IRS Pub 550, page 14 says: "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."

In California the taxing authority is, as far as can be detected, completely silent on the issue. So we go ahead and treat it as non-taxable Treasury interest and if the FTB doesn't like it we'll deal with it later. California has a form "CA" where you make adjustments to your Fed interest declarations. That seems like the place to back it out.

DetroitRick

Level 2

All brokers offer a choice on treatment of discounts for Treasury Notes and Bonds, at least the one's that I am familiar with. Schwab, for example, defaults to recognize the market discount in maturity year, unless you ELECT to accrue it. So, depending on your election or default, that is what will appear on your 1099.

So if you are removing the market discount included from your Federal income for CA, it at least seems logical to remove based on what is reflected in your 1099 and thus in your Federal Income.

So if a $1,000 Note (or Bond) was purchased in 2022 for $950, and matures in 2023, the amount to remove as accrued market discount is $50. That $50 should be in your 2023 1099 and thus in your Federal AGI. If you had instead elected to accrue, your broker will reflect a lower number in 2023 and a number in 2022. With a total across years still $50. Since your state adjustment will follow income from your 1099, deduct accordingly, as far as I know.

DetroitRick

Level 2

Clearly states have different rules on this subject. They are different.

My state, Michigan, like the poster's does not tax accrued market discount on Treasuries. It is therefore deducted on a subtractions worksheet in preparing state taxable income. In fact, Michigan, also does not tax capital gains from sales of Treasuries in the secondary market. Which would be a consistent position. State tax law can readily differ from Federal tax law. There is no uniformity.

TurboTax's exclusions on each state return needs to follow state tax law. In my case, they do not.

af17672875

Level 3

Turbo Tax removes 1099B w/box A checked from short term capital gains as well as 1099 w/Box D checked from long term capital gains on mature Treasury Notes (and Bonds I presume) on form 8949 column g from total short and long term cap gains using code D) It then lists all these gains as 1040 Schedule B interest in order to make all proceeds from US Treasury Notes (interest + cap gains) fully taxable as ordinary interest income (and not tax preferred cap gains levels) at the federal tax level.

No matter what state one lives in, this interest is NOT taxable at the state level by federal law. If the federal government taxes cap gains as interest on Treasury Notes they cannot be taxed again at the state level. Turbo tax needs to provide us a method of removing this federal interest currently blindly copied over to the state tax interest documents.

Who can I discuss this with at Turbo Tax.

DaveF1006

Level 15

To clarify, what state do you live in?

**Say "Thanks" by clicking the thumb icon in a post. **Mark the post that answers your question by clicking on "Mark as Best Answer"

Pammy2

Level 2

Nebraska. See other reply from a Maryland Resident who used a similar method. I filed and got my refund from Nebraska and with no errors on the return per Turbotax.

baldietax

Level 12

After going through the many threads on this - which hopefully means TT will address properly in 2024 - it seems the only/best way to handle this is make an adjustment on the state tax form. For VA the only option (as suggested by a TT expert for a different state in one of these threads) seems to be to make a manual adjustment under "Here's the income that Virginia handles differently" > Misc > "Other Subtractions from Federal Income" and put in the total with a description.

When buying Treasuries on secondary market for specific dates there are usually multiple Notes available with different coupons/discounts. I had purchased low coupon notes at a discount but going forward will switch to notes at par/premium if this saves a manual step on state taxes.

DW from CA

Level 2

I noticed that as well and believe that Accrued Market Discount should not be taxable in California for US Treasury Obligations. I made the adjustment in the input section for "State", then "Miscellaneous" > "Adjustments to Income". Then input the description and amount as a subtraction.

It seemed to work and corrected the California Adjustments - Subtractions in the CA 540 line 14.

tpennello

Level 2

I just read a disturbing section in Michael Gray's tax letter that I received today (Oct 4 '24).

It appears that CA still wants to tax any interest that is not paid directly by the treasury!

Below is the quote. [removed]

FTB says Accrued U.S. Treasury bond market discount interest is subject to California tax.

In response to an inquiry by Spidell Publishing, the California Franchise Tax Board said accrued U.S. Treasury bond market discount interest is subject to California tax. The market discount interest isn’t paid by the U.S. Treasury, so it isn’t eligible for an exclusion. It is taxable as ordinary interest income. The income does not represent tax-exempt interest earned on a federal obligation.

(Spidell’s California Taxletter, October 2024, p. 11, "California treatment of U.S. Treasury bond accrued discount income.")

jdxray

Level 3

I found that link independently and sounds like anyone not paying tax on accrued market discounts in CA (as tax on ordinary income) who gets audited after this CA FTB determination is going to be paying interest & penalties on top of the tax due.

Taxing7

Level 2

I posted a similar problem to the blog yesterday. TT is not excluding US Treasury Bond discounts on my MA tax return. I read another post that suggested filing the Federal return, then delete the 1099 INT & 1099 B and filing the State return. I am not comfortable divorcing the State return from the Federal return. It seems to me that TT needs to fix this so that I have the ability to file my state return without these very dubious machinations.

Please fix this so I can file!!

Brad999

Level 2

There are two scenarios if you bought treasuries at a discount. One is selling before maturity and the other is holding to maturity. I had argued that the capital gain for the latter should be excludable, but the law is apparently written such that in both cases the capital gain is taxable in Massachusetts. Follow this link:

https://www.mass.gov/technical-information-release/tir-80-2-income-tax-treatment-of-interest-and-gains-on-certain-bonds

baldietax

Level 12

the rub is the definitions of "interest" and "gain" (referred to as "gain/loss on sale") which needs to be looked at with the rest of the state tax code; I've seen arguments elsewhere for states that explicitly state they are following Fed definitions for income, then in this case the AMD is reported as interest on Fed 1040 not a gain, so is it exempt based on this list. etc.

As to the 'how' the only way to handle it I've seen on the many threads on this topic, is to put in a manual subtraction with explanation, I assume all state programs allow for this.

Separating Fed and State in TT sounds messy - technically on desktop you could save a different version to submit to state, maybe manually rather than e-file. But you need to submit your 1040 and schedules to the state and the Schedule D would look different for a start. Ugh, feels like having inconsistencies is a recipe for more issues than being up front with a manual adjustment if confident in the exemption.

Not a CPA/Expert - just my 2 cents on this long-running topic.