Reporting interest from Treasury Inflation-Protected Securities (TIPS)

[gtd1234]

I am regretting buying a TIPS bond for the first time in 2021! I downloaded my 2022 1099-INT from Treasury Direct.

For the box labeled "Interest on US savings bonds and Treas obligations (Ref Box 3)" it shows two interest payments totaling 13.24.
For the box labeled "Bond Premiums on Treasury obligations (Ref Box 12)" there is one entry totaling 138.10.

I entered both these numbers in Turbotax Deluxe (downloaded) on a 1099-INT form in the appropriate boxes, and it complains during the Smart Check as follows:

Schedule B - Form 1099-INT (Treasury Direct): Bond premium on treasury obligations.
The bond premium adjustment of 138.10 reported on this form 1099-INT (Treasury Direct) is greater than the related Box 3 interest on U.S. savings bonds and treasury obligations of $13.24.
You must reduce the bond premium amount reported on this 1099-INT to the amount of Box 3, and report any excess on Schedule A (subject to any required limitations).

I am completely stymied. I am clearly dealing with this TIPS reporting incorrectly but I have no idea how or what to do. So many people have TIPS bonds there must be a straightforward way of reporting this. I would appreciate help/advice.

(separately I have entered the OID info on a 1099-OID and that worked fine)

[hbl3973 · Accepted solution]

gtd1234,

I've been purchasing TIPS for decades in a taxable account and, yes, I agree, the calculations and reporting are a pain.  Most financial columnists strongly recommend buying them in a retirement account instead.  Your situation is rare, or at least I never had to deal with it in the past, but with the recent markets and inflation, will likely be more frequent.

TurboTax is parroting the entry in IRS publication 550 (https://www.irs.gov/pub/irs-pdf/p550.pdf) :

"Bond premium amortization more than interest. If the amount of your bond premium amortization for an accrual period is more than the qualified stated interest for the period, you can include the difference in Other Itemized Deductions on Schedule A (Form 1040), line 16.
But your deduction is limited to the amount by which your total interest inclusions on the bond in prior accrual periods is more than your total bond premium deductions on the bond in prior periods. Any amount you cannot deduct because of this limit can be carried forward to the next accrual period."

which says you can wipe out all the interest and OID on the bond you purchased  up to that Box 12 amount and anything past that is an itemized deduction, quite possibly of no value to you with standard deductions set so high these days.  Not seeing the OID value, I wouldn't know if that pushed the total to exceed Box 12.

However, it is quite possible you can ignore Box 12.  Publication 550, page 33, states that amortization is a choice you make in writing in an attached statement with the first tax return year you choose to amortize.  If you didn't use the Amortizable Bond Premium adjustment on Schedule B for 2021, you aren't amortizing.  Even if you did, it's unlikely you attached the statement, so in principle you could simply opt to stop amortizing and keep the 2021 reduced basis constant until you sell.  However, it is conceivable that the IRS could argue that using the ABP adjustment at all on Schedule B is a choice in writing.  (Doubt they have the staffing to get down into such penny-ante weeds.)  If you want to be absolutely safe, I would suggest amending the 2021 return to remove the ABP adjustment and keep the original cost basis.

[gtd1234]

Thank you very much hbl3973!  I actually bought the bond on 12/31/21 so had nothing to report on my 2021 tax return.  My OID interest was much more than box 12.

So you are saying I can just ignore box 12 and not enter it into TT?  Are there any implications for when the bond matures in 4 years? 

[hbl3973]

Yes, you can ignore the amortization figure.  At the end of 4 year when it matures or when you sell, your cost basis is the same as what you paid for it. 

[gs406]

hbl3973, 

With TIPS, the inflationary adjustments made during the year are reported on a 1099-OID.   My 1099-OID only has entries in Box 8 (representing inflationary adjustments on US Treasury Obligations ) and Box 10 (representing the bond premium).  Box 8 exceeds Box 10, so no problem there.  However, Turbo Tax returns an error on the Box 10 amount, indicating that it's more than Box 2 (representing interest).  My form has no entry in Box 2, which it shouldn't. 

It's as if Turbo Tax hasn't updated to recognize that TIPS inflationary adjustments and the premiums paid are reported on 1099-OID.   If I enter the info from the 1099-OID on a 1099-INT, I can work around Turbo Tax's error, but I'm hesitant to do that because I don't know if those self-filled 1099s are submitted to the IRS and I'll be missing a reported 1099-OID. 

Have you had this issue, and if so, how do you work around it? 

[JulieS]

Yes, that is correct, the bond premium can't be more than the taxable interest income. The reason is that the bond premium reduces the taxable interest.

The error that you get reads:

"You must reduce the bond premium amount to no more than the amount in Box 2, and report any excess on Schedule A subject to limitations."

This means that if Box 2 is $0, Box 10 must also be $0. You can deduct the excess amount in Box 10 on Schedule A, if you itemize your deductions:

1. Click on Federal Taxes, then Deductions & Credits.
2. Scroll down to Other Deductions and Credits, expand the section.
3. Click Start to the right of Other Deductible Expenses.
4. Answer the next two questions No.
5. Answer Yes to Did you have any of these other expenses?
6. Enter the amount next to Amortizable bond premiums.

This is consistent with IRS Publication 550. Click here for more. 

[hbl3973]

gs406,

I do not want you to throw away money via Schedule A as it is unlikely you will have enough itemized deductions to overcome the current high standard deduction.  TreasuryDirect reports TIPS interest on their 1099-INT form, box 3, rather than on 1099-OID box 2.  If TurboTax is insisting that 1099-OID box 2 is the only place to find interest, TurboTax has a bug.  (On the paper Schedule B, you tot up the OID and ABP (adjustable bond premium) numbers and subtract each total from the total interest.)  I'll report it as an issue to the TurboTax powers that be.  I suggest the following workaround:

Shift your TIPS-related interest from 1099-INT Box 3 to the 1099-OID Box 2 field  for the securities.  This keeps the total interest reported to the IRS constant but now correctly pairs the interest earned against the bond premium.  If this results in a positive difference, you are done.  If not, as I discussed earlier, if you haven't already told them that you do want to amortize the bond premium, you can simply enter it as zero on the 1099-OID page.  If you had already begun deducting bond premium in prior years, you can do what I did which is write the letter to the Treasury folks telling them that I do not want to adjust for bond premium in the future and change your TIPS cost basis from your original cost basis by subtracting the amount of bond premium you have already taken.  They will respond with a letter confirming your choice.  Be aware that this choice applies to all of your TreasuryDirect holdings, not to just one particular security.

[taxnovice15]

Let me ask about another possible way of dealing with the situation when the bond premium (shown in Box 12 of Form 1099-INT) on a TIPS exceeds the interest shown in Box 3.  Would it be possible to use the remaining amount of the premium to reduce the Original Issue Discount shown in box 8 of the Form 1099-OID issued for the same TIPS?  I ask this because IRS Publication 1212 (Guide to Original Issue Discount Instruments) states the following general proposition: "A purchaser reduces any OID income by the acquisition premium, as discussed under Information for Owners of OID Debt Instruments, later."  I realize the devil may be in the details, which is why I am seeking guidance from someone who has more familiarity with IRS publications than I have.  (I would note that the Form 1099-OID worksheet on Turbotax has a place to enter the acquisition premium as an adjustment to the OID interest.)

[hbl3973]

taxnovice15,

First of all, I sincerely congratulate you for researching this on your own and landing on IRS Publication 1212!

On page 6 of that publication (https://www.irs.gov/pub/irs-pdf/p1212.pdf) there is a recipe for how to lump everything into OID:

"Choice to report all interest as OID. Generally, you can choose to treat all interest on a debt instrument acquired after April 3, 1994, as OID and include it in gross income by using the constant yield method. See Constant yield method under Debt Instruments Issued After 1984, later, for more information.

For this choice, interest includes stated interest, acquisition discount, OID, de minimis OID, market discount, de minimis market discount, and unstated interest, as adjusted by any amortizable bond premium or acquisition premium. For more information, see Regulations section 1.1272-3. (https://www.law.cornell.edu/cfr/text/26/1.1272-3)"

This does require you to calculate what the "constant yield method" entails which is detailed on pages 9-10.  And, yes, I've done that calculation for every Treasury security, TIPS or not, that I've ever bought.  I chose to use an accrual period of 1 day, but any length no longer than 1 year can be used.

Hope this is not too arcane and has been of some help.

[gs406]

taxnovice15 and hbl3973,

Pub 1212 on page 12 specifically addresses inflation-indexed instruments.  Importantly, it states "In general, the premium allocable to a tax year offsets the interest otherwise includible in income for the year. If the premium allocable to the year is more than that interest, the difference generally offsets the OID on the debt instrument for the year. See Regulations section 1.1275-7 for an example." 

In reviewing 1.1275-7, for my situation, the section and example that apply is  "(2) TIPS issued with more than a de minimis amount of premium—(i) Coupon bond method."  This provides the "recipe" for offsetting the OID if the allocable premium is more than the interest.

It seems Turbo Tax is not handling the complexity of TIPS properly and the user must educate themselves and do a work-around if they elect to amortize the premium.   

[hbl3973]

gs406,

I have alerted the TurboTax powers that be to this deficiency.  Glad you found a way to handle your situation. We now have 3 ways to get around the limitation. With the paper returns I do from my own spreadsheets, OID and/or ABP just show as adjustments to the interest subtotal.

[hbl3973]

One correction: the remaining bond premium added to the amount you receive when the TIPS matures is the cost basis you will use, i.e. you will report a loss on the bond.  Each OID payment is added to the original par value for which you paid a premium and so your cost basis will always be the current inflation adjusted par value plus your unrecovered bond premium.  (This would even be the case in the extremely unlikely case that deflation brings the bond value at maturity below its original par value.)

[gs406]

Thank you, hbl3973, for another way to calculate cost basis.  I've checked the cost basis Schwab has reported, and I'm a dollar here, few pennies there different, which I'm not going to sweat.  But I went about it using a less straightforward way than you described, so that may account for the differences.  My brain has a tendency to take the long route 🙂  

[hbl3973]

gs406,

The TurboTax folks got back to me and said we'll have to do TIPS manually as an exceptional case for OID.  They did mention that they were impressed by the analysis and procedures that arose in our exchanges.  This certainly underscores why financial advisors strongly recommend having them only in retirement accounts. 

BTW, I was a math major so gravitate towards elegance and simplicity whenever I can.

[mdfled]

So TIPS have been around for more than 20 years and Intuit can't figure it out, so they tell their experts that you are on you own?  I guess I'm left wondering what their Maximum Return Guarantee disclaimer is for TIPS!  I didn't buy their software so I could do things manually and spend hours researching how to maximize my return.  I guess we know where the money at Intuit is spent.....the Marketing Department.