Accrued market discount from Treasury bills and notes

Hi - Did you ever find an answer to this? I'm dealing with the same thing this year.

While an accrued market discount is earned over time in exactly the same way that interest is it is not seen as interest for tax purposes either federally or in California and is therefore taxable by the state.

@notAnAspiringAccountant 

Is that the case for just California, or all states (ie, that it is not tax exempt)?

EDIT: Actually, never mind. I think my case is different. I held the securities till maturity; I didn't sell them like it appears OP did.

I also held mine to maturity. Turbotax does not carry it to the tax-exempt column in Alabama. CPA's here say it is indeed exempt. 

I am far from an expert here, very far.......  But TurboTax specifically converts these from the 1099-B to treat them just like interest for federal returns.  It does this based upon Box 1f or the 1099-B.  The Tax Guidance in TurboTax for box 1f States:

@tfgatlin - Interesting to hear what your CPA said about AL!

@fjsingel - I still haven't submitted my taxes because I'm still trying to see if I can get an answer somewhere for MA, but I was able to make the adjustment in TurboTax in one of the last screens for the state flow. There's an interview like, "Any additional income to exclude from MA taxes?" MA also has some kind of "other adjustments" form that this info goes to.

Hmmmm.  I don't get that screen.  I do get a screen on the PA State that asks me for "Accrued market discount not reported on 1099-int, but taxed as ordinary income"    This form already has a number filled in that it generated from the 1099-B, it is only asking me to split the amount between me and my wife.  I cannot change the total.

It seems like my problem is somehow related to the software even asking me this question.  Basically, it thinks that all my accrual needs to be taxed by the state, it just wants me to split this between my me and my spouse.  I think if I can somehow flag this as not state taxable, everything else may clean up.

Secondary market Treasury security transactions can be pretty complicated, maybe even more than other types of bonds.

I think they are subject to the de minimis rule which determines if the accrued market discount should be treated as interest or as a capital gain.  Don't know if TT handles this for you or not.  Theoretically it could once you enter the data.

Also, you can opt to report the accrued market discount annually or at maturity.  If you report it annually you have a choice of methods to calculate the amount to report.  I wouldn't try this unless you study it very carefully.  But it is an important decision you need to make between deferring the tax on the market discount or reporting it annually.

Also if you sell the bond before maturity it becomes even more difficult because any gain attributable the accrued market discount will be interest and any gain (or loss) attributable to market forces will be treated as a capital gain or loss.  So gains may be treated two different ways for tax purposes.

Also there is different tax treatment depending on if the gain was short term or long.

Also there is a difference in the way different types of Treasury securities are handled for tax purposes.  A Note and a Bill for instance are treated very differently. (Note that the subject of this thread mentions both Bills and Notes, but the tax treatment of each is different so one answer doesn't necessarily fit both.)

This is a complex topic and you need to be sure you are comparing your situation to the same example in all respects or the answers as to the tax treatment can be different.

The specific example I am trying to find out the answer to is this and pretty straightforward:

If you:

(A) Buy a US Treasury Note on the secondary market for a discount and;

(B) Hold it to maturity then redeem it and;

(C) Have determined that the entire accrued market discount is to be reported as interest on your federal return then;

The Question: Is that interest tax exempt in the state of New York.

I actually have a CPA because I have several returns I have to prepare including several 1041 trust returns.  I can ask him this question, but his answers are not always reliable.  So I want to find out the answer myself in advance of asking him to see if the answers match and to make sure he handles it right for the trusts.

I do my personal returns with TT.

Notes:

* While researching this I saw a page somewhere online from what I believe was a California tax attorney's website who said that in the case above that California does NOT exclude this interest from taxation.  Sorry don't remember where I saw it.  Also don't know if is reliable or not so sorry this is of limited help but thought I'd mention it anyway.

*I plan to call the NY tax helpline too but I consider them the least reliable (if you can even get through).

I would love to get an answer to this from an expert.  Very hard to find information about it.

PS: What Edition of TT are you using that allows you to enter box 1f on the 1099-B?  Thanks.

I am using TT Premier 2023 and it supports box 1f.  There are probably better ways to get there, but here goes.

1) Be in step-by-step

2) I'll choose what I work on

3) In investments income, select Stocks, Cryptocurrency, Bonds, Other select the Update Box

4) Edit one of your 1099s

5) Edit one of lines of your 1099

6) At the bott of the screen, the is a box you need to check that says "I have other boxes on my 1099-B to enter"

This will cause the other boxes to show u and be able to be edited.

Hope this helps

We need a pro to tell us the story about whether or not the market discount is exempt from state tax and if so what states that applies to.  That's the bottom line I think.

FWIW

I just tried entering one of the bonds that fits the example I posted above into TT Deluxe 2022 which is the latest version I have installed now.

I filled in boxes 1a-1f on the 1099-B.

The difference between the cost and maturity value shows up as ordinary interest on both the federal form and on the NY tax form.  No adjustment for exempting the interest is shown on the NY Tax form it is just shown as ordinary fully NY taxable interest.  I would not expect it to because it doesn't know if the bond entered is a NY tax exempt Treasury security or not.  I assume you will have to tell IT whether it is exempt or not.  TT does not know and at the moment neither do I.

Box 1f did not have any effect on the NY interest amount.  It stays the same no matter what number that box contains.  But it does affect the federal return.  I assume this is because the federal return treats interest and capital gains differently, but the NY return does not.

The federal return shows the amount of 1f on Schedule B Part I Interest on a separate line labeled "Bond Accrued Market Discount" (as expected).

My guess is that the market discount is not state tax exempt, maybe not in any state that has an income tax.  My reasoning is this.  The market discount is not income paid to you by the issuer of the instrument, it is simply based on a price set in the marketplace.  So if it isn't paid to you by the government, which has a special exemption from state taxes for income paid to you, why should it not be subject to state tax?  Or is that too logical for the people who write the tax code?

That is just speculation of course.  There is a way to put in the exemption on the NY form, so if it is applicable that is how I would enter it.  But the question is still open.

Maybe the discount is exempt in some states... but maybe not.

Still an open question, but this test shed some light on things at least for me.

An Accrued Market Discount is taxed as interest.  Which means it is taxed at the same rate and in the same manner as interest.  It is not interest and is therefore taxable even when interest would not be and even when the discount is accrued on a treasury stock.

@TurboLover2 

True for Federal taxes, but do you know this is true for the state of Alabama? Also, how would TurboTax know this is a US Treasury as opposed to any other bond? The description is just a text field.

Thank you @RobertB4444.  I appreciate your response.

I interpret what you wrote to be a confirmation of what I speculated in my last post...  that is that even if the accrued market discount is treated as interest, it is not in fact interest paid by the US Treasury to the bondholder and therefore is NOT exempt from state income tax in any state.

So you are saying that any interest from accrued market discount on a US Treasury Note is NOT exempt from income tax in any state.

Do I understand what you wrote correctly?

If so, do you have any links to sources (expert's articles or tax related sources) you can post that support this conclusion?

Thanks again. 

@tfgatlin 

"Also, how would TurboTax know this is a US Treasury as opposed to any other bond? The description is just a text field."

I think the answer is almost certainly that no TT does not know it is a US Treasury security when you enter the 1099-B info.  But your question is the right one to ask, because if it does not know what kind of security it is, how can it give it the right tax treatment on the state level.

I am guessing there are two possible answers:

1. It doesn't matter if it is a Treasury security or not because the AMD is not exempt from tax in any state anyway so it doesn't care if it is a Treasury or not.

2. In order to exempt the AMD from interest on your state return you have to switch to the state return and separately enter the amount of the AMD as a subtraction from federally reported interest on that return.

But the first thing you need to know with certainty is if the AMD is in fact exempt from income tax in your state.  This seems a very difficult question to get a definitive, documented answer to.

That's actually what I'm (and many others) are asking. IS it exempt for state taxes? If its treated like interest, then it should be. If it's not interest, then why is it transferred to Part I of Schedule B,  with all the other interest? I've also got a call in to Charles Schwab asking how to identify US Treasuries that are going to produce an Accrued Market Discount so I can make sure this never happens again. 

Thanks for your posts, hopefully we can zero in on solution.

I have been scouring the Net looking for an authoritative answer to this question and posted the question in several forums.  So far nothing I consider authoritative.

You have to be really careful with things like this.  Just because someone on the Net says something doesn't mean is correct.

A few months ago I read an article from TurboTax posted on their site, written by someone they titled an "Expert" AND it was also noted that it had been reviewed for accuracy by a CPA.  But it was still materially inaccurate.  So the best way to go is to get multiple authoritative sources.  But I have a feeling that may require input from a tax attorney on this one.

I also have a question in to my CPA regarding whether NY exempts the AMD.  If he answers soon, I will post his response here.

I have not be able to research this completely yet, and I am not an expert, but this MAY be what is happening.
1) if you buy the Treasury in the primary market, you have an OID (Original Issue Discount).  This is reported as Interest on your 1099-INT
2) If you buy the Treasury on a secondary market,  discount you get is not longer matched to the original OID of the treasury (for example, when interest rates move).  Therefore, it is further away from representing interest.  This all comes on your 1099-R as accrued market discount that gets pushed to your Schedule B as interest (instead of a gain) so it can be taxed like interest.  I think the states may take away the state tax-exempt status of the Treasury in the secondary market because because the discount may have changed when interest rates changed and you really are not getting anything that resembles the original intent.

Again, this is just a theory, I need to look at this more.  If it is true, I just learned a lesson the hard way.

An OID bond is not the same as a coupon bond.  Treasury Bills, for example are OID.  They pay no coupon interest payments.  Treasury Notes and Bonds are not OID, they do pay coupon interest payments.  The difference between the price of a primary original issue discount (OID) Treasury security and the maturity value is always treated as interest that is exempt from state income tax and will be reported on a 1099-INT just like the coupon interest from a Treasury Note or Bond.  But a Note is not OID so the OID rules do not apply to it.

Fwiw, I called up the Massachusetts Dept of Revenue today, and they told me that accrued market discount on US Treasury Notes (Box 1f of 1099B) is tax-exempt in MA.

That's a good sign.  👍 Let's hope it's right.

Just got off the phone with the New York Department of Taxation and Finance.

The first answer they came up with when I asked the question was (and this is verbatim):

"I assume if there is federal tax on it then there must be New York tax."

I immediately knew it was all over at that point but still hoped against hope.

So I asked if there was some sort of specialist I could speak to since the question was technical.  Answer: No

I patiently restated the question in several different ways to try to simplify it.  Each time ended in an excuse as to why they cannot answer: "We can't tell you how to fill out your tax form," "1099-B is a federal form, we cannot address what is on that form," etc.  Each time I restated the question to eliminate the excuse.  It went nowhere.

I can't say she wasn't willing to try... in the end she was actually Googling for it on the Internet.  She was a very nice person but she had no idea what I was talking about and it sounded like she didn't even know what a 1099-B was.

Finally she told me she cannot answer, I would have to ask my tax preparer and they could not assist.

Your tax dollars at work.

So, any idea how to get TT state to let you do this?

From Investopedia.com:

'The accrued market discount may be taxable at the federal, state and/or local level. An investor who chooses to accrue the market discount over the period during which s/he owns the bond would include the amount accrued each year as interest income.'

The Accrued Market Discount is most likely taxable at the State level.  You would need to confirm that it is NOT with your State Dept. of Revenue, or perhaps a local CPA.

@fjsingel 

@fjsingel 

As I previously mentioned I think step #1 is to find out if the accrued market discount for the particular bond that is on your 1099-B IS in fact exempt from income tax in your state because if it is not, you don't have to worry about entering anything else in TT other than the federal 1099-B.

So far I have not found a convincing answer to this question so for me I am not up to step #2 which would be to turn that answer into proper entry of information in TT.

However, from my experience with TT in past years, I am guessing that step #2 would be accomplished by manually entering the amount that is exempt from state tax (if any) into your STATE tax form.  For my state there is a place to enter subtractions from the amount of federal taxable income reported on the federal return into the state return in TT.   Don't know about other states.