Accrued Market Discount on Treasury Bonds State Taxability

[DaveF1006]

To clarify, what state do you live in?

[Pammy2]

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.

[bluepost22]

For Californians here is a way to subtract the Treasury Accrued Market Discount (AMD) from the CA state taxable income using Turbotax Premier 2023.   This mirrors the method my CPA used in 2022.

On Schedule CA, click on Line 8z Column B Other Income Subtractions. You will get a drilldown with a magnifying glass. Click the mag glass. You will get a worksheet, California Other Income Statement. Enter the Treasury AMD as a positive number in a line that has a column B available.  Last week it was line 12, this week it is line 32.  Feeds through correctly to Schedule CA.  

[af17672875]

This should not be a state-by-state issue.    If the IRS wants cap gains on discounted treasury notes and bonds re-characterized as interest then it is interest and no state can make a claim that its taxable.    I fixed my issue by going to the underlying Turbo Tax interest worksheet for my state return and over-riding each entry issue description its amount by clearing them out to blank.  I also clicked the pop up  "+"  and entered the reason for the override.   Voila it all went away and the return passed review with no Turbo Tax flags.    

[af17672875]

Your reasoning does not make sense.   My Treasury Notes purchased at discount through my broker (Schwab)  and held to maturity reflects such cap gains on 1099-B as either long or short gains.  Irrespective of long or short, Turbo Tax re-characterizes such gains as simple interest for federal taxation purposes, presumably not by fiat but by IRS regulation.   The reason is simple:  The IRS does not want to render favorable cap gains tax treatment for treasury notes or bonds held to maturity.     If the feds claim cap gains are interest then they are interest and cannot be taxed at the state level (any state)      

[Pammy2]

I agree that the Accrued Market Discount on U.S. Treasury Notes is taxed as interest by both the Fed and the State.  In my state, Nebraska, interest on U.S. Treasury Notes are exempt from income tax for state income tax purposes.  I am not treating them as capital gains.  I'm not sure where you are disagreeing with my logic, but I have filed my Nebraska return using Turbotax, and the state accepted my return.

[jksmithpa2]

In doing Pennsylvania taxes, I had the case of a T-note bought at a discount, maturing during 2023. TT handles federal tax perfectly. But when looking at the PA state form for gains/losses, you see that TT has put the face value of the t-note in both the cost and proceeds columns, resulting in a zero gain. In fact, I think the gain should be the difference between face value and the purchase price (cost) of the T-note. I believe that although the interest paid on the notes is not state taxable, the gain in value (=the discount) is taxable. Comments?

On PA form, TT also screws up treatment of the accrued interest paid and puts it in a positive number (causing a tax burden instead of a reduction).

[bluepost22]

Hi jksmithpa2 --

Regarding gains on Treasuries, your apparent gain may be accrued market discount (AMD) plus a cap gain if you buy at a discount and sell before maturity.   My TT Premier seems to handle that well.  It's convoluted, the AMD gets adjusted out and then "interest" is added on Schedule B.   Regarding accrued interest paid by buyer, that is lumped in on your 1099.  TT didn't screw it up.  You have to back it out manually when you are entering the interest via a dialogue that begins  "We Need to Adjust the Taxable Amount", and then you select something like "it's on my 1099".  This thread is about preserving state non-taxability of Accrued Market Discount.

[af17672875]

For discounted bonds purchased after 1982 and held to maturity the IRS claims the discount is interest.   When such bonds are held more than a year the bond discount can be amortized by the number remaining days to maturity and increasing its basis accordingly for each year the bond is held.   The amount by which the basis in increased is reported as ordinary income (interest) for that year .    Alternatively you can wait until the year of maturity and adjust the basis by the full amount of the discount.   Look at your 1099 B and you will see gain/loss set to zero. 

You adjust the basis by entering a D in column f of form 8949 and entering the amount of the basis in column g by the discount (a negative number)  this will result in a net zero cap gain (0).     The amount in column g is recorded as ordinary income (interest)  and reported on 1040 schedule B Part I.

The IRS now treats cap gain on any bond held to maturity as interest (treasury or corporate) If the IRS recognizes this as interest on a US Treasury obligation that means no state can legitimately claim its taxable at the state level.     I would dearly love to reduce my federal taxes by claiming these are long term gains or even short term gains (offset by capital loss carryovers)   The IRS says no - its interest.                 

You need to remove all such bond interest that TT  transfers to your state return.  I did it by overriding the entries on my state tax return interest worksheet and it all passed TT review.   Doing it any other way failed review.    

[af17672875]

I think the solution to the problem must be found on a state by state basis.   My TT step-by-step interview for my state return offered no such interest adjustment dialog.    I had to go to an underlying worksheet to remove the treasury bond interest from  my state return.   

[leviton11]

Just out of curiosity, did you get any type of documentation or statute that was quoted from the person at the Nebraska revenue office?  The reason I am asking is because sometimes these workers tell you what they think rather it is accurate or not. 

[Pammy2]

The individual I spoke to at the Ne Dept of Revenue was knowledgeable of the topic, and readily responded in the affirmative to my question seeking confirmation that the language in Ne statutes exempting interest on US Treasury Notes from Nebraska taxes would include Accrued Market Discount, reported as interest for Federal and State Income Tax purposes.   I was confident and satisfied with the answer I received.  Of course, you can always call them too.  I clearly described the Accrued Market Discount that was being excluded on my Nebraska Schedule.  

[baldietax]

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]

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.

[af17672875]

I checked both the Arkansas Individual Income Tax Instructions booklet as well as the underlying tax code from the state taxing statutes and could find nothing that addresses this issue.   After doing so,  the course of action was clear to me.  If the IRS considers T-Note market discount as T-Note interest, that's good enough for me and should be for the State of Arkansas DFA (Department of Finance and Administration) as well.