Accrued Market Discount on Treasury Bonds State Taxability

[baldietax]

I noticed a thread on bogleheads specific to NY which may be helpful - https://www.bogleheads.org/forum/viewtopic.php?t=425494#:~:text=Treasuries%20are%20clearly%20obligat...

The gist of one of the main arguments in that discussion is that AMD is exempt from NY state tax bc NY follows Fed definitions and Fed treats AMD as interest income.  Unfortunately for NC, the courts ruled explicitly on this topic that AMD is taxable at state level, because NC has a narrower definition of interest income.

Absent a court decision either way like NC, I don't think you'll get a definitive and accountable answer here that should drive you down the unhappy path of paying NY tax on this income, if you need that you will need to consult directly with a local CPA.  I'd suggest trying Fidelity again but ask your financial adviser or regional brokerage consultant for fixed income (not the service center), they may be able to refer you to some local CPAs for this.  How much to worry about this depends how big the subtraction is and your overall audit risk.

Personally - I was comfortable subtracting it for VA (which is a manual subtraction in TT State) for 2023, and had taken the similar approach of buying low coupon notes, tho I have since avoided low coupon notes where possible, just to minimize this adjustment going forward.

[jdxray]

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]

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]

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-gai...

[baldietax]

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.

[bluepost22]

Hi -- I'm the OP (original poster).  In my first post I suggested that we limit the discussion to "how", how to get TT to do what we want on state returns.  This may vary state by state and also can change even within a single tax year.  Last year the very specific way I found for CA worked in March but not later in the year.  

In other words, there is plenty to discuss just with "how", and "how" is what many people are looking for.  

The decision about whether deduct it from your state at all is a personal one, let's have another thread for that.

Thanks.

[SusanneIB]

On US treasuries purchased on the secondary market: How is the accrued interest and purchased at a premium or discount treated in NY. Will it flow correctly to the state taxes forms?  Does it have to be modified?  

[MarilynG1]

Enter the amount from Box 1f as a negative number in the Total adjustments to gain (or loss) and Code D as the adjustment code.

Code D lets the IRS know the gain is being adjusted for an accrued market discount. The adjustment amount will be reported as interest income on your tax return.

If it does not carry to Schedule B automatically, you will have to carry it over by entering the amount in the Capital Gains Adjustments Worksheet in Forms mode. The Accrued interest to Schedule B in Part IV should be highlighted. Enter the adjustment amount here.

What is happening is that you are recognizing less of a gain on this sale because a portion of the gain is being reported as interest.

Review the info on Income Tax Treatment of Interest and Gains on Certain Bonds for Massachusetts. 

@Taxing7 

[golfinvestor]

Found this regarding California:

https://www.google.com/search?q=does+california+tax+accrued+market+interest+on+treasuries&sca_esv=1d...

[Susanne B]

My question about US Treasury Secondary Accrued Interest is related to NEW YORK, not CALIFORNIA?

[DaveF1006]

According to the New York State Department of Taxation and Finance, interest income from U.S. Treasury securities is generally exempt from New York State income tax. However, the accrued market discount is not considered interest from the Treasury itself, so it may not be exempt from New York State income.

According to this NYS source interest form US treasury securities is exempt but it doesn't mention accrued market discounts. In researching numerous sources, accrued market discounts are the same as interest income however and under the guidelines given by NYS in the source i mention above, these are also exempt from NYS tax.

@Susanne B 

[af17672875]

The IRS: 

1) Treats cap gains from US Treasuries purchased at discount as INTEREST 

2) The IRS Forbids ALL states from taxing INTEREST on US Treasuries 

Case closed:   States can try to con you into paying interest on US Treasuries but in doing so they are violating IRS code.  

[TR-6060]

Just found additional guidance for Massachusetts.  See the section entitled "Massachusetts Treatment of Interest from Bonds and Obligations" in the mass.gov link below where the following is stated:

"Additionally, Massachusetts gross income doesn't include interest on obligations of the United States to the extent such interest is included in federal gross income. These excluded amounts also are reported on  Schedule B, Line 1 and subtracted out on  Schedule B, Line 6."

As the Accrued Market Discount is included as federal gross interest income on federal Schedule B, it should be excluded from taxation in Massachusetts.  This adjustment can be made by editing the Schedule B "Massachusetts Interest Income Worksheet" and moving amounts from the "Regular Interest" column to the "U.S. Government Interest" column.  As discussed elsewhere in this topic, capital gain from the sale of a treasury before maturity should be taxable.

https://www.mass.gov/info-details/learn-about-the-filing-requirements-for-dividends-and-interest

Obligatory Disclaimer: The above is only my opinion and not tax advice

[sorka95032]

There seems to be a lot of confusion in the thread about who pays interest. If you buy a treasury on the open market or from the feds and hold it to maturity, 100% of all income generated from that bond/note is 100% treated interest income by the Feds and may not be taxed at the state level and for notes that have coupons, any interest payments you receive after purchasing the bond is paid by the Feds, not the seller you bought the note from.

If you sell a bond on the open market, the buyer pays you're accrued interest. This is NOT exempt at the state tax level. Given the amount of confusion by undoubtably very smart people in this thread, I have to wonder how many paid tax preparers are getting this wrong. 

I found this thread because etrade's 10990-B shows an Accrued Market Discount despite that fact that I held every treasury to maturity. TurboTax did not do the right thing when transferring this to my 540 so now I have to step in and fix it. What's worse is that last year I did not catch this but it was a much smaller amount. I caught it this time because the difference was enough to notice that my state taxes owed were not adding up.

[sorka95032]

So digging a little deeper and a little more about my situation. Etrade reported AMD on 6 of my bond redemptions (all held until maturity). All the rest of the bond redemptions were zero coupon treasuries all bought at a discount of course. None of the AMDs for the zero coupon notes were added to box 1f but were instead all accounted for in box 3.

The IRS treats all income held to maturity as interest income. Conflicting sources say CA does or does not count AMD if it's a treasury held to maturity. A more nuanced interpretation is that the difference between OID minus the actual discount is taxable and treated as ordinary income if your purchase price was at a deeper discount than the OID. At the very minimum, the FTB couldn't tax you if your price was OID or higher since you'd not be getting a discount greater than the what the Feds issued in the first place. 

Etrade's 1099-B 1f doesn't take into account OID. It just counts the entire difference between face value minus price paid.