Accrued Market Discount on Treasury Bonds State Taxability

[golfinvestor]

sorka95032, are you planning on subtracting all your box 1f AMD income from your state return?  What state do you live in?  I actually live in AZ and found nothing except this:

"Arizona conforms to federal tax treatment for the taxation of U.S. Treasury notes and bonds but does not specifically tax the accrued market discount on these securities."

"does not specifically tax", whatever that is supposed to mean???

My prior CA post was just for informational purposes for people in that State.

[Susanne B]

I live in New York. My bond advisor at fidelity states that fidelity automatically puts everything into the correct boxes for you and then it flows through correctly. Im

trying to find out if that is correct. 

[Susanne B]

I live in New York

[RobertB4444]

New York taxes everything.  So your Fidelity advisor should be correct.

@Susanne B 

[af17672875]

Hello Golf,   When you buy T-Bills (Zeros) the AMD is included as 1099-INT as Box 3 income and taxed fully as interest ad the federal level but ALL states are forbidden from taxing this interest.   

The problem arises when you buy T-Notes or T-Bonds below par value owing to their low interest yields.   the sub par interest is reported as box 1099-INT box 3 income and treated the same way as T-Bills    The glitch the occurs is that unlike T-Bills (all interest box 3),   the 1099-B capital gains that occurs on these instruments is converted to ordinary interest but without box 3 checked and is fully taxed at both the federal and state levels.

This is BS, all of the income  (maturity gains plus annual interest) of T-Bills and Bonds bought at discount on the secondary market is recognized by the IRS as US Treasury Interest and therefore cannot be not state taxable interest.   In my case I bought deeply discounted  T-Notes which yielded only $251 as box 3 interest but nearly $6000 in cap gains converted to ordinary interest. I forced the Turbo Tax state interest calculations to recognize it as such and my state tax return passed TT screening.            

[golfinvestor]

I'm with Fidelity as well and I agree it flows through correctly for the IRS.  However, in Arizona for the State return you have to input AMD as "other adjustments" on Form 140 Other Subtractions from Income.

[leviton11]

Form 140?

[sorka95032]

New York can't tax interest earned from federal obligations.

[sorka95032]

@golfinvestor , Since all earnings from federal obligations, even those bought below par are considered interest on federal bonds as long as they're held to maturity, my current plan to is to  make the for 1f.

However, I'm confused by how etrade treated the Treasury Zero redemptions. All of them were bought below par and had no interest payments, yet the entire gain from these were included in box 3 and not 1f. Fortunately this was the vast majority of my bond redemptions were Treasury Zeros....assuming etrade treated them correctly, otherwise I would have expected most of the treasury redemptions to go into box 1f instead of 3.

Still, for this tiny amount, it's about a $5000 difference in taxes depending on how it's treated so probably still worth it for me to consult with a paid tax expert. 

I'm also confused that for the amount in 1f, why etrade includes par minus purchase price rather than OID minus purchase price since the amount gained from par minus OID is clearly paid directly by the fed vs OID minus paid which is paid by the seller by deducting that amount from what the seller gets from the buyer.

[golfinvestor]

Yes, last page of AZ 140 form.

[sorka95032]

So for anyone making this adjustment for California on the "Interest and Dividend Adjustments Worksheet" 2024 line 12, what did you put in the description for the adjustment???

Also, searching through google, I could not find a single reference to anyone ever using this section to make this adjustment on line 12 for AMD adjustments.

[AmyC]

CA is a bit more picky in how they look at investments. I found CA FTB Pub 1001 lists which US Obligations count in CA. The list for interest and dividends are on pages 7 and 8. Accrued market discount isn't listed at all in the publication. Look through and see what applies to you and then you will know how to adjust and if allowed.

@sorka95032 

[sorka95032]

@AmyC 

All that says is:

"Federal law requires the interest earned on federal bonds (U.S.
obligations) to be included in gross income. California does not
tax this interest income."

And for how to handle it:

"Enter the amount of federal bond interest
included in federal income on Schedule CA (540),
Part I or Schedule CA (540NR), Part II, Section A,
line 2, column B."

The Federal government considers AMD to be interest on US obligations when the AMD is from bonds held to maturity. The instructions do not handle this case.

Also, can ANYONE explain why Treasury Zero bonds which are always purchased below par do not show up as AMD on the 1099-B for the year the reached maturity and are redeemed?

[baldietax]

@sorka95032 if by Treasury Zero you mean a Treasury Bill, per IRS publication 550 "The difference between the discounted price you pay for the bills and the face value you receive at maturity is interest income" and is specifically reported on 1099-INT Line 3, not 1099-B.

[sorka95032]

Yes. Treasury Bills. So that publication does answer at least why they don't have AMD as bills seem to be in their own special category and are always purchased at a discount and have no OID rules at all. 

So that at least answers that question. It doesn't resolve the overall question in the original post other than what others have already said they did to adjust for AMD.

One thing to consider for those that want to avoid this confusion in the future. If you purchase a treasury that matures in less than a year, always make sure to select a Bill which will never show AMD on your 1099-B. For longer duration treasuries, make sure to select a Note or Bond that has a price at or above par which will generally mean selecting a high coupon treasury. 

Since the broker included full difference between face minus purchase rather than OID minus purchase, it seems making sure that you purchase at or above OID on the secondary market isn't enough to keep from have AMD added to 1f.