bond premium amortization (another try)


J

Jay

Sorry for the repetition, but there was no response to the
original post for 10 days. Maybe this is an area where
there's no general interest for some reason. __

IRS Publication 550 talks about premium amortization for
taxable bonds. I've learned how to calculate the
amortization in normal cases of taxable bonds held to
maturity (see below), but have two questions about the
details.

First, it's common to buy a bond between interest payment
dates. For example, suppose a bond pays interest each
January and July, but you buy it in May. Is a special
calculation required for the initial short May-to-July
interval? Or is it ok to calculate the amortization the same
as when the bond is held the entire six months?

Second, amortizing is optional for taxable bonds. Suppose
you chose not to amortize before, but to start amortizing
for the 2003 tax year. How do you do the calculation for a
bond that you could've started amortizing in 2002? Do you
start with the old original cost and amortize the entire
premium over the shorter interval from 2003 to maturity? Or
do you consider 2002 to be a lost opportunity, and end up
later (at maturity) with a capital gain equal to the
calculated (but not used) 2002 amortization amount?

Thanks in advance!

________________________
This is "below":
There's an Excel template for "Bond Amortization" at
http://office.microsoft.com/templates/
under "personal finance." Fill in the first four parameters,
then use "goal seek" to calculate the "effective rate" that
makes the final "carrying amount" value equal to the "face
value."
 
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M

Michael T Wing CPA

Jay said:
Sorry for the repetition, but there was no response to the
original post for 10 days. Maybe this is an area where
there's no general interest for some reason. __
You might have hit the nail on the head. <g>

This is one of those areas that I just don't bother with. If
the CLIENT tracks the amortization, and I'm convinced that
the client knows what he's doing, I will use the numbers.
But I won't bother to compute them myself, nor will I
recommend the method to clients who don't already know about
it.

MTW
 
J

Jay

You might have hit the nail on the head. <g>

This is one of those areas that I just don't bother with. If
the CLIENT tracks the amortization, and I'm convinced that
the client knows what he's doing, I will use the numbers.
But I won't bother to compute them myself, nor will I
recommend the method to clients who don't already know about
it.
Thanks for the response.

Do others of you take a similar approach?

Maybe I'm missing the point, but it seems that amortizing
has advantages that make it worth a bit of effort.

First, instead of waiting for a bond to mature to claim a
capital loss, you can get the tax benefit sooner by
amortizing.

Second, you offset ordinary income rather than capital
gains, so you benefit from the difference between the two
tax rates.

Other than the calculation effort*, are there disadvantages?
Does it raise a red flag to the IRS, for example?

______

* There's an Excel template for "Bond Amortization" at
http://office.microsoft.com/templates/
under "personal finance."
 
E

Ed Zollars, CPA

Jay said:
Other than the calculation effort*, are there disadvantages?
Does it raise a red flag to the IRS, for example?
The calculation effort also includes the time and expense of
gathering the information to perform that calculation--and
the expense of paying someone to do that (meaning walk you
through the information needed, calling you back when you
forgot to send a piece of information or sent the wrong
part, and then calculating and storing that information to
be used in the future) may cost more than the benefits you
mentioned. There's also the time involved in educating the
client about the issue and then explaining the concepts you
just mentioned.

The client who is most likely to be good at getting that
information to the preparer to compute those adjustments is
generally going to be one that understands the issue and
walks in the door with either the information already in
hand or even the adjustments already computed. However, for
the majority of clients that will not be true, and it likely
would add at least an hour (and likely quite a bit more the
first year) of time to processing the return once we are
able to walk the client through the information gathering
process.

As well, a good percentage of the client base, even if
presented with your arguments about the advantages and even
clear documentation that it *is* worth their while to do so
even after fees, will decide against it. Of course, they
can't make that decision unless given all the information
we've mentioned with a question and answer session. But, if
they decline the option, they won't want to be charged for
that time--so that means increased overhead, which just
means the base charge would need to be raised for everyone
to cover it <grin>. As well, this is far from the only such
issue that exists under the IRC--there are a number of
things that "might" be done/elected which would produce a
small advantage before considering the cost of compliance.

Because of that, virtually all preparers do a "quick and
dirty" cost/benefit calculation in deciding what issues to
raise with a client. If someone has a single small bond, it
quickly becomes clear that there is no way for the
cost/benefit to work. Similarly, if someone has a large
portfolio of bonds worth millions, the calculation goes the
other way.

Now, if you want to pay me to go through every possible tax
election or action you might make that could reduce your tax
without regard for the cost of compliance, I'll be glad to
oblige you so long as you pay me up front at my hourly
billing rate since we'll be doing this for a while <grin>.
 
M

Michael T Wing CPA

Jay said:
Maybe I'm missing the point, but it seems that amortizing
has advantages that make it worth a bit of effort.
As Ed notes, the "effort" might be worth it if the bond
portfolio was large enough. I have yet to meet an individual
client where that was the case. <g> Most clients don't want
to pay preparers to pursue OPTIONAL strategies unless there
is an assurance that the benefits will exceed the additional
fees.

MTW
 
J

Jay

Jay wrote:
The calculation effort also includes the time and expense of
gathering the information to perform that calculation--and
the expense of paying someone to do that (meaning walk you
through the information needed, calling you back when you
forgot to send a piece of information or sent the wrong
part, and then calculating and storing that information to
be used in the future) may cost more than the benefits you
mentioned. There's also the time involved in educating the
client about the issue and then explaining the concepts you
just mentioned.

The client who is most likely to be good at getting that
information to the preparer to compute those adjustments is
generally going to be one that understands the issue and
walks in the door with either the information already in
hand or even the adjustments already computed. However, for
the majority of clients that will not be true, and it likely
would add at least an hour (and likely quite a bit more the
first year) of time to processing the return once we are
able to walk the client through the information gathering
process.

As well, a good percentage of the client base, even if
presented with your arguments about the advantages and even
clear documentation that it *is* worth their while to do so
even after fees, will decide against it. Of course, they
can't make that decision unless given all the information
we've mentioned with a question and answer session. But, if
they decline the option, they won't want to be charged for
that time--so that means increased overhead, which just
means the base charge would need to be raised for everyone
to cover it <grin>. As well, this is far from the only such
issue that exists under the IRC--there are a number of
things that "might" be done/elected which would produce a
small advantage before considering the cost of compliance.

Because of that, virtually all preparers do a "quick and
dirty" cost/benefit calculation in deciding what issues to
raise with a client. If someone has a single small bond, it
quickly becomes clear that there is no way for the
cost/benefit to work. Similarly, if someone has a large
portfolio of bonds worth millions, the calculation goes the
other way.

Now, if you want to pay me to go through every possible tax
election or action you might make that could reduce your tax
without regard for the cost of compliance, I'll be glad to
oblige you so long as you pay me up front at my hourly
billing rate since we'll be doing this for a while <grin>.
Thanks for the response.

So then suppose one has decided to amortize for tax year
2003. And suppose there's a bond in the portfolio that was
purchased between interest payment dates; for example, it
pays interest each January and July, but it was purchased in
May. Is a special calculation required for the initial short
May-to-July interval? Or is it ok to calculate the
amortization the same as if the bond were held the entire
six months? (I'm hoping it's the latter.)
 
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