The IRS and Treasury issued proposed and temporary regulations (REG-130777-11; T.D. 9561) requiring the use of the coupon interest method to amortize a premium in excess of a de minimis amount related to Treasury inflation-protected securities (TIPS). The regulations apply to TIPS issued on or after April 8, 2011.
TIPS are U.S. Treasury securities with an inflation/deflation-adjusted principal amount used to compute interest payments and the final payment at maturity. Under prior regulations, taxpayers purchasing TIPS at par or at a de minimis premium or discount were required to recognize income using the coupon bond method of Regs. Sec. 1.1275-7(d), while taxpayers purchasing TIPS with more than a de minimis discount were required to use the discount bond method of Regs. Sec. 1.1275-7(e). Historically, TIPS had not been issued at more than a de minimis amount of premium, so the existing regulations did not address that contingency. But in Notice 2011-21 issued April 8, 2011, to advise of the impending rule change, the IRS said Treasury anticipated doing so “due to recent financial conditions.”
An amount is de minimis if it is no more than 0.25% of the bond’s stated principal multiplied by the bond’s term. The new regulations now require the coupon bond method for TIPS purchased at a premium exceeding a de minimis amount.
Under the coupon bond method for TIPS, taxpayers must include in income each year (using their regular accounting method) qualified stated interest, which is computed by multiplying the inflation/deflation-adjusted principal by the stated interest rate. Also, any increase in the principal amount during the tax year due to inflation (positive inflation adjustment) is treated as original issue discount and is included in income, while any decrease in the principal amount due to deflation (negative inflation adjustment) first reduces the qualified stated interest, and any excess can create a loss.
Under the new regulations, premium amortization is equal to the excess of the stated interest, using the unadjusted principal, over the product of the unamortized purchase price and the bond’s yield to maturity (YTM). The YTM is computed as if there is no inflation or deflation. The premium amortization first reduces the qualified stated interest, and any remainder is treated as an additional deflation adjustment that reduces any inflation adjustment or increases any deflation adjustment.
By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota–Duluth.
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