Temporary regs change TIPS bond premium method

BY CHARLES J. REICHERT, CPA
March 1, 2012

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.

More from the JofA:

 Find us on Facebook  |   Follow us on Twitter  |   View JofA videos

PROFESSIONAL DEVELOPMENT: EARLY CAREER

Making manager: The key to accelerating your career

Being promoted to manager is a key development in a young public accountant’s career. Here’s what CPAs need to learn to land that promotion.

PROFESSIONAL DEVELOPMENT: MIDDLE CAREER

Motivation and preparation can pave the path to CFO

CPAs in business and industry face intense competition to land a coveted CFO job. Learn how to best prepare yourself for the role.

PROFESSIONAL DEVELOPMENT: LATE CAREER

Second act: Consulting

CPAs are using experience to carve out late-career niches. Learn how to successfully make a late-career transition to consulting, from CPAs who have done it.