Daily Archives: December 1, 2011

Wealth Advice: Taxation of Corporate Premium Bonds

Thurs, DEC 1st, 2011

The below entry was penned by Devin Pope, a financial advisor here at Albion. I found the information concise and insightful speaking on a topic that is often anything but – bond taxation.

Jason Ware Market Strategist, Analyst (801) 487-3700; (877) 487-6200


A bond is considered a “premium bond” when the purchase price is greater than its face value. Investors typically see more premium bonds in the market when interest rates are decreasing – as they have over the past several years – because bond prices and interest rates have an inverse relationship. When interest rates fall investors are more willing to pay a premium, or a higher price for that same bond, because the coupon [i.e. interest payment] is superior relative to what you would receive buying a new issue.

Indeed, given the decline in interest rates over the past several years many high quality or investment grade bonds on the secondary market are now selling at premiums. This is known by market participants and bond holders alike. What most investors may not know is that they have an option in dealing with the taxation of these premium bonds. According to publication 550 of the IRS tax code, if a bond yields taxable interest you can choose to amortize that premium or show it as a capital loss. By amortizing the premium you diminish the amount of taxable interest included in your income and reduce your basis in the bond so that when it matures your cost basis is the same as the face value. For instance if you paid $105,000 for a corporate bond with a face value of $100,000 and 5 years until maturity, you could reduce that bond’s income by $1,000 a year while amortizing the value of the bond by the same amount. The second option is to show a $5,000 capital loss when the bond matures in year 5.

Most custodians will either show the amortization method or the capital loss method on the 1099 tax form. An investor can change to the amortization method but they will need written approval from the IRS. Once the change is made it will be binding for all current taxable bonds owned and all future bonds purchased. Of course, it is prudent to discuss with your tax advisor to determine which method is best suited for your individual situation.

Devin Pope, MBA, CFP® dpope@albionfinancial.com