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January 2015

Problems with New IRS Bond Premium Amortization Rules

By Carol G. Warley, CPA, JD, Kenneth M. Horwitz, CPA, JD, Christina A. Mondrik, CPA, JD, William Stromsem, CPA, JD, and Thomas Ochsenschlager, CPA, JD

Preparers and their clients with taxable bond portfolios need to be aware of potential problems with the new IRS rules for reporting taxable bond premium amortization so they can promptly initiate necessary communications with brokers. The new rules are included in the instructions for the 2014 Form 1099-INT ( and the temporary regulations 1.6049-9T (  

In the past, few taxpayers elected to amortize taxable bond premiums under IRC Section 171 because the information for making the election was not readily available. New rules generally require brokers to report taxable bond interest and the basis on “covered” taxable bonds (generally certain bonds that were acquired after 2013 and that are covered by the broker basis reporting rules as described in Reg. Section 1.6045-1(a)(15)(i)) assuming that taxpayers elected to amortize taxable bond premiums even though the election likely was not made. While this election is generally advantageous to taxpayers, the election must apply to all taxable bonds held by the taxpayer. This can cause problems if the taxpayer’s portfolio also includes “non-covered” taxable bonds (generally certain bonds acquired before 2014 that are not covered by the broker basis reporting rules as described in Reg. Section 1.6045-1(a)(15)(i)). For non-covered taxable bonds, the temporary regulations do not require the broker to assume taxable bond premiums are being amortized, and thus the broker will report interest income without amortization. This inconsistent 1099 treatment between covered and non-covered taxable bonds can cause several problems, including a possible invalid election and mismatching of both interest income and basis reported on tax returns versus that reported on Forms 1099.

If the taxpayer only has covered taxable bonds - The brokerage firm will report interest income either net of amortization or with both gross interest and the amortization amount. The broker will also reduce the investor’s basis by the amortization amount. The taxpayer should attach a statement to his or her income tax return to make the election to amortize taxable bond premiums. Absent this affirmative election, an IRS representative has indicated that the current unofficial position of the IRS is that simply reporting interest net of amortization is sufficient to elect amortization. Taxpayers and their preparers likely will not want to rely on an unofficial position, so care must be taken in reporting interest income. If the election is made, it is only revocable with IRS approval, and it applies to all taxable bonds currently held and subsequently acquired. The election will automatically apply to taxable bonds that were not previously amortized. The broker should, but may not, track the unamortized premium in the basis of these partially unamortized taxable bonds, so the taxpayer may wish to do so.

If the taxpayer has both covered and non-covered taxable bonds - The taxpayer must choose between two approaches, neither of which is simple. The taxpayer can choose either to not amortize premiums on all taxable bonds or to calculate amortization on the non-covered taxable bonds and report all taxable bonds with amortization of taxable bond premiums. The taxpayer should weigh the relative costs and benefits of each approach. In making this choice, if the taxpayer must determine the amount of amortization, this will require information from the broker, a potentially difficult process that requires the brokers’ cooperation. For non-covered taxable bonds, the Form 1099 will likely not report amortization, and for covered taxable bonds, the broker might provide interest net of amortization. Even if amortization is provided, it likely will be a single figure for all taxable bonds and not be detailed for each bond held. The basis of taxable bonds will also have to be calculated for non-covered taxable bonds.

Choice to not amortize any taxable bond premiums - The taxpayer does not get to offset interest income with the amortization of taxable bond premiums, and the tax benefit will be deferred until the bond is disposed of in a capital transaction, with a higher basis that will not have been reduced for amortization. This will result in the recognition of a capital loss rather than a reduction to interest income (likely a permanent difference in the tax benefit related to the taxable bond premium).

Electing not to amortize bond premiums on covered taxable bonds can cause issues with basis reporting. If the taxpayer notified the broker before Dec. 31, 2014 that taxable bond interest was not going to be amortized, the broker should be reporting both covered and non-covered taxable bonds consistently and will not reduce basis for amortization. However, few taxpayers were aware that notification was required. Thus, the broker likely will not reverse the covered taxable bond basis reduction and interest income reduction for 2014, requiring the taxpayer to not offset interest income and to track the basis until the bond is disposed. This will be necessary in order to avoid both a reduction of interest income currently and a capital loss on disposition. For future years, the taxpayer can notify the broker by Dec. 31 that premiums are not being amortized. This should avoid additional basis calculation issues. If this is done, the taxpayer will only have to keep track of the erroneous basis adjustment for 2014.

For covered taxable bonds, the broker may report Form 1099 interest net of amortization or the gross amount with the amortization amount. If the broker provides the net amount, the taxpayer will have to determine the interest income without amortization. Hopefully, the broker will provide the information from its records. However, if the broker does not issue a corrected Form 1099 (and the broker likely will take the position that the taxpayer should have given notice by Dec. 31 as required in Reg 1.6045-1)(n)(5)(ii)(B)), an IRS computer may generate a matching notice because the Form 1099 shows interest income net of amortization and the tax return shows interest without amortization. The unofficial IRS position is that this should not be a problem because not amortizing will result in higher interest income on the tax return that is easily explained. The taxpayer should consider attaching an explanatory statement to the tax return.

Choice to calculate amortization on “non-covered” taxable bonds - While this will reduce interest income, the taxpayer will have to obtain information from the broker and likely incur additional costs to calculate the amortization. This may also result in a computer-generated matching notice, but this time, the interest income on the tax return will be less than reported on the Form 1099. Again, a statement with the return may help resolve the issue. The taxpayer must maintain records for basis adjustments because the brokerage firm is not required to adjust basis for amortization for “non-covered” taxable bonds. In order to avoid the issues associated with holding both “covered” and “non-covered” taxable bonds, the taxpayer might consider selling his or her non-covered taxable bonds and buying new taxable bonds (i.e., covered taxable bonds), thus enabling the taxpayer to make the election to amortize premiums on all taxable bonds on his or her 2015 tax return. Otherwise, this result will be achieved over time as non-covered taxable bonds mature or are sold. Of course, there may be adverse economic consequences of disposing of taxable bonds purchased before 2014 that must be considered.

Bond discounts - Note that Form 1099 reporting rules do not require amortization of taxable market bond discounts. This is favorable to the taxpayer who might otherwise have to pay tax on the additional interest income without having received cash. 

TSCPA’s Federal Tax Policy Committee discussed these issues with an IRS representative and will submit a comments letter to the IRS and the Department of Treasury.


For topic update, go to:   

Lower Oil Price Environment Creates Estate and Gift Tax Planning Opportunities

By Ryan G. Bartholomee, CPA, R. Byron Ratliff, CPA, and Carol G. Warley, CPA, JD

West Texas Intermediate NYMEX crude oil prices have dropped over 50 percent since June 2014[1]. In this lower oil price environment, any oil-related assets (whether they are mineral rights, royalty interests, overriding royalty interests, working interests, or especially stock in oil companies) should have a substantially lower value now than they did six months ago. It is important to keep in mind that the current global oil supply exceeds global oil demand by approximately 1 to 2 percent[2]. This oversupply might be corrected within a year or so (possibly sooner as geopolitical tensions mount and threaten supply). Capital expenditure budgets should continue to be reduced for 2015 for exploration and production companies. Lower fuel prices should serve to stimulate our national economy, which happens to be the largest consumer of oil-related products on the globe[3]. Sixty-nine percent of our country’s gross domestic product comes from consumer spending[4]. It is estimated that these lower gasoline prices add $1,000 annually to each household’s discretionary spending[5]. The oil industry is cyclical in nature as demonstrated by the dramatic price swings of 2008.

Wealthy clients with such assets might consider gift tax planning transactions due to the lower valuations. There might be an opportunity to use some or all of a person's gift/estate tax exemption ($5,430,000 per person in 2015[6]) to gift oil-related assets now. This is especially true for assets that won’t require additional development capital (such as mineral rights, royalty interests, overriding royalty interests and oil company stock), and if one believes that oil prices will be higher again at some point in the future due to the oil industry’s cyclical nature. Note that oil company stock may be lower in value right now relative to other oil-related assets because the comparable sales of mineral interests have not fallen in value as quickly as the majority of oil stock prices have. Also, note that it is generally unwise to gift undeveloped leased acreage or even proven undeveloped or behind-pipe reserves because of the issue of additional capital that will be required for development and the risk associated with the assets that the value will not be there after development.

If the client does not anticipate having a taxable estate at his or her death in excess of the gift/estate tax exemption as indexed for inflation, it is obviously better for heirs to receive the stepped-up basis in oil-related assets by receiving the assets as an inheritance.

For example, if a married client had oil-related assets valued at $15 million and a total net worth of $20 million that they estimate might grow to $30 million by their death, then it may make sense from a tax standpoint for that couple to consider gifting oil-related assets to heirs now utilizing a portion of, or even all of, the $5.43 million per person estate tax exemption. This would result in up to $20.86 million of the $30 million passing to heirs without being subject to federal estate taxes (assuming the $10 million in growth comes only from the gifted oil-related assets and any other growth in the estate is offset by spending and charitable giving).

If, however, a married client had oil-related assets valued at $1 million (with a basis of $0 because of percentage depletion) and a total net worth of $2 million that they estimate might grow to $3 million by their death (so the oil-related assets are worth $2 million at their death), then it is better for the oil-related assets to be transferred through inheritance to heirs rather than as a gift while the client is living. This is because the stepped-up basis the heirs would receive (the fair market value at the time that the asset is inherited of $2 million in this example) eliminates taxes on unrealized gain (a $2 million unrealized gain in this example given that the couple had no basis in the properties) or would provide significant tax shield from cost and percentage depletion if the heirs decided to retain the properties.

Of course, there are many non-tax factors to consider in estate planning, and the above examples are extreme and simplified to illustrate a point. Perhaps we will soon look back and see this time as a rare gift and estate tax-planning opportunity for a small percentage of wealthier clients with substantial oil-related assets.



[1] U.S. Energy Information Administration, Short-Term Energy Outlook, January 13, 2015,

[2] CNN Money, OPEC vs. U.S.: Who Will Blink First On Oil?, by Travis Hoium of The Motley Fool, January 13, 2015, ¶ 5,

[3] U.S. Energy Information Administration, 2012 World Oil Consumption, accessed January 18, 2015

[4] YCHARTS, US Personal Consumption Expenditures: 69.00% of GDP for Nov 2014, accessed January 18, 2015,

[5] Value Walk, The Bright Side of Cheap Oil, by LPL Financial, January 14, 2015, ¶ 2,

[6] Rev. Proc. 2014-61, Section 3.33, p. 19,

U.S. v. Finley Hilliard, et al. $83 Million Dollar Indirect Gift?

By Joseph D. Brophy, MBA, CPA/ABV, CVA, ABAR, CM&AA

The Fifth Circuit decided November 10, 2014, the case of U.S. v. Finely Hilliard, et al. (114 AFTR 2d 2014‒6578) handing the gift recipients a significant loss because of an indirect gift of company stock (an over $83 million  gift resulting in $35 million gift tax plus close to $75 million in unpaid interest) because of a sale of company stock at below fair market value by the donor.

In 1995, J. Howard Marshall, II sold his stock in Marshall Petroleum, Inc. (MPI) back to the company at a price the government argued was significantly below market value. The remaining five shareholders in the company included a trust funded by stock for the benefit of his former wife and other family members, including his son and various trusts. He died soon after the indirect gift. It is not clear from the Fifth Circuit decision the method used to determine fair market value of the company stock sold by J. Marshall to Marshall Petroleum, Inc., and the amount paid to J. Marshall for his stock, which was stipulated to in an earlier case.

The Fifth Circuit Court to Appeals (“court” hereafter) held that the former wife of the donor and the trustees were liable as transferee for the unpaid gift tax. The court affirmed a lower court decision that the recipients of the gift remained liable for gifts made in 1995.

The court ruled “that Code Section 2501 imposes a tax on gifts ‘whether the gift is direct or indirect’ and includes the transfer of property (like stock) when the transfer was not for an adequate and full consideration.”

The donor is primarily liable for payment of gift tax; however, when the donor fails to pay the gift tax, the government has the right to sue the donee under the theory that the transferee got the asset and the tax follows the asset if not paid by the donor.

The artifice used by J. Marshall and his tax planners was to sell his stock in J. Marshall Petroleum back to the company at a price below fair market value resulting in transferring wealth to the remaining shareholders. The five remaining shareholders were family members who in turn benefitted by the net transfer.

The court held consistent with Helvering v. Hutchings, 312 US 393 (1941) that gifts to a trust were gifts to the trust beneficiaries for purposes of transferee liability.

The issue on appeal was whether interest is due on the unpaid gift tax going back to 1995.  The answer is “yes,” even though the interest due exceeded the amount gifted. Further, the court held that the government could collect against the donees, both the tax and the interest:

We hold that J Howard’s indirect gift was a transfer of a present interest. It is clear under our holding in Kincaid and the Treasury Regulations that a shareholder’s transfer of property to a corporation for less than full consideration is generally a gift to the individual shareholders.

The ex-wife argued that since she had been divorced for over 35 years from J. Howard Marshall and he remarried several times after their divorce that Treas. Reg. 25.2512-8 stating that “a sale, exchange or other transfer of property made in the ordinary course of business (a transaction which is bona fide, at arm’s length, and free of donative intent) will be considered as made for an adequate and full consideration in money or money’s worth.”  The Fifth Circuit concluded this  regulation did not apply and agreed with the Tax Court that a gift was intended.

This case also presented a number of related thorny tax issues, such as when is a trustee liable personally for payment to beneficiaries before payment to the IRS for unpaid gift taxes? One of the claims paid by the trustees was to a charity. The court ruled the trustees remained liable for distributing prior to payment of all government claims. Perhaps oddly, the trustees argued that they should not be held liable since the government had not asserted a claim at the time of distribution, meaning they had no knowledge, which reminds me why serving as a trustee has its hazards.

The dissenting opinion, written by Circuit Judge Priscilla R. Owen, argues that a conflicting decision was issued by the Third Circuit limiting the donee’s responsibility to the amount received in the gift. “The Government seeks to hold the Marshalls personally liable for almost $75 million over and above the value of gifts that were made to them. Most of the $75 million is interest.” A possible conflict between the circuit courts could give rise to a review by the Supreme Court.

The dissent continues, “In spite of the clear language of 6324(b,) the panel’s majority opinion concludes that section 6324(b), however, says nothing about any limit on the donee’s liability and the government’s ability to assess interest when the donee fails to fulfill his or her obligation to pay the donor’s unpaid gift tax.”

Estate planning has significant risks. Deathbed planning with possible asset transfers below market value must be reviewed.

Reprinted from the Dec. 22, 2014, QuickRead issue with permission from the National Association of Certified Valuators and Analysts and the Consultants’ Training Institute

Joseph D. Brophy, MBA, CPA/ABV, CVA, ABAR, CM&AA, is a former member of the AICPA’s IRS Practices and Procedures Committee and former chair of the Texas Society of CPAs’ Relations with IRS Committee. He is frequent writer for tax and valuation publications. He can be reached at or  (214) 522-3722.


Be Prepared for Tangible Property Regs This Tax Season

By David P. Donnelly, CPA

The new Treasury Regulations under IRC Section 263(a), also known as the repair regulations and/or the tangible property regulations, went into effect Jan. 1, 2014 for 2014 tax returns. Prior to these regulations, the question of whether an expenditure was capital in nature or a repair was determined primarily by reference to common law, which is voluminous, confusing and contradictory. This has now been replaced by the new regulations, which are merely voluminous and confusing, but not contradictory.

The new rules address what is a repair versus a capital expenditure. They also contain a statutory safe harbor for a taxpayer’s capitalization threshold, address partial asset dispositions, and require time-consuming analysis and potential changes in depreciation calculations, among many other complex provisions. 

Virtually no taxpayer could have adopted these methods of accounting prior to the promulgation of these rules. As a consequence, these new rules will require most taxpayers to apply new accounting methods. These regulations require that taxpayers request permissions in order to change those accounting methods. As a result, most taxpayers will need to file at least one Form 3115, Application for Change in Accounting Method

All of these accounting method changes required for 2014 returns are automatic changes. Taxpayers who defer adopting these accounting methods until later years may be subject to the $7,000 user fee to file the Form 3115 (or multiple user fees for each method change), for advance consent requests to change their accounting methods to the required methods. 

Adopting these new accounting changes, calculating the Section 481(a) adjustments (if any) and preparing the required Forms 3115 will make the upcoming filing season challenging. We’ve heard many practitioners familiar with these required changes comment that there has not been such a radical effect on tax preparers since the Tax Reform Act of 1986.

TSCPA’s Federal Tax Policy Committee submitted formal comments on these regulations during the review period, seeking relief from some of the more onerous provisions of the law.  Many other professional and industry organizations also contacted the Treasury Department. Two areas of specific concern were the low safe-harbor thresholds for capitalization ($5,000 for taxpayers with audited financial statements, $500 for everyone else) and the fact that most of the changes require a look-back calculation instead of using a cutoff of Jan. 1, 2014. 

In order to understand the government’s attitude about these new rules, note the comments from Alexa Clayborn, a Treasury official quoted in 2013 on the de minimis capitalization rule, “Maybe it would be better if people weren’t forced to expense…”

Data Security and Client Portals: What are Your Thoughts?

By Miguel Reyna, CPA

With the increasing number of security breaches in the news, we as CPAs have to take extra precautions with our clients' data.

Client data typically includes employee information with Social Security numbers, credit card records, bank account information, as well as client passwords for accounting books and records such as the QuickBooks backup.

At this time of year, we also have the opportunity to educate our clients. We should inform clients to never send the types of information listed above by email. Plus, how many of our clients do not have anti-virus software? How many of our clients do not regularly backup the company data?

Client portals—secure online storage areas—have been around for a few years now. We would like to know if you have had success with the use of a portal. Do clients find them hard to use and therefore resort to email?