1092. What is a Treasury bill?
Treasury bills (T-bills) are obligations of the United States government, generally issued with 4-week, 13-week, 26-week, and 52-week maturity periods. Treasury bills are issued in minimum denominations of $100 with $100 increments thereafter. Treasury bills are issued without interest and on a discount basis (that is, they are issued at a price that is less than the amount for which they will be redeemed at maturity). The price is determined at auction (generally on Monday of each week for 13- and 26-week bills; 4-week bills are generally auctioned on Tuesday of each week; 52-week bills are generally auctioned every four weeks on Tuesday).
1093. Is an investor who holds a T-bill required to include interest in income prior to sale or maturity of the bill?
No. The amount of interest, represented by the discount (at issue or on the market) from face value, is not required to be included in income by a cash basis investor until the date on which the obligation is paid at maturity, sold or otherwise disposed of as discussed in Q 1094. (1)
However, a cash basis investor may elect to include in income as it accrues prior to sale or redemption the difference between the stated redemption price at maturity and his basis in the obligation (this difference is called "acquisition discount"). Such an election may not be limited to a particular bill, but applies to all short-term taxable obligations acquired on or after the first day of the first taxable year for which the election is made, and it continues to apply until the Service consents to revocation of the election. (2) (Short-term obligations are those having a fixed maturity date of one year or less after issue. (3)) The election affects short-term taxable corporate obligations, as well; however, in the case of corporate obligations, original issue discount is included unless the investor chooses to include "acquisition discount" with respect to all of them. (4) With respect to interest-paying, short-term corporate obligations, elections to include discount as it accrues will also have the effect of requiring the taxpayer to include stated interest payments (not otherwise includable in income until paid) in income as they accrue. (5) See also Q 1095.
Under the election, acquisition discount is considered to accrue daily on a ratable basis. That is, the amount of discount is divided by the number of days after the day the taxpayer acquired the obligation up to and including the day of its maturity. (6) He must include an amount equal to the sum of the daily portions for each day in the tax year he held the obligation. (7) However, a taxpayer electing to include acquisition discount as it accrues may elect, under regulations, with respect to particular obligations, a constant interest rate (using yield to maturity based on the cost of the bill and daily compounding) and use ratable accrual on other short-term obligations. Once made, this election is irrevocable with respect to the obligations to which it applies. (8)
This election may, under some circumstances, be advantageous where leveraging is used by a cash basis investor to purchase or carry Treasury bills, since deduction of the interest expense up to the amount of discount accruing during the year must be deferred unless discount is currently included (see Q 1307).
While a cash basis investor is not usually required to include discount in income prior to sale or other disposition, certain taxpayers must include acquisition discount in income. The mandatory accrual rules apply to bills (1) held by accrual basis taxpayers, (2) held by a bank, (3) held by a regulated investment company or common trust fund, (4) held as inventory, (5) identified (1) as part of a hedging transaction, or (6) held by a pass-through entity (e.g., a trust, partnership or S corporation) formed or availed of to avoid the mandatory inclusion rule, or a pass-through entity in any year in which 20% or more of the value of the interests in the entity are owned for 90 days or more in a year by taxpayers who would be subject to the rule. (2) A taxpayer subject to these mandatory accrual rules may, under regulations, elect irrevocably to accrue discount with respect to any obligation on a constant rate (compounded daily) instead of ratably. (3)
The basis of a T-bill is increased by amounts of accrued discount and interest included in income prior to disposition or redemption. (4)
1094. How is an investor taxed on the gain or loss on the sale or maturity of a Treasury bill?
T-bills are capital assets. (5) On sale or maturity of the bill, the seller recovers his tax basis (generally his cost plus broker's fees on acquisition) tax free. Any gain realized over his tax basis must be treated as ordinary income to the extent it represents recovery of discount. Any excess over that is capital gain. (6) (Generally, the gain is short-term because the holding period for short-term gain is one year or less. (7) See Q 1420 for the treatment of capital gains and losses.)
The amount of discount treated as ordinary income is determined in the following manner. Any individual holding the bill at maturity includes as ordinary income the difference between his tax basis and the bill's face value. (The difference between an individual's basis and the bill's face value is called "acquisition discount.") Any individual who sells the bill prior to maturity includes as ordinary income only a portion of his acquisition discount based on the total time he held the bill; the amount included is his acquisition discount multiplied by a fraction having as numerator the number of days he held the obligation and as denominator the number of days after he acquired the bill up to and including the maturity date. (8) This formula enables each holder to determine the portion of any gain to be treated as interest income without reference to the original discount or the treatment applicable to any other holder.
An owner may elect irrevocably on a bill-by-bill basis to compute the amount of discount on a daily compounding basis instead of in equal daily portions. (9)
If the investor has elected to include discount in income as it accrues prior to sale, his basis is increased by the amount included, and the entire gain is capital gain (see Q 1093). (1)
If instead of a gain, loss is realized on sale or maturity, it is capital loss.
The installment method for recognizing and taxing gain is not available for securities traded on an established securities market. As a result, gain from sale is included in income for the year in which the trade date occurs even if one or more payments are received in the subsequent tax year. (2)
The interest is exempt from all state and local income taxes. (3)
If a Treasury bill was held as part of a tax straddle, the additional rules and qualifications explained in Q 1077 to Q 1084 apply; if a Treasury bill was held as part of a conversion transaction, the additional rules explained in Q 1085 and Q 1086 apply.
If the transfer is between spouses, or between former spouses incident to divorce, see Q 1447. (4)
(1.) IRC Secs. 454(b), 1272(a)(2).
(2.) IRC Sec. 1282(b)(2).
(3.) IRC Sec. 1283(a).
(4.) IRC Sec. 1283(c).
(5.) IRC Sec. 1281(a)(2).
(6.) IRC Sec. 1283(b)(1).
(7.) IRC Sec. 1281(a).
(8.) IRC Sec. 1283(b)(2).
(1.) Under IRC Sec. 1256(e).
(2.) IRC Sec. 1281(b).
(3.) IRC Sec. 1283(b)(2).
(4.) IRC Sec. 1283(d).
(5.) IRC Sec. 1221.
(6.) IRC Sec. 1271(a)(3).
(7.) IRC Sec. 1222.
(8.) IRC Sec. 1271(a)(3).
(9.) IRC Sec. 1271(a)(3)(E); Treas. Reg. [section] 1.1271-1(b)(2).
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|Title Annotation:||PART I: FEDERAL INCOME TAX ON INVESTMENTS|
|Publication:||Tax Facts on Investments|
|Date:||Jan 1, 2010|
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