A few steps to elucidate this one. First, think through the municipal bond market. When local governments need to fund projects (schools, community centers, chains of massage parlors, etc.) they issue bonds to pay for them. These are called municipal bonds, or muni bonds to their close friends and family.
These muni bonds have some market advantages compared to other fixed income investments (like corporate bonds, which carry full tax loads as opposed to muni bonds which are tax favored). Interest on muni bonds is exempt from federal (and most state) taxes.
Okay, we’re not quite there yet. Now a few words on bond pricing in general. When bonds are issued, they are sold at a certain price (based on the structure of the bond...like maturity date, interest rate, etc.). This initial price is know as "par."
From there, a bond’s price will move around, based on how overall rates look. A high-rate bond increases in value (sells above par) when overall rates fall. It becomes more valuable because you can get a better rate with that bond than new bonds being issued at the lower prevailing rates. And vice versa. A bond will sell below par in a rising rate environment.
If you buy a muni bond below par and hold onto it, you make a profit on that difference. But unlike the interest on the muni bond, you need to pay taxes on that profit.
Okay, we’re finally ready for the De Minimis Tax Rule. This determines whether this profit is taxed at the individual income level or the (usually lower) capital gains level. Basically, there is a line set by the rule. If the profit is below a certain amount (set by the rule, hence the catchy name "minimis"), the profit gets taxed as income. A profit above the line receives capital gains treatment.
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Finance: What are the tax implications o...0 Views
Finance allah shmoop What are the tax implications of zero
coupon bonds All right well from the investors side you
think that a zero coupon bond would simply have attacks
being paid when the bond and interest payments fully mature
a goal that we hear it shmoop clearly have not
yet achieved That is you buy a zero for half
or two thirds or three force of its par value
and something like that You get no interest or any
payments of any kind along the way for years But
then at the end you get par like three thousand
box or whatever amount of the zero yabba like you
spent two grand and it matures and pars three grand
cause he had three bonds and then you're done well
At that point you pay a tax right and you
think it might be assessed as a long term game
kind of tax because you bought and held it over
a year just like you would have you bought in
equity and held it on five six seven years and
then sold it some gain At that point in an
equity you'd be taxed the long term gains cheaper tax
treatment iaea You know when you sold and turned into
cash but oh so not the case with zero coupon
bonds instead with zero coupon bonds taxes are paid on
the annual imputed maturity of the bond itself such that
if you paid say five hundred bucks for a zero
coupon bond matures with all payments included at a thousand
dollars five years later well you'd be paying tax on
an imputed gain of one hundred bucks a year which
would comprise basically a bundled gain of notional principal gagne
plus whatever imputed interest was included in the bond And
that is tax as ordinary income not long term game
that is you pay the higher tax rate because well
it's a bond and its interest on the bonds you're
paying on so things air re calculated annually And that
hurts So you don't really own anything for more than
a year before uncle sam comes by tio you know
pick your pocket You actually lose cash along the way
with zero coupon bonds and then get a whole bunch
Each of it vomited back to you at the end
On top of everything zeroes are riskier than normal bonds
because they pay nothing along the way and well all
bets iran that they eventually pay off fully at the
end But you know you never know So given everything
you'd better be sure you're getting a big premium for
buying a zero coupon bond over a normal one If
you do some day you want to go in this 00:02:19.8 --> [endTime] direction you know putting your nuts to work
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