Attn R.C. White (and others) - accounting for interest in US Savings Bonds?

Hi, Andrew.

What happened in the real world?

You bought bonds and recorded their purchase price in your Bonds account, right? Then you cashed them for more than you paid for them. And you put all the cash into your CU.

First, record all the accumulated interest to date of redemption. In accountant-speak: Debit Bonds; Credit Interest Income. This should bring the Bonds account balance up to the redemption value of the Bonds.

Second, record redemption of the bonds: Debit Cash; Credit Bonds. Don't worry about principal vs. income at this point; that has already been taken care of by the previous entry.

Third, record deposit of the redemption check into your CU: Debit CU; Credit Cash. The CU couldn't care less if the cash is from principal or interest - or from your wages or gambling winnings or anything else.

Ending balances: Bonds: Zero Cash: Zero CU: Previous balance plus redemption proceeds "_Int Inc:US Savings Bonds" Category: All the accumulated interest. The interest income is fully taxable on the US Income Tax return, but is entirely exempt from state and local taxation.

I've never owned a US Savings Bond, Andrew. Some of my clients did, but that was at least a couple of decades ago. Rules may have changed in that time, and my memory may be fuzzy, too. Anyone "reading over our shoulders" should be aware that there are several series of US Savings Bonds (E, EE, H - and others) and each series has its own rates and methods for paying interest. Some pay the interest in periodic checks, much like most other bonds. Others (such as Series E/EE) are bought at a discount and mature at the face amount; the taxpayer may elect at the first year-end after purchase of the bond to report the accumulated interest annually, but most taxpayers choose to wait and report it all at redemption - which you apparently did. My comments are limited to my understanding of your specific situation and may not apply to others.

Be sure to check with your own CPA to validate my comments.

RC

Although you've said to defer recording the interest until cashed, that distorts the picture of net worth through the years. Since some bonds MAY be reasonably held for 30 years and some people have significant holdings in Savings bonds, that seems to be a valid but incorrect way to handle. My Dad, for whom I run his finances, has bonds old enough to no longer pay any interest and they are cashed in wgen they hit that point.

I'm new to Quicken and I have not yet answered this for myself. As a user of MS$, i have accrued interest as it's earned on the investment account Savings Bonds and carried it all as "cash", both the cost/ purchase and earnings which were accounted as tax-free. When the bonds ARE cashed in, I create two transactions. I remove the proceeds from Savings Bonds (uncategroized) and create a deposit to the receiving account properly accounting for the interest and return of capital. That kept net worth and Tax projections accurate.

Since Quicken is using Cash Flows, I don't believe this method will provide an acceptable picture, but since I'm still establishing accounts, I haven't yet setup these EE/E Bonds. I sense the same problem as I encountered in MS$, you can't categorize a transfer transaction differently on the two sides (accounts) of the transfer.

I'm in a bit of quandary as to how to proceed with setup.

Thanks RC -glad you saw my post!

I understand; but if I recorded the original purchase (at 50% face say in

I think the method you provide above will indeed get my interest credited correctly in the year that I cash the bonds in, but at the expense of not having a build up of the asset based on unrealized interest over the years....I hope you understand what I mean.

But perhaps I can't have it both ways - as you say, I could indeed elect to report interest over the years but I choose, as I am sure 99% of the people who own EE bonds, to only report the interest when I sell. So maybe from an accounting point of view, I never really should think I even *had* that interest until the day I sold!

Thoughts?

I could be wrong here but if you buy bonds at purchase price (X bonds at $Y) then at each interval, or yearly, you mark the bonds to their current price (reflecting the interest earned but not paid) then you would have a market value for the bond and the account would not have excess cash - cash that does not get credited in the real world. At sale you would show a gain of 50% but if you enter an adjusting entry debiting the gain and crediting the interest your bottom line would tie upon transfer.

Hi, Andrew.

Steve's point is very valid and my response should be corrected to recognize that. See my reply to Steve.

Oh, yes, the interest was yours, but it was non-cash until the sale. Accrual accounting reflects economic reality. But Congress writes the tax laws for other purposes, and they often allow us to deviate from reality on tax returns. For example: the personal exemption is not economic reality, is it? It's just a number created by the law for political purposes. And there's no good way to record that in Quicken.

As I said to Steve, if you choose to recognize income annually on your financial statements, but defer it on your tax returns, you certainly may. But you will need to keep supplemental records so that you can reconcile the two income amounts.

RC

Hi, Steve.

Good catch! You are right, of course. Since Andrew was asking about the redemption transaction and apparently had not reported interest income during prior years, I focused on that redemption. My comments are correct for federal income tax purposes, but not for annual accounting purposes.

Of course, Quicken was not designed as an accounting program, really, but only as a checkbook program - and then it "just growed". ;^}

When faced with bonds subject to OID (Original Issue Discount), as with several other kinds of assets, we have to choose whether to have Quicken reflect economic reality, or go by tax rules. Either way, we also have to keep supplemental records for the other method if we want to have our cake and eat it, too.

If we wanted to reflect economic reality and GAAP (Generally Accepted Accounting Principles), we would need to graft a lot of accounting rules onto Quicken's simple checkbook design.

For these US Savings Bonds, we would need to make an entry at least once a year as of December 31. In that entry, we would debit Savings Bond (asset) and credit Interest Income for the amount by which the bond value increased during that year. That would correct our income account for the year, and correctly value our bond asset at the end of the year.

But if we elected to defer the tax on that interest until redemption, we would have to keep that annual interest increment from being included in "gross income" for tax purposes. And, in the year of redemption, we would need to be sure that we included all the interest on redeemed bonds, not just the current year's increment. We would need some sort of supplemental record to reconcile our recorded income with what we report on the tax return.

I'm not sure that I follow this at all! The annual interest income is an asset, but it is not cash until the bond is redeemed. It should be added to the bond account itself, as I said above, or be entered into a separate asset account, such as Accrued Interest Receivable, if you want to see that amount separately. Either way would be fine with me.

Whether cash received at redemption is a "sale" or a "return of capital" may be only a matter of semantics, but to me, it clearly is a sale. A return of capital leaves us holding the asset from which the capital was returned. But redemption of a bond means surrendering the bond, so we no longer hold the asset. If we could somehow redeem only a part of the bond's value while still holding the bond itself, I might agree with the return of capital characterization. This is what happens when a corporation downsizes and returns a part of its capital to its shareholders, who continue to hold their shares, for instance.

As I told Andrew, set up the cost of the bond as an asset when it is purchased. Then, as you reminded me, annually record the year's interest increment as income and add it to the bond account (or to a separate asset account). If you elect to defer reporting the income until redemption, then keep supplemental records so that it will not be reported as taxable income until the proper year. When the bond is redeemed, first record interest to the date of redemption, then record the sale of the bond including the accumulated interest - with no gain on the sale.

Thanks for the catch, Steve.

RC

Mark W wrote in news: snipped-for-privacy@p69g2000hsa.googlegroups.com:

Wouldn't it work like OID? On a "normal" OID bond, IRS requires you to recognize imputed interest each year. The only difference is you don't have to get taxed on imputed savings bond interest on EEs. I have some treasury zeros, but they are in a fund so I get a declared dividend and don't have to do anything special in Q.

scott s. .