Entering Municipal Bonds

Good for them that they kept all the original confirms; surprising how many people do not have them when tax time comes. I don't see why would you want to account for original accrued tax-exempt interest paid in this situation. It already was returned as part of their first tax-exempt interest payment. From your post it appears that this is true for all their munis. I'm assuming here that they are citizens/residents in the U.S; if not, ignore the last paragraph.

In your example, I'd enter 50 for the number of bonds, $4,844.80 for the total cost (principal + SEC fee), and Quicken will show the price as 96.896 (actual cost basis), and forget about accrued tax-exempt interest paid and returned.

When I buy more municipal bonds, I use two separate transactions for each, a Buy for the purchase and a Miscellaneous Expense for any accrued tax-exempt interest paid. I do not put accrued tax-exempt interest in the Buy transaction, because Quicken treats it as taxable interest. I use one of two Quicken income (not expense) categories I set up (with appropriate tax schedule) for the municipal bond interest I received or paid: Federal Tax Exempt (for out-of-state bonds); or Totally Exempt (for in-state, and U.S. territories and possessions, e.g. Puerto Rico, Guam, and Virgin Islands). This matches the way new muni purchases download from my brokerage accounts, except that I have to change the MiscExp category. When I receive semi-annual muni interest payments, I assign one of these categories to them. I also set up my Schedule B reports to include these categories separately (to be added to Form 1040 line 8b).

.............................. Hell was full, so I came back!

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I'm not sure what version of Quicken you are using, but in Q2005, if I enter accrued interest in a Bonds Bought transaction: I get a separate MiscExp transaction categorized to "_Accrued Int". But this is not the end of the "categorization"; if the bond bought was a "tax free" bond, then the "_Accrued Int" is further categorized to "_IntIncTaxFree" for Quicken tax reporting.

QH&B 2006. Was not aware that somewhere Quicken further split the _Accrued Int field into taxable and tax-free, likely based on the security description properties. However, because I buy some out-of-state bonds, that generate state taxable interest, I still need further categorization for tax purposes. I suppose I can recategorize that MiscExp transaction afterwards. I'll try it if/when I find another muni worth buying. Thanks. .............................. The More Things Change, the More They Stay Insane

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Thanks to all of you for your help. I should have mentioned that I am using

2004 vers. I think I may upgrade this year to 2006...sounds like they added some clarification to municipal bond purchases. To John Pollard, I can't enter the bonds as "buy bonds" yet because I am just entering everything for the first time and therefore have no cash to draw from for all the entries, so with the "Add Shares", there is no place to enter the accrued interest. I guess I really don't have to worry about the interest being that they are all muni bonds but just wanted to do things as accurately as possible. Route 101's suggestion makes sense to me, so I will just ignore the accrued interest on those bonds already purcased. I am not real familiar with municipal bonds. Once everything is in, it should be accurate from that point on.

I can't test this because I don't have Q2004, but you can test it easily: identify your muni bond securities as security "Type", "Bond", and check the "Tax Free" box (you probably have to do both after you have added the security to Quicken, I don't think those options are in the new security dialog). Then record a MiscExp transaction for a muni bond as "_Accrued Interest" (I assume Q2004 uses that category). Then run a Tax Summary (or Tax Schedule) report (with investment accounts included) and see if the accrued interest appears under the category "_IntIncTaxFree" (heading) while the actual transaction category remains "_Accrued Interest.

Exactly: Security Type: Bond; and check the Tax Free box.

Hi, Barbara.

Most of your questions have already been tackled by the other posters. I'd like to focus on just the accrued interest purchased.

Except for bonds purchased within the past year, that purchased interest should have been forgotten by now. In your example, the $87.05 that your parents paid out for accrued interest would have been returned to them as a part of their first interest income check. On a typical bond that pays interest semi-annually, the $87.05 would have reduced their income for the year of purchase or the following year, depending on the timing of their purchase.

Accrued interest purchased is not an expense, exactly; it is a reduction of income. If the first interest income is in the same year as the purchase, it is obvious that only the net amount is income. If that first interest is not received until the following year, the proper treatment is the same, but it is not so obvious.

Suppose you buy a $5,000 bond paying 6%, with $150 checks paid semi-annually on March 1 and September 1. If you buy the bond on July 1, you will have to also buy the $100 interest accrued since the last March 1. On September 1, you will receive $150, representing the $100 you bought plus $50 accrued from July 1 to September 1. Your income for that year will be only $50, although you actually received $150.

If you bought that same bond on November 1, 2005, you would have to pay $50 for the interest accrued since September 1. You will not receive any interest check until March 1, 2006, when you will get $150, representing the $50 you paid plus $100 accrued since your purchase. For 2005, you will report no income. You also will not be allowed to deduct the $50 you paid for the accrued interest you bought. You must remember that Accrued Interest Purchased and carry it over to 2006, when you receive the first interest income, which includes what you purchased.

For current bond purchases, you can handle accrued interest purchases in the theoretically correct way, or in the more practical way, especially if there are only a few of them. The correct way is to use an Asset Account called Accrued Interest Receivable. When you buy the bond, put the principal in Bonds and the purchased interest in this separate account. When you receive the first interest check, reduce this purchased interest account to zero and put only the excess in the Interest Income Category. With this method, your Income Statement will always show only the interest you've earned, not what you've purchased, and your Balance Sheet will show the interest you've purchased as a part of your net worth.

The more practical handling, for most people, is to just put the purchased interest into the Interest Income Category as a debit (a "negative income" amount). When the first interest check arrives, put it into this category as usual. The plus and minus amounts will result in your correct net income for the year. But if your year ends before the first interest check is received, then you must remember to NOT deduct purchased interest for THIS bond this year. You'll have to remember to deduct it from next year's interest receipts. And you can't use interest purchased with Bond A to offset interest received on Bond B.

In your parents' situation, most of those bonds were purchased more than a year ago. The first interest check on each of them was received - and reported - in prior years. For those bonds, the interest purchased is no longer relevant and need not be recorded at all now. Even for bonds purchased last year, if the first interest receipt was in the prior year, the purchased interest is not relevant now. But for bonds on which the first interest has not been received, you should record the purchased interest as either Accrued Interest Receivable or as a minus in income, to offset that first interest check when it is received.

Since these are all municipal bonds and, presumably, the interest has always been excludable from your parents' taxable income, it might not matter if the accrued interest was not reported properly in the past. But if the amounts are significant, you might want to review prior years' returns to see if any of them need to be amended. Were those returns prepared by a CPA or other competent tax professional?

Since the bond in your example was purchased at a discount, you have a further issue of the amortization of the discount, but let's leave that complex subject for another day. The $2.35 fee should be included in the tax "basis" of the bond.

RC

Thank you so much for that very clear explanation on how to handle accrued interest. I now understand it so much more completely. I have already entered the bonds and did enter the accrued interest as a negative income, realizing that for those bought a few years ago it really didn't matter; and I realize that I won't have a complete history of all the interest paid in the past but will from this point forward, as well as bond performance. I went back and looked at bonds bought in 2005 and there were a couple that were bought after the interest paid dates (accrued interest only amounted to $55) but I learned something about how to handle this interest in the future. My parents do have a tax professional do their taxes. I have not had much experience buying bonds in my portfolio and I certainly understand the whole process better now. Thanks again to all of you who helped. Newsgroups are great!

Hi Barbara - After reading all these posts! No one has mentioned htat there is a government uro for just this thing. It may be cumbersome initially because the bonds have to be entered into the program. You then can save the file with your data ( the bonds ) and check once or twice a year. I update in January and July.

Here is the URL address

go here. To update change the "Value As Of" date and update.

Have fun John :-)

Hi, John.

Thanks for posting that URL. But that is for US Government SAVINGS BONDS, such as the familiar E Bonds that so many people have owned - and still own. There are some special rules for this kind of bond, but they don't apply to this discussion.

Barbara's parents own MUNICIPAL BONDS, which are issued by STATE and local governments, NOT by the US Treasury. I've been retired long enough to have forgotten and I'm too lazy to look it up now, but there are both statutory and constitutional issues as to whether the federal government can burden states and their "political subdivisions" (such as school districts and cities) by taxing their bondholders on what the local governments pay out as interest on their borrowings. Because such interest income is exempt from the federal income tax, taxpayers are willing to accept a lower interest rate than if the interest were fully taxable to them. Some benefit flows to the bondholder, obviously, but the rationale of the exemption is to benefit the local government borrowers. We pay lower school district taxes because the district can borrow more cheaply to build a new school; at the same time, if we lend money to the district by buying their bonds, we save federal income tax because our interest income on those bonds is exempt from that tax.

US Savings bonds are bought directly from the US Treasury at a discount and redeemed at their face amount several years later. No interest checks are received by the bondholder. All the interest income is received at maturity, when a bond that was bought for $75 is redeemed for the $100 face amount, including the $25 interest. Bondholders are taxed on the full $25 in the year of redemption unless they have elected to be taxed on each year's increment as it occurs. If they have made such election, they can refer to the URL you posted to determine how much to include as income for each year.

Municipal bonds take many forms, but the most common is sold at par (usually $1,000) and pays interest semi-annually by sending a check to the bondholder. On a $1,000 bond paying 6% annually, a county government would pay $30 twice a year, on June 1 and December 1, for example. If you buy that bond from the county at issue and hold it to maturity, your interest income accounting is pretty cut and dried. But if you sell the bond before maturity, you are entitled to the interest to the date of sale. If you sell it on November 1, you are entitled to the interest for the five months since your last interest check on June 1. You will insist that the buyer pay you $25 for that 5 months' interest, in addition to the $1,000 for the bond itself. That $25 will be interest income to you.

From the buyer's point of view, he had to pay $1,025: he has bought the bond for $1,000, plus he has bought $25 interest. A month later, he will receive a check for $30, but only $5 of that is his income. The other $25 simply reimburses him for what he paid the seller. That was the issue that Barbara was facing.

Thanks again for the URL, John. It won't help Barbara, but it should benefit other readers here who hold US Savings Bonds.

RC

Like most people I hae a vision problem. Sometimes called CRC (can't read crap).

Regards John

Hi, John.

That's not as bad as my CRS (can't remember stuff)! ;>{

RC