Individual investors are sometimes confused
about whether they own a stock or a bond.
A bond or note always has a maturity date
and an interest coupon % rate associated
with it. If you see a due date and a stated
interest percent, you own a note or a bond.
The term "bond" refers to longer maturity
dates (over ten years), while the term
"note" refers to short and intermediate
maturity dates (one to ten years.)
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These are also called fixed-income investments or fixed-income securities because the amount of annual interest you will receive in cash is fixed by the coupon rate of interest. The par value is the face amount of the bond or note, meaning the amount of principal that will
be paid back to the investor on the maturity date. The par value of a bond is typically a round number ending in three zeroes (thousands.)
| Click on the image below
to access our handy tool
to calculate the cost basis
of your bond.
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| Amortization Table Generator |
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There are three things you need to know about your bond to determine the proper approach and method of calculation of the cost basis:
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"Compound interest is the most
powerful force in the universe."
--Albert Einstein |
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(1) The first thing you need to find out is whether your bond is classified as taxable or
tax-exempt. You can usually tell from the name of the bond whether it is a taxable or
tax-exempt entity that issued the bond. If the name of the issuer is a state or local
governmental body or taxing authority, it is generally tax-exempt. There are a few
exceptions where a bond with a governmental sounding name is in fact taxable, but
these are rare. If the name of the issuer includes the word "Federal" or "U.S." or
the name of a for-profit corporation, it is generally taxable for Federal income tax
purposes.
(2) The second thing you need to know is whether you bought the bond exactly at
par value, at a premium over par value, or at a discount below par value.
(3) The third piece of information is whether you held the bond until redemption
at maturity or sold it (or it was called by the issuer) prior to maturity.
Thus, for the three questions, there are twelve possible combinations to address.
Let's start with the three possible purchase price scenarios:
If you bought it at par value ($100.00), go HERE> PAR VALUE If you bought it at a Premium over par value (more than $100.00), go HERE> PREMIUM
If you bought it at a Discount from par value (less than $100.00), go HERE> DISCOUNT
Assumptions for all answers:
• You did not elect to amortize (write off) premiums on taxable bonds (which
is way too complicated for individual investors, anyway.)
• Adjustments for state individual income taxes are not addressed.
• You bought the bond after 1993 (the rules changed then.)
• These instructions apply to either bonds or notes in the same manner.
FINAL WORDS
Be sure to tell your Congressperson that they need to simplify the tax code.
It is ridiculous to expect the average taxpayer to understand and follow these rules.
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