Question

1. Steven Price invests in high quality bonds. He currently holds several of such bonds, all of which have a par value of $1000 and pay a fixed rate of interest twice a year.
   1. A 10 year bond issued by Black Industries. Steven purchased this bond at original issue when it was sold to the public for $1020.
   2. A 10 year bond issued by the Beach Corporation. Steven purchased this bond when it was sold to the public at $970.
   3. A 10 year bond issued by the New Jersey Highway Authority on which the interest is tax exempt. Steven purchased this bond at original issue for $1010.

For each of the above, describe how the discount and/or premium should be treated by Steven. You need not calculate the amount of premium or discount amortized, but your answer should precisely describe the tax requirements relating to discount and premium adjustments, if any

Answer 1

a. In the given case, Steven Price purchased the bond issued by Black Industries at a premium of $20. It is assumed that the interest income is taxable, Steven Price can take advantage by amortizing the premium. He can offset the amount of taxable interest from the amount of amortized premium.

b. In the given case, Steven Price purchased the bond issued by Beach Corporation at a discount of $30. Thus, the amount of discount is required to be amortized over the life of the bond.

c. In the given case, Steven Price purchased the bond issued by the New Jersey Highway Authority at a premium of $10. Here the interest income is tax-exempt, Steven Price can't take the taxation benefits by amortizing the premium because the interest income is already tax exempted. But he will be required to reduce his basis in the bond by amortizing the premium over the life of the bond.