Other Issues Affecting Bonds

March 13, 2024

7700 / What is a structured product? How are structured products taxed?

<div class="Section1"> “Structured products are not specifically defined in the securities laws. They have been described as securities that may be derived from or based on a particular security or commodity, a basket of securities, an index, a debt issuance, or a foreign currency. Many involve innovative financing techniques creating customized financing and investment products to suit specific financial needs of customers. They may involve complex “tranched” (i.e., segmented) liabilities and transfers through special purpose vehicles. Such transactions may be structured for any number of reasons – for example, for principal protection, tax minimization, accounting cosmetics, monetization, or other specific purposes.”<a href="#_ftn1" name="_ftnref1">1</a> Some of the more popular types of structured products sold to retail investors include principal-protected notes, equity-linked notes, and indexed-linked notes. The taxation of a structured product will depend on the tax treatment of its individual components. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7517">7517</a> – stock; Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7556">7556</a> through Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7585">7585</a> – options; Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7634">7634</a> through Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7638">7638</a> – corporate bonds; Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7643">7643</a> through Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7649">7649</a> – market discount; and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7650">7650</a> through Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7654">7654</a> – original issue discount. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  “Speech by SEC Staff: Structured Finance Activities: The Regulatory Viewpoint,” given by Mary Ann Gadziala, Associate Director, Office of Compliance Inspections and Examinations, U.S. Securities and Exchange Commission to the International Bar Association Conference – Financial Services Section, Chicago, Illinois, September 20, 2006, at: www.sec.gov/news/speech/2006/spch092006mag.htm. </div></div>

March 13, 2024

7699 / What tax limitations apply to the holder of registration required bonds that are not in registered form?

<div class="Section1"> Income from otherwise tax-exempt bonds that do not meet the registration requirement (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7698">7698</a>) is not exempt from federal income tax in the hands of a U.S. person. However, this limitation does not apply to interest exempt from tax by the United States under a treaty.<a href="#_ftn1" name="_ftnref1">1</a> Loss on the sale, exchange, theft, loss, etc., of a registration required obligation that would be tax-exempt if registered is not deductible if the obligation is not in registered form.<a href="#_ftn2" name="_ftnref2">2</a> Gain on sale or exchange of a registration required bond that would otherwise be tax-exempt but that is not registered must be treated as ordinary income. It is denied capital gain treatment.<a href="#_ftn3" name="_ftnref3">3</a> These sanctions also apply to U.S. persons holding unregistered bonds that are not required to be registered because they were designed for distribution outside the United States.<a href="#_ftn4" name="_ftnref4">4</a> Regulations allow the loss deduction and capital gains treatment by a holder who, within 30 days of the date when the seller or other transferor is reasonably able to make the bearer obligation available to the holder, surrenders the obligation to a transfer agent or to the issuer for conversion into registered form.<a href="#_ftn5" name="_ftnref5">5</a>   <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC §§ 103(b), 149; Temp. Treas. Reg. § 5f.103-1. <a href="#_ftnref2" name="_ftn2">2</a>.  IRC § 165(j)(1). <a href="#_ftnref3" name="_ftn3">3</a>.  IRC § 1287. <a href="#_ftnref4" name="_ftn4">4</a>.  IRC §§ 165(j), 1287(a). <a href="#_ftnref5" name="_ftn5">5</a>.  IRC § 165(j)(3); Treas. Reg. § 1.165-12(c)(4). </div></div>

March 13, 2024

7691 / What is a "Ginnie Mae" mortgage-backed pass-through certificate?

<div class="Section1">A Ginnie Mae pass-through certificate represents ownership of a proportionate interest in a fixed pool of mortgages insured or guaranteed by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), the Department of Agriculture's Rural Housing Service (RHS), and the Department of Housing and Urban Development's Office of Public and Indian Housing (PIH). The mortgages in the pool have the same interest rate, term to maturity, and type of dwelling. The certificates are generally issued by a mortgage banker or savings and loan association and are secured by the pool of mortgages that have been placed by the issuer with a bank custodian. They call for payment by the issuer of specified monthly installments based on the amortization schedules of the mortgages in the pool. In addition, the certificates provide for payment of a proportionate share of prepayments or other early recoveries of principal. An amount is withheld each month by the issuer to discharge the certificate holder's obligation to pay servicing, custodian, and guarantee fees. Pass-through certificates may be either "fully modified" or "straight."</div> <div class="Section1"> Timely payment of the principal and interest, whether or not collected, is guaranteed to the fully modified pass-through certificate holder by the Government National Mortgage Association (GNMA, or "Ginnie Mae"). Straight pass-through certificates provide for the payment by the issuer of a proportionate share of proceeds, as collected, on the pool of mortgages, less servicing fees and other costs. Straight pass-through certificates are guaranteed by GNMA only as to proper servicing of the mortgages by the issuer (i.e., payment of interest and principal actually collected or collectible through due diligence). The full faith and credit of the United States is pledged to the payment of all amounts guaranteed by GNMA.<a href="#_ftn1" name="_ftnref1">1</a> Certificates are issued in registered form and are fully transferable and assignable. They are marketable in the secondary market. They are available in minimum denominations of $25,000 ($1 thereafter) and may be available for less in the secondary market. The maximum maturity is 30 years; however, experience has shown that the average life is shorter. If all certificate holders and the issuer agree, the pool arrangement may be terminated at any time prior to the final maturity date. Similar mortgage backed pass-through certificates are issued and guaranteed by "Fannie Mae" (Federal National Mortgage Association or FNMA), but are not backed by the full faith and credit of the United States. </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. 8 U.S.C. § 306(g). </div>

March 13, 2024

7693 / What is a "REMIC?"

<div class="Section1">A REMIC is a “real estate mortgage investment conduit.” In general, a REMIC is a fixed pool of real estate mortgages that issues multiple classes of securities backed by the mortgages and that has elected to be taxed as a REMIC. It can issue several different classes of “regular interests” and must issue one (and only one) class of “residual interests.”<a href="#_ftn1" name="_ftnref1">1</a> A regular interest is a debt obligation (or is treated as one) and a “residual interest” participates in the income or loss of the REMIC.<a href="#_ftn2" name="_ftnref2">2</a> A REMIC is not treated as a separate taxable entity (unless it engages in certain prohibited transactions); instead, the income is taxable to the interest holders as explained in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7694">7694</a>.<a href="#_ftn3" name="_ftnref3">3</a><div class="Section1"> Generally, entities that do not qualify as REMICs, but that issue multiple maturity debt obligations, the payments on which are related to payments on the mortgages and other obligations held by the entity, are classified as Taxable Mortgage Pools (TMPs).<a href="#_ftn4" name="_ftnref4">4</a> (Domestic building and loan associations are not considered TMPs.) TMPs are taxed as corporations.<a href="#_ftn5" name="_ftnref5">5</a> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.   IRC § 860D. <a href="#_ftnref2" name="_ftn2">2</a>.   IRC §§ 860B, 860C. <a href="#_ftnref3" name="_ftn3">3</a>.   IRC §§ 860A, 860F(a)(1). <a href="#_ftnref4" name="_ftn4">4</a>.   IRC § 7701(i)(2); Treas. Reg. § 301.7701(i)-1(b). <a href="#_ftnref5" name="_ftn5">5</a>.   IRC § 7701(i). </div></div>

March 13, 2024

7697 / What are REMIC inducement fees? How are these fees taxed?

<div class="Section1">The IRS released regulations relating to the proper timing and source of income from fees received to induce the acquisition of noneconomic residual interests in REMICS. The regulations provide that an inducement fee must be included in income over a period reasonably related to the period during which the applicable REMIC is expected to generate taxable income (or net loss) allocable to the holder of the noneconomic residual interest. Under a special rule applicable upon disposition of a residual interest, if any portion of an inducement fee received with respect to becoming the holder of a noneconomic residual interest has not been recognized in full by the holder as of the time the holder transfers (or otherwise ceases to be the holder for federal income tax purposes) that residual interest in the applicable REMIC, the holder must include the unrecognized portion of the inducement fee in income at that time.</div> <div class="Section1"> The regulations set forth two safe harbor methods of accounting for inducement fees, and contain a rule that an inducement fee is income from sources within the United States.<a href="#_ftn1" name="_ftnref1">1</a> The Service also released the procedures by which taxpayers can obtain automatic consent to change from any method of accounting for inducement fees to one of the two safe harbor methods.<a href="#_ftn2" name="_ftnref2">2</a> The Service reached a settlement with two entities that purportedly brokered noneconomic residual interests in a manner based on what the IRS perceived to be an overly aggressive interpretation of the tax laws.<a href="#_ftn3" name="_ftnref3">3</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Treas. Reg. §§ 1.446-6, 1.860C-1(d), 1.863-1(e), 1.863-1(f), 69 Fed. Reg. 26040 (5-11-2004). <a href="#_ftnref2" name="_ftn2">2</a>. Rev. Proc. 2004-30, 2004-1 CB 950. <a href="#_ftnref3" name="_ftn3">3</a>. IR-2004-97 (July 26, 2004). </div>

March 13, 2024

7692 / How is the monthly payment on a Ginnie Mae mortgage backed pass-through certificate taxed?

<div class="Section1">Payments on pass-through certificates to certificate holders are made monthly. Each payment represents part interest and part principal (i.e., payments on the underlying portfolio of mortgages passed through to certificate holders). The issuer provides each certificate holder with a monthly statement indicating which part of the distribution represents scheduled principal amortization, which part is interest, and which part represents unscheduled collection of principal. Interest and other items of income, including prepayment penalties, assumption fees, and late payment charges, must be included in gross income in the year received. Principal payments are tax-free to the extent they represent recovery of capital.<a href="#_ftn1" name="_ftnref1">1</a> To the extent they represent discount on purchase of the mortgages, they must be included as ordinary income. As owners of undivided interests in the entire pool, pass-through certificate owners must include as ordinary income their ratable shares of any discount income realized on purchase of each of the mortgages in the pool. Discount on mortgages that are taxable obligations of corporations or governments or their political subdivisions, is included in income as original issue discount under the rules discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7650">7650</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7653">7653</a>.<a href="#_ftn2" name="_ftnref2">2</a><div class="Section1"> Income from Ginnie Mae certificates is not exempt from state taxation despite the pledging of the full faith and credit of the United States on all amounts guaranteed by the GNMA because the government is a guarantor, not an obligor, of the instruments.<a href="#_ftn3" name="_ftnref3">3</a> Amounts withheld by the issuer of the certificate to pay servicing, custodian, and guarantee fees are expenses incurred for the production of income. (See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8049">8049</a> for an explanation of the rules governing deduction of such expenses by pass-through entities.) Certificate holders may amortize their proportionate share of any premium paid to acquire mortgages under rules applicable to corporate interest-bearing bonds (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7654">7654</a>).<a href="#_ftn4" name="_ftnref4">4</a> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.   Rev. Rul. 84-10, 1984-1 CB 155; Rev. Rul. 70-545, 1970-2 CB 7. <a href="#_ftnref2" name="_ftn2">2</a>.   Rev. Rul. 84-10, 1984-1 CB 155; Rev. Rul. 74-169, 1974-1 CB 147; Rev. Rul. 70-544, 1970-2 CB 6. <a href="#_ftnref3" name="_ftn3">3</a>.   Rockford Life Ins. v. Illinois Dept. of Rev., 482 U.S. 182 (1987). <a href="#_ftnref4" name="_ftn4">4</a>.   Rev. Rul. 84-10, 1984-1 CB 155. </div></div>

March 13, 2024

7696 / How is excess inclusion income from a REMIC residual interest coordinated with a taxpayer's net operating losses?

<div class="Section1">Any “excess inclusion” (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7695">7695</a>) for any taxable year is not to be taken into account in determining the amount of any net operating loss (NOL) for the taxable year (i.e., in determining the loss for a “loss year”).<a href="#_ftn1" name="_ftnref1">1</a> Any excess inclusion for a taxable year is not to be taken into account in determining taxable income for the taxable year for purposes of Subsection (a)(2)(B)(ii)(I) and the second sentence of IRC Section 172(b)(2).<a href="#_ftn2" name="_ftnref2">2</a><div class="Section1"> The Service has ruled that in computing an NOL for the taxable year, no excess inclusion is taken into account. If, during the same taxable year, a taxpayer both recognizes an excess inclusion and incurs an NOL, the excess inclusion may not be offset by the NOL and is not taken into account in determining the amount of the NOL that may be carried to another taxable year. The Service has further ruled that if an NOL is carried back or carried over to a taxable year in which an excess inclusion is recognized, the excess inclusion cannot be offset by the NOL carryback or carryover, and is not included in the calculation of taxable income for NOL absorption purposes.<a href="#_ftn3" name="_ftnref3">3</a> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.   IRC § 860E(a)(3)(A). <a href="#_ftnref2" name="_ftn2">2</a>.   IRC § 860E(a)(3)(B), as amended by the 2020 CARES Act. <a href="#_ftnref3" name="_ftn3">3</a>.   Rev. Rul. 2005-68, 2005-2 CB 853. </div></div>

March 13, 2024

7695 / What is a "residual interest" issued by a REMIC? How is the owner of a residual interest taxed?

<div class="Section1">In general, a residual interest is any interest in a REMIC, other than a regular interest, that is issued on the startup day and is designated as a residual interest.<a href="#_ftn1" name="_ftnref1">1</a> However, there may be only one class of such interests and any distributions with respect to such interests must be pro rata.<a href="#_ftn2" name="_ftnref2">2</a><div class="Section1"> The holder of a residual interest takes into account his or her daily portion of the taxable income or net loss of the REMIC for each day that he or she held the interest during the taxable year.<a href="#_ftn3" name="_ftnref3">3</a> Any reasonable convention may be used to determine the holder’s daily portion of income or loss.<a href="#_ftn4" name="_ftnref4">4</a> This amount is treated as ordinary income or loss.<a href="#_ftn5" name="_ftnref5">5</a> Such income in excess of daily accruals of income on the issue price at 120 percent of the long-term federal rate is called “excess inclusions,” and a holder of a residual interest can in no event have a taxable income of less than his or her excess inclusions. In other words, they cannot be offset by any deductions.<a href="#_ftn6" name="_ftnref6">6</a> In addition, a REMIC must allocate to certain residual interest holders each calendar quarter a proportionate share of investment expenses paid or accrued for the quarter for which a deduction is allowed under IRC Section 212 to the REMIC: these holders are (1) individuals, (2) any other persons (such as a trust or estate) that compute taxable income in the same manner as an individual, and (3) certain pass-through entities (such as partnerships, S corporations, and grantor trusts) having as a partner, shareholder, beneficiary, participant, or interest holder (x) an individual, (y) a person who computes taxable income in the same manner as an individual, or (z) a pass-through entity. Such a residual interest holder must include in income his or her allocable share of these expenses. Prior to 2018, a residual interest holder was permitted to deduct them as miscellaneous itemized expenses subject to the 2 percent floor (these deductions have been suspended for 2018-2025).<a href="#_ftn7" name="_ftnref7">7</a> Distributions from a REMIC are not included in gross income by the holder unless they exceed his or her adjusted basis in the interest. To the extent distributions exceed the holder’s basis, the excess is treated as gain from sale of the residual interest.<a href="#_ftn8" name="_ftnref8">8</a> The amount of net loss that may be taken into account by the holder with respect to any calendar quarter is limited to the adjusted basis of the interest as of the close of the quarter. Disallowed loss may be carried over indefinitely in succeeding quarters.<a href="#_ftn9" name="_ftnref9">9</a> The adjusted basis of a residual interest is increased by the amount of taxable income of the REMIC taken into account by the holder; it is decreased (not below zero) by the amount of distributions and by any net loss taken into account.<a href="#_ftn10" name="_ftnref10">10</a> However, no increase in the holder’s basis is allowed for the amount of miscellaneous expenses allocated to the holder and included in his or her income.<a href="#_ftn11" name="_ftnref11">11</a> With certain exceptions, a REMIC’s taxable income, for purposes of determining the amount includable by holders of residual interests, is determined in the same manner as for individuals, using a calendar year and using the accrual method of accounting.<a href="#_ftn12" name="_ftnref12">12</a> The Service privately ruled that whether a holder is liable for taxes associated with a noneconomic REMIC residual interest depends on the facts and circumstances associated with the transfer of the interest.<a href="#_ftn13" name="_ftnref13">13</a> The REMIC is required to provide information quarterly (on Schedule Q) to holders of residual interests regarding their share of income or loss, the amount of excess inclusion, and allocable investment expenses.<a href="#_ftn14" name="_ftnref14">14</a> For purposes of the wash sale rules (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7537">7537</a>), a residual interest in a REMIC is treated as a security and, except as provided in regulations, such a residual interest and an interest in a “taxable mortgage pool” are treated as substantially identical stock or securities. Furthermore, the 30-day period in the wash sale rules is enlarged to six months in applying it to such interests. (For this purpose, the definition of a taxable mortgage pool is treated as if in effect in tax years beginning after 1986.)<a href="#_ftn15" name="_ftnref15">15</a> The Service released regulations in 2002 relating to safe harbor transfers of noneconomic REMIC residual interests in REMICs. The regulations provide additional limitations on the circumstances under which transferors may claim safe harbor treatment.<a href="#_ftn16" name="_ftnref16">16</a> The Service also issued regulations in 2008 relating to income associated with a residual interest in a REMIC that is allocated through certain entities to foreign persons who have invested in those entities.<a href="#_ftn17" name="_ftnref17">17</a> If a charitable remainder trust (CRT—see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8079">8079</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8088">8088</a>, and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8089">8089</a>) is a partner in a partnership or a shareholder in a real estate investment trust (REIT—see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7975">7975</a>), and if the partnership or the REIT has excess inclusion income from holding a residual interest in a REMIC, the Service has ruled that: (1) the excess inclusion income allocated to a CRT is not unrelated business taxable income (UBTI) to the CRT and, thus, does not affect the CRT’s tax exemption for the taxable year; (2) a CRT is a disqualified organization for purposes of IRC Section 860E; and (3) a pass-through entity that has excess inclusion income allocable to a CRT is subject to the pass-through entity tax under IRC Section 860E(e)(6)(A).<a href="#_ftn18" name="_ftnref18">18</a> In a legal memorandum, the Service concluded that, in general, a holder of a residual interest in a REMIC may not offset excess inclusion income by an otherwise allowable charitable contribution deduction.<a href="#_ftn19" name="_ftnref19">19</a> In 2006, the Service provided interim guidance relating to excess inclusion income of pass-through entities, particularly real estate investment trusts. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7975">7975</a>. The interim guidance applies to excess inclusion income from REMIC residual interests (and REIT taxable mortgage pools), whether received directly or allocated from another pass-through entity.<a href="#_ftn20" name="_ftnref20">20</a> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.   IRC § 860G(a)(2). <a href="#_ftnref2" name="_ftn2">2</a>.   IRC § 860D(a). <a href="#_ftnref3" name="_ftn3">3</a>.   IRC § 860C(a). <a href="#_ftnref4" name="_ftn4">4</a>.   Treas. Reg. § 1.860C-1(c). <a href="#_ftnref5" name="_ftn5">5</a>.   IRC § 860C(e). <a href="#_ftnref6" name="_ftn6">6</a>.   IRC § 860E(a); Treas. Reg. § 1.860E-1(a). <a href="#_ftnref7" name="_ftn7">7</a>.   IRC § 67(c); Temp. Treas. Reg. § 1.67-3T(a). <a href="#_ftnref8" name="_ftn8">8</a>.   IRC § 860C(c). <a href="#_ftnref9" name="_ftn9">9</a>.   IRC § 860C(e)(2). <a href="#_ftnref10" name="_ftn10">10</a>.   IRC § 860C(d). <a href="#_ftnref11" name="_ftn11">11</a>.   Temp. Treas. Reg. § 1.67-3T(b)(5). <a href="#_ftnref12" name="_ftn12">12</a>.   IRC § 860C(b). See Treas. Reg. § 1.860C-2. <a href="#_ftnref13" name="_ftn13">13</a>.   Let. Rul. 200032001. <a href="#_ftnref14" name="_ftn14">14</a>.   Treas. Reg. § 1.67-3(f); Treas. Reg. § 1.860F-4(e)(1). <a href="#_ftnref15" name="_ftn15">15</a>.   IRC § 860F(d). <a href="#_ftnref16" name="_ftn16">16</a>.   Treas. Reg. §§ 1.860E-1(c)(4), 1.860E-1(c)(5) through 1.860E-1(c)(10), 67 Fed. Reg. 47451 (July 19, 2002), superseding Rev. Proc. 2001-12, 2001-3 CB 335. <a href="#_ftnref17" name="_ftn17">17</a>.   TD 9415, 73 Fed. Reg. 40171 (July 14, 2008). <a href="#_ftnref18" name="_ftn18">18</a>.   Rev. Rul. 2006-58, 2006-2 CB 876. <a href="#_ftnref19" name="_ftn19">19</a>.   ILM 200850027. <a href="#_ftnref20" name="_ftn20">20</a>.   Notice 2006-97, 2006-2 CB 904. </div></div>

March 13, 2024

7694 / What is a "regular interest" issued by a REMIC? How is the owner of a regular interest taxed?

<div class="Section1">Editor’s Note: The IRS provided relief to REMICs under the 2020 CARES Act. Modifications to mortgage loans held by REMICs, or REMICs that resulted from mortgage forbearance permitted under the CARES Act, were not treated as prohibited transactions under IRC Section 860F(a)(1). Forbearance-related loan modifications were also not treated as having created new mortgages. The relief applied to forbearances and all related modifications requested by borrowers between March 27 and December 31, 2020 and provided by lenders or servicers with respect to mortgage loans under forbearance programs for borrowers experiencing financial hardships caused directly or indirectly by COVID-19.<a href="#_ftn1" name="_ftnref1">1</a><div class="Section1"> As a general rule, REMICs issue several classes of “regular” interests and a single class of “residual interests.” (See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7695">7695</a> for a discussion of “residual interests.”) Regular interests are subject to federal income tax under the following rules. An interest in a REMIC is a regular interest if it (1) was issued as a designated regular interest on the “startup day” selected by the REMIC, (2) unconditionally entitles the holder to a specified principal amount, and (3) provides for interest payments (if any) that (a) are based on a fixed rate, or, to the extent provided in regulations, at a variable rate, or (b) consist of a specified, unvarying portion of the interest payments on qualified mortgages.<a href="#_ftn2" name="_ftnref2">2</a> See Notice 93-112 for the Service’s acceptance of a floating rate as a variable rate.<a href="#_ftn3" name="_ftnref3">3</a> Under regulations effective for most obligations issued on or after April 4, 1994, a variable rate includes a qualified floating rate as defined in Treasury Regulation Section 1.1275-5(b)(1). In addition, a rate equal to the highest, lowest, or average of two or more qualified floating rates is a variable rate for purposes of IRC Section 860G. A REMIC may issue a regular interest that bears interest that can be expressed as a percentage of the interest payable on a specified portion of a regular interest acquired from another REMIC (sometimes called a specified portion regular interest or an “Interest Only” interest or “IO”). The Treasury Department and the Service are considering whether to issue regulations with respect to the tax treatment of REMIC IOs for issuers and initial- and secondary-market purchasers. An advance notice of proposed rulemaking was released in 2004 regarding the proper timing of income or deduction attributable to an “interest only” regular interest in a REMIC. The advance notice provided additional background information and set forth summary descriptions of possible approaches to the pertinent issues.<a href="#_ftn4" name="_ftnref4">4</a> Nothing has yet come of this project, however. The timing (but not the amount) of the principal payment may be contingent on the extent of prepayment on mortgages and the amount of income from permitted investments.<a href="#_ftn5" name="_ftnref5">5</a> No minimum specified principal amount is required; it may be zero.<a href="#_ftn6" name="_ftnref6">6</a> Similar requirements apply if the interest is in the form of stock, a partnership interest, interest in a trust, or other form permitted under state law. If an interest is not in the form of debt, it must entitle the holder to a specified amount (even if it is zero) that would, if it were issued in debt form, be identified as the principal amount of the debt.<a href="#_ftn7" name="_ftnref7">7</a> A REMIC may issue regular interests that are subordinated to other classes of regular interests, which bear all or a disproportionate share of losses or expenses from cash flow shortfalls, such as losses from defaults or delinquencies on mortgages or other permitted investments.<a href="#_ftn8" name="_ftnref8">8</a> The Service has ruled that, in the event payments received from certain pre-existing interests were insufficient to distribute interest at the applicable stated rate on interests in a newly formed REMIC, a “funds-available” cap would not prevent the new interests from qualifying as regular interests under IRC Section 860G.<a href="#_ftn9" name="_ftnref9">9</a> Generally, holders of regular interests are taxed as if the interest were a debt instrument, except that holders must account for income from the interest using the accrual method of accounting (regardless of the accounting method otherwise used by the holder).<a href="#_ftn10" name="_ftnref10">10</a> Periodic payments of interest (or similar amounts) are treated as accruing pro rata between interest payment dates. Original issue discount on regular interests is includable as it accrues. Special rules apply to the determination of original issue discount on regular interests.<a href="#_ftn11" name="_ftnref11">11</a> For proposed regulations issued in 2004 addressing the special rule for accruing original issue discount on certain REMIC regular interests, which provide for delayed payment periods of fewer than 32 days, see Proposed Treasury Regulation Section 1.1275-2(m).<a href="#_ftn12" name="_ftnref12">12</a> The IRC prohibits (with some exceptions) the indirect deduction through pass-through entities of amounts that would not be allowable as a deduction if paid or incurred directly by an individual.<a href="#_ftn13" name="_ftnref13">13</a> Under some circumstances (e.g., if the REMIC is substantially similar to an investment trust) holders of regular interests may be required under IRC Section 67(c) and regulations thereunder to include in income as interest an allocable share of certain investment expenses of the REMIC. Prior to 2018, the amount could be deducted as a miscellaneous itemized deduction if the holder itemized deductions; however, aggregate miscellaneous deductions were subject to a 2 percent floor (all of these miscellaneous itemized deductions were suspended for 2018-2025).<a href="#_ftn14" name="_ftnref14">14</a> No increase in basis was allowed for the amount passed through as miscellaneous expense even though it was included in income.<a href="#_ftn15" name="_ftnref15">15</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="733">733</a> regarding the treatment of miscellaneous itemized deductions. The REMIC is required to report to regular interest holders amounts includable as interest and original discount and the allocable share of expenses.<a href="#_ftn16" name="_ftnref16">16</a> However, under regulations effective June 16, 2000, the requirement that REMIC issuers set forth certain “legending” information on the face of certificates when issued (i.e., the total amount of original issue discount on the instruments, the issue date, the rate at which interest is payable as of the issue date, and the yield to maturity) has been eliminated.<a href="#_ftn17" name="_ftnref17">17</a> On disposition, gain is ordinary income to the extent that it does not exceed the excess (if any) of (1) the interest the holder would have included in gross income if the yield on the regular interest were calculated at a rate of 110 percent of the applicable federal rate as of the beginning of the taxpayer’s holding period, over (2) the amount of interest actually includable in gross income by the taxpayer prior to disposition.<a href="#_ftn18" name="_ftnref18">18</a> Regular interests may be treated as market discount bonds (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7643">7643</a>) if the revised issue price (within the meaning of IRC Section 1278) exceeds the holder’s basis in the interest. Market premium on a regular interest can be amortized currently. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7654">7654</a>. FASIT transfers to REMICS. The FASIT rules have been repealed.<a href="#_ftn19" name="_ftnref19">19</a> The amendments are generally effective on January 1, 2005.<a href="#_ftn20" name="_ftnref20">20</a> The definitions of REMIC regular interests, qualified mortgages, and permitted investments have been modified so that certain types of real estate loans and loan pools can be transferred to, or purchased by, a REMIC. According to the Conference Committee Report, modifications to the present-law REMIC rules are intended to permit the use of REMICS by taxpayers that have relied on FASITs to securitize certain obligations secured by interests in real property.<a href="#_ftn21" name="_ftnref21">21</a> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.   Revenue Procedure 2020-26. <a href="#_ftnref2" name="_ftn2">2</a>.   IRC § 860G(a). <a href="#_ftnref3" name="_ftn3">3</a>.   1993-1 CB 298. <a href="#_ftnref4" name="_ftn4">4</a>.   See REG-106679-04, 69 Fed. Reg. 52212 (Aug. 25, 2004). <a href="#_ftnref5" name="_ftn5">5</a>.   IRC § 860G(a)(1). See Treas. Reg. § 1.860G-1(a)(5). <a href="#_ftnref6" name="_ftn6">6</a>.   Treas. Reg. § 1.860G-1(a)(2)(iv). <a href="#_ftnref7" name="_ftn7">7</a>.   Treas. Reg. § 1.860G-1(b)(4). <a href="#_ftnref8" name="_ftn8">8</a>.   Treas. Reg. § 1.860G-1(b)(3)(iii). <a href="#_ftnref9" name="_ftn9">9</a>.   Let. Rul. 199920030. <a href="#_ftnref10" name="_ftn10">10</a>.   IRC § 860B. <a href="#_ftnref11" name="_ftn11">11</a>.   IRC § 1272(a)(6). <a href="#_ftnref12" name="_ftn12">12</a>.   REG-108637-03, 69 Fed. Reg. 52217 (Aug. 25, 2004). <a href="#_ftnref13" name="_ftn13">13</a>.   IRC § 67(c). <a href="#_ftnref14" name="_ftn14">14</a>.   Temp. Treas. Reg. § 1.67-3T(b)(3). <a href="#_ftnref15" name="_ftn15">15</a>.   Temp. Treas. Reg. § 1.67-3T(b)(5). <a href="#_ftnref16" name="_ftn16">16</a>.   Treas. Reg. § 1.67-3(f); Treas. Reg. § 1.6049-7(f). <a href="#_ftnref17" name="_ftn17">17</a>.   TD 8888, 65 Fed. Reg. 37701 (6-16-2000); Treas. Reg. § 1.6049-7(g), withdrawn. <a href="#_ftnref18" name="_ftn18">18</a>.   IRC § 860B(c). <a href="#_ftnref19" name="_ftn19">19</a>.   IRC §§ 860H, 860I, 860J, 860K, 860L, as repealed by Act. § 835(a), AJCA 2004. <a href="#_ftnref20" name="_ftn20">20</a>.   Act. § 835(c)(1), AJCA 2004. <a href="#_ftnref21" name="_ftn21">21</a>.   H.R. Conf. Rep. No. 108-755 (AJCA 2004). See IRC §§ 860G(a)(1), 860G(a)(3), 860G(a)(7), as amended by AJCA 2004. </div></div>

March 13, 2024

7698 / Must bonds be in registered form? What are "registration required" bonds?

<div class="Section1">Any obligation of a type offered to the public that has a maturity of more than one year must be in registered form (a “registration required” bond). This includes obligations of federal, state, and local governments as well as corporations and partnerships. An exception is made for certain obligations reasonably designed to be sold only outside the United States to non-United States persons and payable outside the United States and its possessions. However, if they are in bearer form, these obligations must carry a statement that any United States person holding the obligation will be subject to tax limitations.<a href="#_ftn1" name="_ftnref1">1</a> A “United States person” is a United States citizen or resident, a domestic partnership or corporation, or an estate or certain trusts (other than a foreign estate or trust).<a href="#_ftn2" name="_ftnref2">2</a><div class="Section1"> Bonds that are “not of a type offered to the public” do not have to meet the registration requirement.<a href="#_ftn3" name="_ftnref3">3</a> Temporary regulations state that a bond is “of a type offered to the public” if similar obligations are publicly offered or traded.<a href="#_ftn4" name="_ftnref4">4</a> Even if a bond is not publicly traded, it may be considered “of a type offered to the public” if: (a) the bond would be treated as readily tradable in an established securities market under the installment sales rules; (2) the bond is comparable to a bond described in (1); or (3) similar obligations are publicly offered or traded.<a href="#_ftn5" name="_ftnref5">5</a> The Treasury also has authority to require registration of other obligations if they are used frequently for tax avoidance.<a href="#_ftn6" name="_ftnref6">6</a> A book entry obligation is considered registered if the right to principal of, and stated interest on, the obligation may be transferred only through a book entry system that identifies the owner of an interest in the obligation. Regulations may permit book entries in the case of a nominee or a chain of nominees.<a href="#_ftn7" name="_ftnref7">7</a> Registration is required for some U.S. Treasury issues after September 3, 1982, and other Treasury issues and issues of U.S. agencies and instrumentalities issued after 1982.<a href="#_ftn8" name="_ftnref8">8</a> Obligations issued by other than the United States and its agencies and instrumentalities must be in registered form in order for the issuer (or holder, in some cases) to qualify for certain tax benefits (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7699">7699</a>). This requirement generally applies to municipal bonds issued after June 30, 1983 (although some previously had to be in registered form in order to qualify for tax-exemption). Other bonds must be in registered form after 1982. The constitutionality of the registration requirement was unsuccessfully challenged in South Carolina v. Baker,<a href="#_ftn9" name="_ftnref9">9</a> in which the Supreme Court upheld the constitutionality of both the registration requirement and the tax consequences imposed on most unregistered bonds. Issuers of registration required obligations not in registered form are denied a deduction for interest paid or accrued on the obligation, and their earnings and profits may not be decreased by such nondeductible interest (except for certain foreign issuers).<a href="#_ftn10" name="_ftnref10">10</a> In addition, they are subject to an excise tax of 1 percent of the principal times the number of years to maturity, except in the case of obligations that would be tax-exempt if issued in registered form.<a href="#_ftn11" name="_ftnref11">11</a> Generally, then, the tax limitations apply to the issuer rather than the holder. However, in the case of obligations the issuance of which would not be subject to the 1 percent excise tax, and obligations that would be tax-exempt if issued in registered form, limitations are imposed directly on the holder (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7699">7699</a>). An obligation, the terms of which are fixed and for which full consideration is received before December 31, 1982, is not required to be registered even if smaller denomination certificates in that obligation are not distributed to ultimate investors until after that date, according to the General Explanation of the Tax Equity and Fiscal Responsibility Act of 1982 by the Joint Committee on Taxation. The Service has provided clarification on whether bonds held through certain book-entry systems are treated as registered or in bearer form under Treasury Regulation Sections 5f.103-1(c) and 1.871-14.<a href="#_ftn12" name="_ftnref12">12</a> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.   IRC §§ 103(b), 149, 163(f). <a href="#_ftnref2" name="_ftn2">2</a>.   IRC § 7701(a)(30). <a href="#_ftnref3" name="_ftn3">3</a>.   IRC § 163(f)(2)(A)(ii). <a href="#_ftnref4" name="_ftn4">4</a>.   Temp. Treas. Reg. § 5f.163-1(b)(2). <a href="#_ftnref5" name="_ftn5">5</a>.   Prop. Treas. Reg. § 5f.163-1(b)(2) (effective for bonds issued after January 21, 1993 unless substantially all of the terms of the obligation were agreed upon in writing on or before that date). <a href="#_ftnref6" name="_ftn6">6</a>.   IRC § 163(f)(2)(C). <a href="#_ftnref7" name="_ftn7">7</a>.   IRC §§ 149(a)(3), 163(f)(3), 4701(b), 165(j); Temp. Treas. Reg. § 5f.103-1. <a href="#_ftnref8" name="_ftn8">8</a>.   TEFRA § 310(d). <a href="#_ftnref9" name="_ftn9">9</a>.   485 U.S. 505 (1988). <a href="#_ftnref10" name="_ftn10">10</a>.   IRC §§ 163(f); 312(m). <a href="#_ftnref11" name="_ftn11">11</a>.   IRC § 4701. <a href="#_ftnref12" name="_ftn12">12</a>.   Notice 2006-99, 2006-2 CB 907, as superseded by Notice 2012-20, 2012-13 IRB 574. </div></div>