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The Financial Planning Center Comprehensive Financial Planning
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How are Zeros Taxed? |
The following information on Zero-Coupon Treasury Bonds was designed to give investors a basic understanding on the subject listed below.
The information provided on Zero-Coupon Treasury Bonds should not be construed as investment advice, tax advice or a recommendation to purchase any security. Always consult a licensed professional and your personal tax advisor to determine if Zero-Coupon Treasury Bonds are right for you.
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What is a Zero-Coupon Treasury Bond? Back by the full faith and credit of the U.S. Government Be Aware of the Taxation Before You Invest Questions to Ask Before You Open an Investment Account |
The annual growth or accreted value of zeros is taxed by the IRS as ordinary income even though no interest is paid. This is known as phantom income because an investor is taxed on income that is being reinvested or compounded and not actually received during the year. Because of the compounding, an increasing tax liability will result as the investment approaches maturity. However, it should be noted that the accreted value, or phantom income, is generally exempt from state and local taxation for treasury zeros. Every investor in zeros receives a report each year displaying the amount of zeros interest income from the financial institution, government securities broker, or government securities dealer that maintains the account in which the zeros are held. This statement is known as IRS Form 1099 - OID, the acronym for original issue discount. The income-reporting requirement has meant that zeros are attractive investments for tax-deferred accounts, such as individual retirement accounts (IRAs), SEP, SIMPLE, profit-sharing, custodial accounts, and 401(k) plans, and for non-taxable accounts, which include pension funds. The income tax treatment of zeros also takes into account market discount and capital gains or losses, if any. Therefore, an investor would be well advised to review possible income tax implications before investing in zeros. For further information on the tax treatment of STRIPS and other zero-coupon securities, see Internal Revenue Service Publication 550, "Investment Income and Expenses" on the Internal Revenue Service website at:
This information should only be used as a general guideline concerning the tax status and consequences of zeros. The Financial Planning Center or its representatives are not engaged in the rendering of legal, tax, or accounting advice. The comments contained herein reflect our understanding of the present tax treatment of zeros, which may change at any time. We recommend you consult your own tax advisor or consultant before making an investment in zeros. |
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