Since the passage of the Tax Cuts and Jobs Act (TCJA) on December 22, 2017, questions have arisen as to whether or not a taxpayer must include accrued market discount on a debt instrument in taxable income at the time it is included in revenue on the taxpayer’s financial statement, as required by new Internal Revenue Code Section 451(b), rather than on disposition of a debt instrument.
In response, the Department of the Treasury and the IRS have recently announced, via Notice 2018-80, they intend to issue proposed regulations clarifying that accrued market discount is not subject to the new Section 451(b) rule. This is a welcome development, as now it appears taxpayers will not need to change the timing of inclusion of market discount in taxable income.
Pursuant to Section 1276, taxpayers are generally required to include the gain, if any, on disposition of a debt instrument as ordinary income, to the extent of the accrued market discount on that debt instrument. Market discount is the excess of a debt instrument’s stated redemption price at maturity over the taxpayer’s basis in the debt instrument. For financial statement purposes, many taxpayers will include a portion of the accrued market discount as income on their financial statements each year, though the debt instrument is not disposed during the year.
Section 451(b), added by the TCJA, requires an accrual method taxpayer to include any item of gross income in its taxable income no later than when that item of gross income is taken into account as revenue in the taxpayer’s financial statement. Section 451(b) effects this by determining that the “all events” test — when all events have occurred to fix the right to receive income and the amount can be determined with reasonable accuracy — is met for federal income tax purposes at the time that revenue is recorded on a taxpayer’s financial statement.
Section 451(b) apparently contradicts the general rule for timing of inclusion of accrued market discount under section 1276. While taxpayers can make an election to include a portion of the accrued market discount each year, this is not the general rule.
Treasury and the IRS indicate the effective date of the proposed regulations will be retroactive to January 1, 2018. So headed into the 2018 tax reporting season, taxpayers holding market discount bonds have a little more comfort knowing the old rules still apply. However, the notice is limited to the timing of inclusion in income of accrued market discount. Other Internal Revenue Code sections specific to debt instruments that may appear to contradict new Section 451(b), e.g., the di minimis OID rule of Section 1273(a)(3)), are not covered by this guidance.
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