You find yourself in a position where you or an elder parent has U.S. Treasury Bonds as part of an investment portfolio and you are wondering if the bonds should be redeemed.
You are concerned because the interest earned on those bonds would be taxable income and would affect the individual’s income tax bracket, outflow of cash to pay the taxes, and could possibly affect the financial statements presented to an Assisted Living or a Continuing Care Retirement Community.
You are asking yourself what is the most effective plan to implement. While this blog will consider some of the more pertinent tax issues, a senior care attorney should always be consulted in these situations.
Let’s first look at the rules regarding the reporting of the interest earned on those bonds. Per the U.S. Treasury website, investors of U.S. Treasury Bonds have a choice. They can
- report the interest every year
- put off (defer) reporting the interest until you file a federal income tax return for the year in which the first of these events occurs (emphasis added):
- you redeem (cash in) the bond and receive what the bond is worth, including the interest, or
- you give up ownership of the bond and the bond is reissued, or
- the bonds stops earning interest because it has reached final maturity
Likely, the first option of reporting the interest every year was not selected.
Let’s assume that the bonds have yet to mature.
- The bonds could be redeemed and the interest reported on Form 1040. Depending upon the individual’s sources of other income, the redemption of the bonds could push the taxpayer into a higher tax bracket and possibly make all social security benefits received in that tax year taxable. Thus the redemption of the bonds should be analyzed by the taxpayer’s tax professional to determine what the “tipping point” is where the higher tax bracket is triggered and how the taxability of social security benefits is affected. If the elderly person will be entering a facility that includes medical care and services in its fees, the cost of the medical care needs to be considered as it could possibly offset or partially offset the interest income resulting in no substantial increased income taxes.
This strategy (periodic redemptions of the bonds) could be implemented over a period of years to minimize the federal income taxes due.
- One can gift the bonds to another person. Thus when the bonds are redeemed, the person receiving the gifted bonds would be required to report the taxable interest income. This gifting is a means to transfer the tax liability to another person, but for Medicaid purposes, there is a five-year look back rule. Thus, the transfer of bonds would need to have occurred over 60 months to avoid the inclusion of the bonds for Medicaid purposes.
Let’s assume that the bonds have matured in an earlier year (or years). This is not an uncommon situation. In these situations, the taxpayer should have reported the interest earned in the year that the bond reached full maturity. However, the taxpayer failed to do so. The taxpayer (bond redeemer) will now receive a 1099-INT statement from the financial institution handling the current year redemption showing the taxable interest. What is the taxpayer in this situation suppose to do? Technically since the interest was to have been reported in an earlier period, it needs to be determined if the taxpayer is eligible to file an amended tax return. If the statute of limitations (SOL) is still open, the taxpayer can file an amended tax return to report the previously unreported interest. Once the SOL has closed, the taxpayer is precluded from filing an amended tax return. An experienced tax professional will then to be consulted to determine how best to report this situation to the IRS.
Another tax reporting option is that the executor of the estate could report all of the accrued interest income on the FINAL Form 1040 in the year of death so that the beneficiaries won’t be burdened with the tax when they redeem the bonds.
A tax planning strategy that should be considered is redeeming the bonds after age 59 ½ and 70 ½ in order to “fund” the deferral of social security benefits to age 70 ½ to get the 32% (4 years X 8% per annual social security increase) increase in social security benefits by deferring the receipt of social security benefits to age 70.
If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
