Old matured US Treasury Series E bonds - Used as a Roth

Technical topics regarding tax preparation.
#1
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Backstory:
In 1970 pseudo client inherited $30 million while in law school. With part of the inheritance he purchased 1,000 $10,000 E US treasury bonds titled in his name only with no payable on death designation. Over the next 30 years he became a very successful tax attorney with his name on the wall. During the years of his practice, he noticed a pattern that the Bureau of the Fiscal Service of the Department of the Treasury was not sending out 1099s for US Treasury bonds that reached final maturity.

Scenario One:
Pseudo Client waits until 2011 before sending his 1,000 $10,000 US savings bonds that reached final maturity in year 2000 to the US Treasury for redemption. He received $54,800,000 from US Treasury. The following year he receives a 1099 reporting $47,300,000 of income. He seeks an outside firm to process his 2011 tax return and specifically details how he would like the bond income to be reported resulting in no tax due on the $47,300,000 reported income. Does the IRS have any recourse or barred by statute of limitations (SOL).


Scenario Two:
Client passes in 2007. Client’s wife precedes him in death. He had one son who is the only beneficiary of his estate. His son who is an executive in an engineering firm discovers a fire safe 6 years after his fathers death. Inside this small fire safe he finds the 1,000 $10,000 US savings bonds issued in 1970 with a note from his father. The note stated: son, take the bonds to my firm, they will know how to handle them. Same bonds described in the backstory. The son is perplexed and concerned about the impact to to estate. He thinks this is going to be horrible because he is not only going to have to pay income tax on the interest but also pay estate tax. He’s heartbroken. He takes the bonds to his fathers old firm and shows them the note. A partner of the firm greats him with a smile and says you found your gift from your father, don’t worry, we take care of it. The firm’s partner seeks an outside firm to process the bonds with the treasury and specifically details how he would like the bond income to be reported resulting in no tax due on the $47,300,000 reported income or any estate tax due. Does the IRS have any recourse or barred by statute of limitations (SOL).

Scenario Three:
Same as scenario two, except the client’s last 1040 was filed with a 454(a) election and reported known interest on different bonds without knowing about the fire safe. Any impacts to the results from scenario one and two?


Opinions appreciated
 

#2
Frankly  
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Interest is taxable. The owner has options on when to recognize the interest income. He can report it annually as it accrues, report it when the bond matures, or report it when he cashes it. Sounds like he opted out of the first two options by taking no action, thus he reports it when he cashed it.
 

#3
Frankly  
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He had one son who is the only beneficiary of his estate.

Son inherits a bond and is the new bond owner. If the bond is matured, he reports the interest income when he cashes the bond. If the bond is not matured he can report the interest annually as it accrues, or report it when the bond matures.
 

#4
Frankly  
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the client’s last 1040 was filed with a 454(a) election and reported known interest on different bonds without knowing about the fire safe. Any impacts to the results from scenario one and two?

"If any such election is made with respect to any such obligation, it shall apply also to all such obligations owned by the taxpayer at the beginning of the first taxable year to which it applies and to all such obligations thereafter acquired by him" - IRC 454(a)
 

#5
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This issue has been beat to death on this Board.

Here’s an example:

viewtopic.php?f=8&t=20005&p=172627&hilit=ee+bonds+final+maturity#p172627

And no idea what “Used as a Roth” means in the title of your Post.

Also, Frankly seems to be making up tax law with his posts.
 

#6
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Jeff-Ohio,
The Roth statement is a hyperbole. In this case the lack of 1099s issued on maturity and IRS blind to the income creates tax free income. Not sure I agree about beat to death but get your point.

Perhaps your reading to quickly through the post. There are undertones of tax evasion, estate tax and 454a election implications. If the stance remains the same .. irs snoozes it loses, so be it.

Then, what happens if final 1040 with a 454a election is amended to remove over reporting of bond interest.. ie interest from matured bonds from 3 years before final 1040?

It’s interesting that two bureaus of the US Treasury have different views on “this topic that has been beaten to death”

It appears Frankly is referencing Bureau of the Fiscal Service stance or at least what is being represented by that bureau.
 

#7
Frankly  
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It appears Frankly is referencing Bureau of the Fiscal Service stance or at least what is being represented by that bureau.

I got that from the IRS website.
"In general, you must report the interest in income in the taxable year in which you redeemed the bonds to the extent you did not include the interest in income in a prior taxable year. "
 

#8
sjrcpa  
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EstatesAndMore wrote: the lack of 1099s issued on maturity and IRS blind to the income creates tax free income.

Really?
Taxable income is reportable whether or not you get a 1099.
 

#9
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Sjrcpa,
Did I say otherwise? From first post, you can see the intent to take advantage and purposely exclude the income. The lack of bureau of fiscal service to issue 1099 results in the IRS to sleep .
 

#10
sjrcpa  
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Seems to me you did. If no 1099 IRS doesn't know about it therefore it is tax free.
 

#11
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Frankly,
Perhaps we have a squadra here. Two bureaus teaming up? This https://www.irs.gov/faqs/interest-divid ... gs-bonds-1

Does not seem to line up with the irs publications. Perhaps someone has some private letter rulings or tax court opine on this topic.
 

#12
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sjrcpa wrote:Seems to me you did. If no 1099 IRS doesn't know about it therefore it is tax free.

In a unscrupulous way yes. Wait until the sol kicks in, then redeem.
 

#13
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Not sure I agree about beat to death but get your point.


There’s been several posts on this issue. And in this thread, in Post #14, there was a comment that predicted your Scenario #2:

viewtopic.php?f=8&t=13242&p=120092&hilit=relatives+find+a+bunch+of+matured#p120092

…and that comment was:

This happens ALL THE TIME and this situation is usually exactly as stated in the OP: Guy dies. Relatives find a bunch of “matured” savings bonds…


Perhaps your reading to quickly through the post. There are undertones of tax evasion, estate tax and 454a election implications.


Yes, I read it quickly, only because it’s a boring issue to me, if you want to know the truth. As to tax evasion, that’s fact specific. So, if the IRS digs into this and your client – or some representative of your client - says, “I knew 1099’s weren’t being issued at maturity for E Bonds, so I bought a bunch of them, then let them mature, full knowing the income was taxable at maturity, but I willfully didn’t report any income or pay any tax,” then I suspect the IRS might have a little problem with this. As to estate tax, since the bonds are assets, whether matured or unmatured, I think we’d agree they’d be part of the taxable estate. As to the kid’s Sec 454 election, it would be moot as to the already-matured bonds.

The Roth statement is a hyperbole.


That’s not good hyperbole. Because with a ROTH, we have lifetime tax free earnings on our principal, if done according to plan. But with this money from the Treasury Bonds, whatever income that cash generates is taxable, to the extent invested in taxable assets.

Taxable income is reportable whether or not you get a 1099.


Right. And it wasn’t reported, just like OP says.
 

#14
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Based on what you laid out, how is scenario 1 not fraud with no statute of limitations on the tax year in which the bonds matured?
 

#15
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Frankly wrote:"In general, you must report the interest in income in the taxable year in which you redeemed the bonds to the extent you did not include the interest in income in a prior taxable year. "

The only way that this lines up with the Code is if the bonds didn't mature in the earlier year. OP tells us that they did --- they matured in 2000 and were cashed in 2011. Here's Sec. 454(c):

(c) MATURED UNITED STATES SAVINGS BONDS.—In the case of a taxpayer who—

    (1) holds a series E United States savings bond at the date of maturity, and

    (2) pursuant to regulations prescribed under chapter 31 of title 31 (A) retains his investment in such series E bond in an obligation of the United States, other than a current income obligation, or (B) exchanges such series E bond for another nontransferable obligation of the United States in an exchange upon which gain or loss is not recognized because of section 1037 (or so much of section 1031 as relates to section 1037),
the increase in redemption value (to the extent not previously includible in gross income) in excess of the amount paid for such series E bond shall be includible in gross income in the taxable year in which the obligation is finally redeemed or in the taxable year of final maturity, whichever is earlier. This subsection shall not apply to a corporation, and shall not apply in the case of any taxable year for which the taxpayer’s taxable income is computed under an accrual method of accounting or for which an election made by the taxpayer under subsection (a) applies.

And there doesn't appear to be any special statute of limitations for not reporting the interest income on the bonds when they mature. So, if they matured in 2000, and they were cashed in 2011, the proper year for reporting the interest was 2000. There's a 6 year statute of limitations if the interest income is more than a 25% omission of income, and fraud will keep the assessment statute of limitations open, but that's about it.
 

#16
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Further .. and was mentioned briefly in the history of this topic. Although this is outside of my swim lane, ignorance is not bliss. There is the matter of law and matter of fact. Unfortunately for the tax payer there is the duty of consistency that can break the barriers of matter of law. To say the three prongs of the duty of consistency don’t apply to this hypothetical seems a little premature. The third prong provides great latitude to the irs even in the absence of fraud.

I personally would not take the matter of law as method for justification of no tax due. At best or worse .. explaining to the client in writing the law and the duty and let them decide how they would like to proceed.
 


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