Tax rules for bond investors
Understand the treatment of different bonds
Paying taxes is an inevitable part of
investing for most bondholders, and
understanding the tax rules, and
procedures can be difficult and
confusing. By following a few
guidelines, however, you can
stay on top of the taxes you
may face as a bondholder.
When considering the tax consequences of investing in bonds, an investor’s first step
should be to categorize each bond purchase as a discount, premium or par bond.
Premium and discount bonds each have their own rules for reporting taxation, and this
report explains how taxes apply to both. Bonds purchased at par have a much simpler
tax treatment. This report is only intended as a general discussion of the tax treatment
of bonds. Investors should always consult a tax advisor regarding a specific situation;
Wells Fargo Advisors does not provide tax or legal advice.
Bonds can be categorized in many ways. The simplest breakdown is those bought at par
(face value), at a premium (above face value) or at a discount (below face value). Bonds
can be further categorized as taxable or tax-exempt.
What is a discount bond?
“Discount bond” describes a fixed-income security with a price that’s lower than its
stated maturity value. When investors buy bonds at a discount, they are able to get
more at maturity for a smaller up-front investment. For example, an investor might
pay $9,700 for a bond that pays $10,000 at maturity.
Discount bonds exist in two forms: market discount bonds and original-issue discount
(OID) bonds. Market discount bonds trade at a price that’s lower than their maturity
value, or even to their accreted value, after issuance. The discount is usually the result
of market forces, such as a rise in interest rates or a decline in credit quality. The
following factors may affect the way an investor accounts for a market discount
on a taxable bond:
• Timetomaturityand/orthedispositionpriceifthebondissold
• Investor’sacquisitiondate
• Depthofthediscount
• Issuedate
By contrast, OID bonds are issued at a discount to their maturity value.
The value of both OID and market discount bonds rises toward maturity value over
time as the discount accretes. A bond may trade above or below its accreted value,
depending on market conditions.
The examples and illustrations used throughout this material are hypothetical and are provided for
informational purposes only. They are not intended to represent any specific return, yield or investment,
nor are they indicative of future results.
Please refer to the important definitions and disclosures beginning on page 11.
1 of 12
Tip
For help understanding this report,
see “Common Tax Terms” starting
on page 11.
What is a premium bond?
Bonds are usually priced at a premium when the coupon is higher than general market rates.
The above-market coupon causes a bond’s price to be higher than the value at maturity. The
premium price brings down a bond’s yield to maturity so it is in line with current market
rates. Bonds purchased at a premium typically provide a higher level of current income
relative to par or discount bonds with comparable maturities and credit quality.
Taxable coupon bonds (purchased at par)
Gain or loss at sale will be determined by comparing the basis (generally the issue price
or par) with the sales proceeds net of commissions. Periodic interest will be taxable upon
receipt. Bonds held to maturity will have no gain or loss and are reported as such on Form
8949 (a new form that includes capital transaction details previously reported on Form
1040 Schedule D).
Market discount bonds
In general, any gain or loss on the sale of a taxable market discount bond issued before
July 19, 1984, is treated as a capital gain or loss. For taxable market discount bonds issued
after July 18, 1984, and any bond acquired after April 30, 1993, any gain on the sale of the
bond is treated as ordinary interest income to the extent of the bond’s accrued market
discount (i.e., the amount of discount that has accrued while the investor held the bond).
The amount of gain that exceeds the bond’s accrued market discount would be treated as
a capital gain. Any loss on the bond determined by comparing the cost or accreted cost,
if you are accreting the discount annually, to the net proceeds is treated as capital loss.
When buying market discount bonds that fall into the latter category, investors can
choose to accrue the market discount over the period they own the bond and include it
as interest income each year until maturity. If they do not make this choice, the following
rules apply:
1. They must treat any gain when they dispose of the bond as ordinary interest income,
up to the amount of the accrued market discount.
2. They must treat any partial payment of principal on the bond as ordinary interest
income, up to the amount of the accrued market discount.
For example, an investor bought a 10-year, 6% corporate bond for $930; the bond’s face
value was $1,000. After two years, the investor decided to sell it for a $960 market price.
The investor found out from his Financial Advisor that the accrued market discount at
the time of the sale was $10. He had to treat $10 as ordinary income and $20 as a capital
gain (cost $930 plus accretion $10 plus capital gain $20 = proceeds of $960).
Take the same scenario, but with the bond being sold for $915. The accrued market
discount is still $10. The investor has not been accreting the discount on his taxes.
The investor will have a capital loss of $15 (cost $930 less proceeds $915 = capital loss
of $15). The market discount will be ignored. If the investor had been accreting the
discount, his loss would be $25 (cost $930 plus accretion $10 less proceeds $915 = capital
loss of $25).
Please refer to the important definitions and disclosures beginning on page 11.
2 of 12
Investors in market discount bonds may choose to include the market discount accrual
in their income annually using either the straight-line or the constant-yield method
(see following discussion). They have this choice as long as they have not revoked a
previous choice to include the market discount in current income within the past five
years. If an investor elects to report the discount accretion annually, he or she must
remember to increase the bond’s cost basis by the income recognized.
Assume you buy a 5.29% Federal Home Loan Bank bond maturing in nine years for
$900.63 and a with a 6.788% yield. The example below shows how the accreted value
would differ under the constant-yield method vs. the straight-line method.
Straight-line method. This method treats the market discount as accruing in equal
daily installments during the period the bond is held. To figure the daily installments,
investors should divide the market discount by the number of days after the date the
bond was acquired, up to and including its maturity date. Multiply the daily installments
by the number of days the bond was held to figure the accrued market discount.
Constant-yield method. This method corresponds to the actual economic accrual of
interest; the discount is allocated over the life of the bond through adjustments to the
issue price for each accrual period. For investors in higher tax brackets who sell their
discount bonds prior to maturity, the constant-yield method can help keep the discount
accrual lower in the early years. To use this method, investors should attach a statement
that identifies the bond and declares that they are electing to use this method. Once
this choice is made, investors cannot change their option for the bond or similar bonds.
Straight-line method vs. constant-yield method
Year
Straight line
Constant yield
Now
$900.63
$900.63
1
$911.67
$908.96
2
$922.71
$917.86
3
$933.75
$927.38
4
$944.79
$937.56
5
$955.83
$948.44
6
$966.88
$960.07
7
$977.92
$972.50
8
$988.96
$985.79
9
$1,000.00
$1,000.00
Source: Wells Fargo Advisors
Please refer to the important definitions and disclosures beginning on page 11.
3 of 12
De minimis under the market discount rules
Tip
A market discount is always taxable
for both taxable and tax-exempt
bonds. However, the tax treatment
(capital gain or ordinary income)
depends on whether the market
discount exceeds the so-called
de minimis threshold.
For market discount bonds, the de minimis rule states that a discount can be treated
as zero if it is less than one-fourth of 1% (0.0025) of the stated redemption price at
maturity multiplied by the number of full years from the date of acquisition to maturity.
The de minimis provision affects both OID and market discount bonds. Whether a
bond meets the threshold for de minimis determines whether the discount is taxed
at ordinary income-tax rates or the more favorable capital-gains-tax rates.
Example. An investor who bought a corporate bond with 10 full years to maturity and a
$1,000 maturity value would have to buy the bond at a $25 discount or greater for the
accrued discount to be taxable as ordinary income (0.0025 times 10 years to maturity
times $1,000 face amount = a $25 per bond de minimis threshold). A discount of $24.99
or less would be de minimis. If the de minimis threshold is not exceeded, the bond
owner would not be subject to the market discount rules. In such a case, however, the de
minimis discount would still be subject to capital gains taxation upon a sale or maturity.
Taxable OID bonds
OID bonds are issued at a discount to face value. Even though the issuer may not make
semiannual interest cash payments, generally the bonds’ income must be reported
annually. This causes OID bonds to gain value at a set accretion rate. Thus, the amount
of OID accreting on a bond in a given year is fixed at issuance. One common type of
OID bond is a zero-coupon bond. From the bondholder’s perspective, OID is simply an
interest component that will be received, but it is paid at maturity instead of annually
throughout the bond’s life.
For OID issues, the bond’s annual accretion is added to the investor’s cost basis
to reflect the recognition of income. OID is allocated over the bond’s life through
adjustments to the issue price for each accrual period. Because of compounding,
the constant-yield method produces a lower accretion in the earlier years of a bond’s
life and increasingly greater accretion amounts in the later years as the bond’s principal
compounds toward maturity. The following formula calculates the amount of OID
accreting on a bond in a given year. It is performed for each period during a given
year, not simply at year-end. The OID accretion for the year is the sum of OID
calculated for all the periods within that year.
Adjusted issue price*
Yield to maturity
Interest received from
Number of actual periods per year
if any, for that period
coupon payment,
X
*The adjusted issue price of a bond at the beginning of the first accrual period is its issue price, or its value at maturity less the OID.
Please refer to the important definitions and disclosures beginning on page 11.
4 of 12
Example. An investor purchased an OID bond on Jan. 15, 2010, at the 30.651 initial
offering price and with a 7.5% yield to maturity. After compounding semiannually,
the bond would increase to an 32.993 adjusted issue price by the end of the first year.
Issue price
Adjusted issue price
End-of-year OID
Year 1
30.651
32.993 (end of year 1)
2.342 points
Year 2
32.993
35.514 (end of year 2)
2.521 points
This amount is calculated using two periods per year and no interest payment.
The price difference at the end of the year is that year’s OID, which in this example is
2.342 points. At the end of the second year, the bond’s adjusted issue price has grown
to 35.514, resulting in 2.521 points in OID accretion.
See IRS Publication 1212 at irs.gov for more details on calculating OID.
Applying the OID rules
In general, the annual accretion from a taxable issue (e.g., corporate, U.S. government
or U.S. agency OID instrument) must be reported as taxable interest income. Form
1099-OID is used to report the OID received during the past year (see note).
Note: OID bonds may also be acquired at a market discount if the investor pays a price below the bond’s
accreted value. By adding the accretion to the original-issue price, an investor can determine the accreted
value when he or she purchases the bond. If the investor pays less than that price, the difference between
the purchase price and the accreted value is the market discount.
A bond bought at original issue can be a market discount bond if the investor’s cost basis is less than
the bond’s issue price or if the bond is issued in exchange for a market discount bond under a plan of
reorganization. The rule does not apply to bonds exchanged for market discount bonds issued before
July 19, 1984, with the same terms and interest rates.
• Forcorporatedebtinstrumentsissuedafter1954andbeforeMay28,1969,and
government instruments issued after 1954 and before July 2, 1982, you do not include
OID in income until the year the instrument is sold, exchanged or redeemed. If
a gain results and the instrument is a capital asset, the OID is taxed as ordinary
interest income. The balance of the gain is a capital gain. If there is a loss and the
asset is a capital asset, the entire loss is a capital loss and no OID is reported.
• FordebtinstrumentsissuedafterMay27,1969,(afterJuly1,1982,ifagovernment
instrument) and before 1985 and held as capital assets, you must include part of
the OID in income each year you own the instruments.
• Foralldebtinstrumentsissuedafter1984,youmustincludepartoftheOIDin
income each year you own the instrument regardless of whether you hold it as
a capital asset.
Please refer to the important definitions and disclosures beginning on page 11.
5 of 12
• Governmentoragencybondsareoftenissuedandthenconvertedto“stripped”
securities. When a government bond is stripped, it may be referred to as a STRIP
(separate trading of registered interest and principal). A stripped bond is a bond
separated into two components: periodic interest payments and principal repayment.
Each segment is then sold as an OID instrument. If the stripped bonds were
purchased after July 1, 1982, the constant-yield method (using the yield as of the
purchase date) must be used to figure the amount of taxable OID included each year
as ordinary income. Bondholders are not required to include OID in income for
stripped bonds acquired before July 2, 1982. Because the accruing OID is recognized
as income and added to the investor’s cost basis, any gain upon disposition in excess
of the adjusted cost basis would be reportable as a capital gain.
Reporting OID to the IRS
Federal Form 1099-OID is used to report yearly OID to the investor using the investor’s
actual holding period for the tax year based on the bond’s issue price and issue date.
However, because most investors buy in the secondary market — and not necessarily at
the bond’s adjusted issue price — the amount of OID shown on the form, although correct
for the bond, may require the taxpayer to report an adjustment to the amount shown on
Form 1099-OID.
For example, you may need to adjust the amount if you paid an acquisition premium or
the obligation is a stripped bond or coupon. See IRS Publication 1212 for instructions
on how to figure the correct amount of OID to report on your tax return.
A zero-coupon security is issued at a substantial discount from its maturity value,
generally offers no periodic interest payments and pays the holder principal, or face
value, at maturity. Even though the bondholder does not receive any interest while
holding these bonds, interest income that has accrued during the year must be reported
annually on the owner’s income tax return. (See “Income Tax Treatement of Tax-exempt
Bonds: OID” on page 9.)
De minimis and OID bonds
As with market discount bonds, you can treat the discount in excess of the OID as zero
if it is less than one-fourth of 1% (.0025) of the stated redemption price at maturity
multiplied by the number of full years from the date of original issue to maturity. This
discount is known as “de minimis” OID.
Example. An investor bought a 10-year bond with a $1,000 stated redemption price
at maturity, issued at $980 with OID of $20. One-fourth of 1% of $1,000 (stated
redemption price) times 10 (the number of full years from the date of original issue
to maturity) equals $25. Because the $20 discount is less than $25, the OID is treated
as zero. (If the investor holds the bond to maturity, he or she will recognize $20
[$1,000 -$980] of capital gains.)
Taxable premium bonds
Taxable bonds are typically issued by corporations or the federal government, and
the income they produce is fully subject to federal income tax. Investors have two
Please refer to the important definitions and disclosures beginning on page 11.
6 of 12
options for dealing with premiums on taxable bonds:
• Amortizingthepremiumandreducingtheirordinaryincomebytheportion
of the premium amortized in the current year
• Notamortizingthepremiumandtakingacapitallosswhenthebondsmature,
are called or are sold prior to maturity, assuming it’s at the same or a lower price
When the premium on a bond is amortized, the bond’s cost basis — the bond’s value
for tax purposes — is reduced annually by the portion of the premium amortized
that year. The first year a bond is owned, the cost basis is adjusted by subtracting the
annual premium amortization from the bond’s original cost basis. In subsequent years,
the premium amortization is deducted from the bond’s adjusted cost basis from the
previous year.
Bonds issued after Sept. 27, 1985, must be amortized using the constant-yield method.
Investors can amortize bonds issued before Sept. 28, 1985, using the straight-line
method, constant-yield method or any other reasonable method.
Using the straight-line method, the amount of premium amortized is the same each
year. Using the constant-yield method, the amortized amount is smaller in early years
and increases as the bond approaches maturity. Both methods will ultimately achieve
the same results. The bond’s premium will be completely amortized on its maturity date
and its adjusted cost basis will be par (for noncallable bonds).
Callable taxable bonds
For callable bonds, the premium will either be amortized to the call date and
corresponding call price or to the maturity date, depending on the specific issue.
Investors must look at the yield to maturity compared to the yield to call. The premium
is amortized to whichever date maximizes the bondholder’s yield. If a premium is
amortized to the next call date and call price and the bond is called on that date, the
investor will not realize a gain or a loss. If the bond is not called, the investor should
amortize the remaining premium to the next call date, or, if there is no other call date,
to the maturity date. If a premium is amortized to the maturity date and the bond is
called prior to maturity, any unamortized premium is treated as an ordinary loss
in the year the bond is called.
Example. An investor bought a five-year corporate bond on Nov. 15, 2009, for
$10,500 ($10,000 face value). A 10% coupon paid annual interest, and the yield to
maturity was 8.72%. The bond was callable on Nov. 15, 2011, at par. The yield to call
was 7.23%. Since the yield to maturity was greater than the yield to call, the premium
was amortized to the maturity date. If the bond were called, the investor who elected
to amortize the premium would have been entitled to an additional $324.65 bond
premium deduction ($10,500 minus the $10,000 face value and amortized
premium for the first two years of $84.01 and $91.34, respectively).
Now assume the same facts as above, except with a call price of $10,350 and with an
8.84% yield to call. Amortization would be $71.82 and $78.18 for each year to the call
date. The call date is used because it maximizes the bondholder’s yield. If the bond
were called, no gain or loss would be recognized. If not, the remaining $350 premium
Please refer to the important definitions and disclosures beginning on page 11.
7 of 12
($10,350-$10,000) would be amortized to maturity.
The information above is hypothetical and is provided for informational purposes only.
Zero-coupon bonds
Although zero-coupon bonds (“zeros”) are always priced at a discount to their maturity
value, they can also be priced at a premium — that is, a premium to their accreted value.
This is referred to as an acquisition premium. Consequently, zeros can also be subject
to premium-bond tax rules.
Reporting premium amortization of taxable bonds to the IRS
Investors who choose to amortize the premiums on taxable bonds simply claim a
deduction for the amortized amount on IRS Form 1040. Investors must claim the
deduction beginning in the year they purchase the bond. If they do not, the IRS will
assume they have chosen to account for the premium when they dispose of the bond
or when the bond matures or is called. Once investors begin claiming a premium
amortization deduction on any bond, they must do the same for all taxable bonds
they own beginning in the year they make the election and for all taxable bonds
they purchase in the future.
How investors deduct a bond’s premium amortization depends on when the bond
was purchased. For bonds purchased:
• BeforeOct.23,1986,premiumbondamortizationshouldbedeductedon
Schedule A (Form 1040).
• FromOct.23,1986,toDec.31,1987,premiumbondamortizationisdeductedas
an interest expense on Schedule A (Form 1040). Form 4952 is used to figure an
investor’s allowable deduction and is attached to the return. However, the taxpayer
may choose to treat it as an offset to interest income on the bond.
• AfterDec.31,1987,premiumbondamortizationshouldbedeductedfrom
interest income for these bonds on Schedule B (Form 1040). To do this, enter
“ABP Adjustment” and the amortization amount on any line below your interest
income items. Subtract the amortization amount from your other interest income
items. Your deduction on Schedule B is limited to the interest income included
for the period from the related bond. You may be able to deduct the excess
amortization for the period, if any, on Schedule A as a miscellaneous
itemized deduction.
Note: If an investor chose to amortize the premium on taxable bonds before 1998 (before March 2, 1998, if a
fiscal year), he or she could deduct the bond premium amortization that is more than their interest income only
for bonds acquired during 1998 (during a tax year that includes March 2, 1998, if a fiscal year) and later years.
Investors generally realize two tax advantages by amortizing premiums on taxable bonds:
• Takingtheannualamortizationdeductionprovidesataxsavingsearlierthan
taking a capital loss when the bonds are sold, called or mature.
• Theamortizationdeductionalwaysoffsetsordinaryincomethatwouldotherwise
Please refer to the important definitions and disclosures beginning on page 11.
8 of 12
be taxed at ordinary income-tax rates. Conversely, the capital-loss deduction is
limited to offsetting capital gains, which may be taxed at a lower rate, and up to
$3,000 of ordinary income per year.
Income tax treatment of tax-exempt bonds
Market discounts and tax-exempt bonds
Market discounts on tax-exempt bonds are not treated as tax-exempt interest for the
holder because they arise from market forces, not the issuer’s actions. How the market
discount is treated depends on when it was acquired.
• ForbondspurchasedafterApril30,1993,thegainonamunicipalbondresulting
from accretion of market discount is treated as ordinary income (incurred when
the bonds are sold) rather than a capital gain. Tax-exempt-bond holders may use
the constant-yield or straight-line method to figure the accrued market discount.
• ForbondspurchasedbeforeMay1,1993,thegainonamunicipalbondresulting
from accretion of market discount is treated as a capital gain.
OID accretion for tax-exempt bonds
The OID on tax-exempt securities is treated as tax-exempt interest and is not included
in the investor’s taxable income; however, the year’s accretion may affect other areas
oftheinvestor’staxcalculation(suchasSocialSecuritybenefitsandstateand/orlocal
tax) and must be taken into account. On tax-exempt obligations, OID is calculated
using the constant-yield method, which increases the investor’s tax basis for purposes
of determining a gain or loss if the bond is disposed of or called prior to maturity.
Note: Investors may have to pay taxes on part of the OID on stripped tax-exempt bonds or coupons that
were bought after June 10, 1987. IRS Publication 1212 provides additional information. Consult a tax advisor
for complete guidelines.
Tax-exempt premium bonds
In contrast to taxable bonds, for which investors may elect amortization, premiums
on tax-exempt bonds must be amortized. The amortization for these bonds, however,
merely serves to reduce the bond’s cost basis and does not result in a federal income
tax deduction. Premium amortization on municipal bonds represents a reduction
of income that is already tax-exempt.
Bonds issued after Sept. 27, 1985, must be amortized using the constant-yield method.
Investors can amortize bonds issued before Sept. 28, 1985, using either the straight-line
or constant-yield method.
Tax-exempt municipal bonds
For a noncallable bond, the premium is to be fully amortized on the bond’s maturity
date, and the bond’s adjusted cost basis will be par. For callable bonds, the premium
will either be amortized to the call date and corresponding call price or to the maturity
date, depending on the specific issue.
Please refer to the important definitions and disclosures beginning on page 11.
9 of 12
Premium bond amortization guidelines
• The annual amortization should be calculated to both the
call date (and call price) and to the maturity date. The smaller
annual deduction is used.
• Each year, the bond’s cost basis and the bondholder’s taxable
income are reduced by the portion of the premium amortized
that year.
Callable
• If amortization to call is used and the bond is not called, the
difference between the call price and the maturity value is
amortized from the call date to the maturity date.
• If amortization to maturity is used and the bond is called,
the additional unamortized premium may be taken as a bond
premium deduction.
Amortized
Call status
• If the bond is sold prior to maturity, the adjusted cost basis is
used to determine the applicable gain or loss.
• The premium is amortized to the maturity date.
Taxable
Amortization
election
Noncallable
• Each year, the bond’s cost basis and the bondholder’s taxable
income are reduced by the portion of the premium amortized
that year.
• If the bond is sold prior to maturity, the adjusted cost basis is
used to determine the applicable gain or loss.
• If the bond is held to maturity, the entire premium is taken as
capital loss.
• If the bond is called, the difference between the original cost
basis and the call price is taken as a capital loss.
Not amortized
• If the bond is sold prior to maturity, the original cost basis is
used to determine the applicable gain or loss.
Tax status
• The premium must be amortized to the call date and call price,
but the amount amortized each year cannot be deducted from
taxable income. Instead it is a reduction in the amount of
tax-exempt interest reported on page 1 of Form 1040.
• Each year, the bond’s cost basis is reduced by the portion of the
premium amortized that year.
Callable
• If the bond is called, there will be no gain or loss because the
premium will have been fully amortized to the call price.
• If the bond is not called, the difference between the call price
and the maturity value is amortized from the call date to the
maturity date.
Tax-free
Call status
• If the bond is sold prior to maturity, the adjusted cost basis is
used to determine the applicable gain or loss.
Premium must be amortized
Noncallable
• The premium is amortized to the maturity date, but the amount
amortized each year cannot be deducted from taxable income.
Instead, it is a reduction in the amount of tax-exempt interest
reported on page 1 of Form 1040.
• Each year, the bond’s cost basis is reduced by the portion of the
premium amortized that year.
• If the bond is sold prior to maturity, the adjusted cost basis is
used to determine the applicable gain or loss.
10 of 12
For callable tax-exempt bonds, the premium should be amortized to the first known
call date with a corresponding call price that is less than the acquisition price. This rule
includes extraordinary or optional calls that have a specific redemption date and price
but excludes extraordinary redemption features (frequently seen on municipal housing
and student loan bonds) that cause the bond to be subject to redemption on an
undetermined date prior to maturity.
If the bond is called, the investor will not realize a gain or a loss. If the bond is not
called on its first call date, the investor should amortize any remaining premium to
the maturity date.
Consult your tax advisor
Your Financial Advisor can discuss the general tax treatment of fixed-income securities
and help you calculate the OID for your bonds. However, for questions on your specific
tax situation, contact your tax advisor.
Common tax terms
Accreted value or adjusted issue price – The price of a debt instrument at the
beginning of the first accrual period is its issue price. The adjusted issue price
at the beginning of any subsequent accrual period is the sum of the issue price and
all of the OID included in income before that accrual period minus any payment
previously made on the instrument, other than a payment of qualified stated interest
(e.g., coupon payment).
Accretion – The process by which a bond’s value increases from a discount to
maturity value as the security approaches maturity.
Accrued market discount – The amount by which a bond’s total market discount has
accreted while the bondholder has owned the security is the accrued market discount.
A bond’s accrued market discount is calculated either by the straight-line method or
the constant-yield method. Both methods let the bondholder compute the portion of
a bond’s market discount that is taxable as ordinary income each year; the bond’s
cost basis is also adjusted by that portion.
Adjusted cost basis – The cost of the investment, adjusted for certain items, such
as accretion (for discount securities) or amortization (for premium securities) is the
adjusted cost basis. The cost basis of a bond acquired at a premium or discount is
adjusted annually for tax purposes as the bond approaches maturity.
Amortization – Amortization of premium is the accounting procedure by which a
bondholder can deduct a portion of his or her bond’s premium each year for tax
purposes. The bond’s cost basis is adjusted by that portion each year.
Bond premium – The amount by which an investor’s basis in the bond immediately
after acquisition is more than the maturity value.
Callable bond – A bond issue that may be redeemed by the issuing authority at a stated
date(s) in the future prior to the maturity date.
Capital gain or loss – A capital gain or loss is incurred when you sell or exchange
11 of 12
You can count on us
Your Financial Advisor will work with
you and your tax advisor on tax issues
related to your bond holdings.
a capital asset, such as a bond. Compute the gain or loss by comparing the amount
you realize on the sale or exchange with the asset’s adjusted basis.
Constant-yield method – This method corresponds to the actual economic accrual of
interest; the discount is allocated over the bond’s life through adjustments to the issue
price for each accrual period. (See page 3 for a more thorough description.)
Coupon – The interest rate as stated on a debt security.
De minimis threshold – The de minimis threshold determines whether a market
discount is treated as ordinary income or as a capital gain for tax purposes. A market
discount is treated as ordinary income if it exceeds the de minimis threshold and as
a capital gain if it does not exceed the threshold.
Market discount – A bond is acquired at a market discount when the bond’s value
decreases below par or its accreted value (in the case of bonds issued at a discount).
Original issue discount (OID) – Generally, applies to bonds that were issued at
less than maturity value, such as Treasury zero-coupon bonds or STRIP securities.
The OID is the difference between the issue price and the maturity value.
Straight-line method – This method treats the market discount as accruing in
equal daily installments during the period the bond is held. (See page 3 for a more
thorough description.)
Yield to call (YTC) – The yield to maturity calculated at the earliest call date of a debt
security rather than the maturity date.
Yield to maturity (YTM) – The yield of a debt security taking the price paid for the
bond into account. The yield will be higher when the bond has been bought at a
discount, lower when bought at a premium, and when bought at par, the yield to
maturity is the same interest rate as stated on the bond.
Investing in fixed income securities involves certain risks such as market risk if sold prior to maturity and
credit risk, especially if investing in high yield bonds, which have lower ratings and are subject to greater
volatility. All fixed income investments may be worth less than original cost upon redemption or maturity.
Yields and market value will fluctuate so that your investment, if sold prior to maturity, may be worth more
or less than its original cost.
Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can
result in a decline in your investment’s value.
Zero-coupon bonds’ market value fluctuates more with changes in market conditions than regular coupon
bonds, and therefore, may not be suitable for all investors. Interest that accrues on zero-coupon bonds may
be subject to income taxes annually, even though no payments are actually received. Investors should consult
with their tax advisors as to the special tax consequences of zero-coupon bonds.
Municipal-bond income is generally free from federal taxes and state taxes for residents of the issuing state.
Although the interest income is tax-free, capital gains, if any, will be subject to taxes. Income for some investors
may be subject to the federal alternative minimum tax (AMT).
NOT FDIC Insured
NO Bank Guarantee
MAY Lose Value
Wells Fargo Advisors is the trade name used by two separate registered broker-dealers: Wells Fargo Advisors, LLC and Wells Fargo Advisors Financial Network, LLC,
Members SIPC, non-bank affiliates of Wells Fargo & Company. © 2009, 2012 Wells Fargo Advisors, LLC. All rights reserved.
0712-0449
E6543
12 of 12
43300-v11
Investment and Insurance Products: