Cal. Code Regs. tit. 18 § 24360-24363(b)

Current through Register 2024 Notice Reg. No. 40, October 4, 2024

Section 24360-24363(b) - Determination of Bond Premium

(1) In general.

(A) Except as otherwise provided in this regulation, bond premium on any bond to which Section 24360 applies is the excess of the amount of the basis (for determining loss on sale or exchange under Section 24911) of the bond over the amount payable at maturity or, in the case of a callable bond, the earlier call date. For determination of applicable call date, see subsection (2) of this regulation.

(B)

(i) The amortizable bond premium on a wholly taxable bond described in 24362(a) shall be computed by reference to the amount payable on maturity or on an earlier call date. For purposes of this subparagraph, the date of acquisition of a bond shall be the date such bond was ordered under a firm commitment to buy and not the date the bond was delivered to the taxpayer.

(ii) The application of the provisions of subparagraph (i) of this paragraph may be illustrated by the following example:

EXAMPLE (1).

Assume that the taxpayer acquired at the date of issue, January 1, 1956, a $100 wholly taxable bond for $112, callable at any time thereafter upon 30 days' notice. The premium of $12 attributable to such bond may be amortized only with reference to the maturity date of the bond. Similarly, assume that in 1957 the taxpayer acquired a $100, 20-year bond, issued on January 1, 1954, for $115. The bond was callable 2 years after the date of issuance or, if not then called, 10 years after the date of issuance. The premium of $15 attributable to such bond may be amortized in accordance with the method of amortization authorized by subsection 24360-24363(b)(6).

(iii) In the case of a wholly taxable bond described in Section 24361(b), which has a call date not more than three years after the date of such issue, the amount of bond premium attributable to the income year in which the bond is called shall include an amount equal to the excess of the amount of the adjusted basis (for determining loss on sale or exchange) of such bond as of the beginning of the income year over the amount received on redemption of the bond or (if greater than the amount received on redemption) the amount payable on maturity. For determining whether an earlier call date is a date more than three years after the date of original issue, consideration will be given to the terms under which a bond is issued. For adjustments proper to reflect unamortized bond premium for the period before the date as of which Section 24360 becomes applicable to the bond in the hands of the taxpayer, see paragraph (D) of this subsection. For example, if a wholly taxable bond, issued on January 1, 1954, and acquired by the taxpayer on January 1, 1955, at a price of $109, matures in 10 years from the date of issue (9 years from the date of acquisition) but is callable at $105 on 30 days' notice, Section 24361(a)(2) requires that the bond be amortized to maturity, that is, at the rate of $1 per year. If the bond is called on December 31, 1956, for $105, then $3, the excess of the adjusted basis of $108 ($109 less $1 deducted in 1955) over the amount received on redemption, $105, may be deducted for the year 1956.

(C) Whether the purchase and immediate transfer of callable bonds occurs in such a manner as to make the entire transaction not bona fide, and hence the deductions for amortization for bond premium not allowable, will depend on all the facts and circumstances.

(D) If the date as of which the basis of the bond was established precedes the first income year with respect to which Section 24360 applies to the bond, proper adjustments shall be made to reflect unamortized bond premium on such bond for the period including the holding period before the date as of which Section 24360 first becomes applicable to the bond in the hands of the taxpayer. Such adjustment is required whether an election was made under Section 24121(o) of the Bank and Corporation Tax Law of 1954 or under Section 24360 and applies to all bonds to which Section 24360 is applicable.

(E) The rule relating to adjustments set forth in paragraph (D) of this subsection may be illustrated by the following examples:

EXAMPLE (1).

On January 1, 1956, T Corporation, which makes its tax returns on the calendar year basis, owns a fully taxable $100 bond, maturing on January 1, 1966. T purchased this bond on January 1, 1946, for $120. T elects to have Section 24360 apply to such bond for 1957 and subsequent income years. In determining the amount of bond premium to be amortized over the remaining 9 years of the life of the bond, T is required but solely for such purpose, to treat the bond as if it had amortized the bond premium thereon during the prior 11 year, and to make the proper adjustments in the original bond premium. Accordingly, T would treat $11 as having been amortized during the first 11 years and would be required to amortize the remaining $9 over the following 9 years. When the bond is redeemed on January 1, 1966, for $100, only the $9 attributable to the last 9 years will actually have been amortized, and the basis of the bond will have been reduced only by that amount. The $11 attributable to the first 11 years will have been treated as an adjustment to the original bond premium but will not have been amortized nor will the basis of the bond have been reduced by that amount. Consequently, T will have a capital loss in the year of redemption on account of the $11 attributable to the period January 1, 1946, to January 1, 1957.

EXAMPLE (2).

Y Corporation makes its income tax returns on the calendar year basis, owns a fully tax-exempt $100 bond maturing on January 1, 1962. It purchased this bond on January 1, 1942, for $120. On December 31, 1955, Y sells the bond for $108 and realizes a gain of $1, computed as follows:

(i)	Total bond premium ($120-$100)........................................................................................................................................................................................................................................	..........................$20
(ii)	Amount of bond premium amortizable if held to maturity (total bond premiums minus unamortized bond premium attributable to 1942 (a year to which Section 24121(o) of the Bank and Corporation Tax Law of 1954 was not applicable), $20-$1).................................................................................................................................................................................................................................................................................................	..........................19
(iii)	Amount of bond premium amortized from January 1, 1943, through December 31, 1955 ($1 for each such year)................................................................................................................	..........................13
(iv)	Adjusted basis of bond at close of 1954 ($120--$13).................................................................................................................................................................................................................................................................................................	..........................107
(v)	Gains ($108--$107).................................................................................................................................................................................................................................................................................................	..........................1

(F) Amortizable bond premium on any bond to which Section 24360 applies is that part of the bond premium on the bond which is attributable to the income year.

(2) Callable Bonds.

(A) For purposes of Section 24360, in the case of a callable bond, the earlier call date will be considered as the maturity date, except as provided in subsection (1)(B) and (C) of this regulation. The amount due on the earlier call date will be considered as the amount payable on maturity unless it is determined under a different method of amortization regularly employed by the taxpayer that another amount shall be the amount payable on maturity. Hence, in the case where a bond premium is to be amortized to the earlier call date, the bond premium on such bond is required to be spread over the period from the date as of which the basis for loss of the bond is established down to the earlier call date, rather than to the maturity date. The earlier call date my be the earliest call date specified in the bond as a day certain, the earliest interest payment date if the bond is callable at such date, the earliest date at which the bond is callable at par, or such other call date, prior to maturity, specified in the bond as may be selected by the taxpayer.

(B) Where a deduction for amortizable bond premium may be determined with respect to alternative call dates, the amount of amortizable bond premium calculated with reference to a particular call date must be calculated thereafter with reference to the same call data. However, if, upon such call data originally selected, the bond has not in fact been called, the bond premium then unamortized must be amortized to a succeeding call date or to maturity. Thus, assume a $100 bond is acquired at time of issue for $125. The bond is callable in five years at $115 and in 10 years at $110. The taxpayer may amortize $10 of premium during the first five years and, if the bond is not then called, an additional $5 of premium during the next five years. If the bond is not called at the end of ten years, the remaining $10 of premium must be amortized to maturity.

(3) Convertible Bonds.

(A) The fact that a bond is convertible into stock does not, in itself, prevent the application of Section 24360. A convertible bond is within the scope of such section if the option to convert on a date certain specified in the bond rests with the holder thereof. However, for the purpose of determining the amount of amortizable bond premium on a convertible bond for the income year, the amount of bond premium shall not include any amount attributable to the conversion features of the bond. For the purpose of the rule stated in the preceding sentence, the term "convertible bond" includes a bond issued with detachable stock-purchase warrants.

(B) The value of the conversion features of a particular bond shall be ascertained as of the time of acquisition by reference to the assumed price at which such bond would be purchased on the open market if without conversion features, and by subtracting such assumed price from the cost of the bond. The assumed price of the bond without conversion features shall be ascertained by comparison to the yields on which bonds of similar character, not having conversion features, are sold on the open market and adjusting the price of the bond in question to this yield. This adjustment may be made by the use of standard bond tables. In selecting quotations for comparative purposes, bonds of the same classification and grade shall be used.

(C) The application of the principles set forth in this subsection may be illustrated as follows:

EXAMPLE.

T Corporation purchased for $115 a $100 bond, maturing in 10 years, on which interest is payable semiannually at the rate of 3 percent a year. This bond is convertible into common stock at the option of the holder. It is found that bonds of the same character, not having conversion features, were sold on the open market on or about the time of T's purchase on a basis to yield 2.6 percent. By recourse to a standard bond table. It is found that bonds of the same character, not having conversion features, were sold on the open market on or about the time of T's purchase on an basis to yield 2.6 percent. By recourse to a standard bond table, it is found that the cost of a 3 percent. 10-year, $100 bond to yield 2.6 percent would have been $103.50. Since the taxpayer paid $115 for the convertible bond, the difference between $115 and $103.50, or $11.50, represents the value of the conversion features of the bond at the time of purchase. The balance of $3.50 represents the bond premium subject to amortization under Section 24360.

(D) If a convertible bond acquired on or before June 15, 1950, is held during the income year, the amortizable bond premium shall be computed as if the provisions for the determination of the bond premium without the inclusion of any amount attributable to the conversion features of the bond were applicable for each year for which the bond was held prior to such income year. Thus, if T, in the example in paragraph (C) of this subsection, had acquired the bond on January 1, 1949, and if T makes its tax returns on the basis of the calendar year, the amortizable bond premium for 1957 would be $0.35, determined as follows:

Bond premium not attributable to conversion feature...........................................................................................................................................................	..........................$3.50
Amortizable bond premium for 1949 and 1950, determined by reference to bond premium not attributable to conversion feature..........................	.......................... .70
Portion of bond premium amortizable over remaining life of bond.....................................................................................................................................	..........................$2.80
Amortizable bond premium for each of the remaining 8 years, including the income year 1957 (one-eighth of $2.80)...............................................	...........................35

(4) Capitalized Expenses.

(A) In the case of a bond to which Section 24360 otherwise applies, on which the bond premium is attributable only to capitalized expenses (such as buying commission), if a taxpayer--

(i) Regularly employs a reasonable method of amortization under which capitalized expenses are amortized,

(ii) Is required by the regulations to use the method of amortization prescribed by subsection (6) of this regulation, or

(iii) Regularly employs a reasonable method of amortization but does not amortize capitalized expenses, such taxpayer is permitted, but is not required, to amortize capitalized expenses in accordance with such method.

(B) In the case of a bond to which Section 24360 applies and on which there is bond premium exclusive of capitalized expenses--

(i) If a taxpayer regularly employs a reasonable method of amortization under which capitalized expenses are treated as being part of the bond premium for purposes of amortization, such capitalized expenses must be treated as being a part of the bond premium for the purposes of Section 24360.

(ii) If a taxpayer is required by regulations to use the method of amortization prescribed by subsection (6) of this regulation, it must treat capitalized expenses as being part of the bond premium for purposes of Section 24360.

(iii) If a taxpayer regularly employs a method of amortization under which capitalized expenses are not treated as being part of the bond premium for the purposes of amortization, it is permitted, but is not required, to treat such capitalized expenses as being part of the bond premium for the purposes of Section 24360.

(5) Income years in which interest not received or accruable. In the case of a taxpayer who makes its tax returns on the cash receipts and disbursements method or one who makes its returns on the accrual method and who owns a bond to which Section 24360 applies and in respect of which no interest is received or accrued by the taxpayer during the income year, if the taxpayer--

(A) Regularly employs a reasonable method of amortization under which the bond premium on such bond for such income year is amortized, or

(B) Is required by the regulations to use the method of amortization prescribed by subsection (6) of the regulation, or

(C) Regularly employs a reasonable method of amortization under which the bond premium on such bond for such income year is not amortized, such taxpayer is permitted, but not required, to amortize bond premium on the bond for such income year in accordance with such method.

(6) Methods of Amortization.

(A) Determination of the bond premium and amortizable bond premium on any bond to which Section 24360 applied shall be made in accordance with:

(i) The method of amortization regularly employed by the taxpayer, if such method is reasonable; or

(ii) In the other eases, the method of amortization prescribed by this regulation.

A method of amortization, will be deemed "regularly employed" by a taxpayer if the method was consistently followed in income years beginning before January 1, 1955, or if for income years beginning on or after such date a taxpayer who has never previously taken a deduction for amortization initiates in the first income year for which such deduction is taken a reasonable method of amortization and consistently follows such method thereafter. A taxpayer who regularly employs a method of amortization may be one, for example, who is subject to the jurisdiction of a State or Federal regulatory agency and who, for the purposes of such agency, amortizes the bond premium on its bonds in accordance with a method prescribed or approved by such agency. However, it is not necessary that the taxpayer be subject to the jurisdiction of such an agency or that the method be prescribed or approved by such agency. It is sufficient if the taxpayer regularly employs a method of amortization and if such method is reasonable.

(B) The bond premium to be amortized shall be determined under the following method:

(i) The amortizable bond premium on such bond attributable to the income year under subsection (1)(F) of this regulation shall be an amount which bears the same ratio to the bond premium on the bond as the number of months in the income year during which the bond was held by the taxpayer bears to the number of months from the beginning of the income year (or, if the bond was acquired in the income year, from the date of acquisition) to the date of maturity or earlier call date. For the purposes of this subparagraph, a fractional part of a month shall be disregarded unless it amounts to more than half of a month, in which case it shall be considered as a month.

(ii) For purposes of subparagraph (i) of this paragraph, the bond premium as of any date on any bond to which Section 24360 applies shall be determined in accordance with subsection (1) of this regulation by ascertaining the excess of the amount of the basis of the bond, as determined under Section 24911 (adjusted to date for amortizable bond premium under Section 24916), over the amount payable at maturity or, in the case of a callable bond, the earlier call date (except as otherwise provided in subsection (1)(B) and (C) of this regulation).

(C) The application of the provisions of this subsection relating to method of amortization may be illustrated by the following example:

EXAMPLE:

(i) A corporation, who makes calendar year returns, on June 20 [30], 1955, acquires at a cost of $119 a $100 bond issued January 1, 1955, maturing January 1, 1965. The amortizable bond premium as of the last day of 1955 is computed as follows:

Bond premium at date of acquisition..................................................................................	..........................$19
Number of months in 1955 during which bond is held by the taxpayer............................	..........................6
Number of months from date of acquisition to date of maturity........................................	..........................114
Amortizable bond premium (6/114 x $19) equals..............................................................	..........................1

(ii) The bond premium as of the close of 1955 would be computed as follows:

Bond premium at date of acquisition (or first day of taxable year)...............................................	..........................$19
Amortizable bond premium for period during which bond was owned in 1955..........................	..........................1
Bond premium as of the close of the income year 1955...............................................................	..........................18

Cal. Code Regs. Tit. 18, § 24360-24363(b)

1. New section filed 12-22-69; effective thirtieth day thereafter (Register 69, No. 52).[FN*]
This regulation is based on Section 26 CFR 1.171-2.

Note: Authority cited: Section 26422, Revenue and Taxation Code.

1. New section filed 12-22-69; effective thirtieth day thereafter (Register 69, No. 52).