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M. Amortization of Bond Premiums (G.S. 105-130.5) (Section .1400)
- Preliminary Statement
If a corporation purchases a bond at more than its face value, the amount
of premium paid may be amortized over the life of the bond. However, the allowance
of a deduction against net income for amortization of the premium paid depends
upon the type of bond purchased by the corporation.
Amortization of premiums on tax-exempt bonds by a corporation is mandatory
with no deduction allowed in computing State net income.
A corporation may at its option amortize the amount of premiums paid on taxable
bonds over the life of the bonds. If the premium is not amortized by the corporation,
it will constitute part of the basis of the bond in determining gain or loss
at maturity or sale.
For State income tax purposes, obligations of the United States or its possessions
and obligations of State of North Carolina or any of its subdivisions are
tax-exempt. Interest income received by a corporation on such obligations
is not taxable; however, a corporation must include in its computation of
State net income any gain or loss realized on the disposal of such obligations.
Premiums paid on all bonds acquired prior to January 1,1963 cannot be amortized
but constitute a part of the cost basis of the bonds in determining gain or
loss when the bonds are sold.
- Tax-Exempt Bonds
The amount of premium paid upon the purchase of a tax-exempt bond is amortized
over the life of the bond. Amortization for the taxable year is accomplished
by reducing the original cost of the bond by a portion of the premium paid,
with no deduction against net income for the year. Therefore, when the bond
is sold or otherwise disposed of, the basis for determining gain or loss will
always be original cost less the amount of premium amortized for book purposes
through the year of disposal.
Example: A corporation pays $5,100 for a 5-year tax-exempt interest-bearing
bond having a par value of $5,000. The premium of $100 paid upon the purchase
of the bond must be amortized over the life of the bond and cannot be used
as a deduction in determining net income. The bond is later sold for $5,100.
Although interest earned on the bond is not taxable, the corporation is required
to report the sale as follows:
| Sales price |
|
$ 5,100 |
| Basis of bond sold: |
|
|
Cost of bond
|
$ 5,100 |
|
Less: Premium amortized
|
50 |
5,050 |
| |
------- |
------- |
| Gain |
|
$ 50 |
- Taxable Bonds
A portion of the premium paid upon the purchase of a taxable bond may be deducted
in the taxable year only if an adjustment is made to the basis of the bond.
If a taxpayer elects to amortize the premium, the basis for determining gain
or loss will always be original cost less the amount of premium amortized
and deducted in its tax returns through the year of disposal. Otherwise, the
basis of a taxable bond for determining gain or loss will always be the entire
amount paid for the bond.
Examples:
- A corporation pays $12,500 for a taxable interest-bearing bond having
a par value of $12,000. The bond matures in ten years. Since the interest
from the bond represents taxable income to the corporation, it elects
to amortize the premium paid over the life of the bond. One-tenth of the
premium, or $50, is allowable as an annual deduction in determining net
income. At the end of five years the corporation sells the bond for $12,375.
The corporation is required to report the sale as follows:
| Sales price |
|
$12,375 |
| Basis of bond sold: |
|
|
Cost of bond
|
$12,500 |
|
Less: Amount of premium amortized
|
250 |
12,250 |
| |
------- |
------- |
| Gain |
|
$125 |
- In the foregoing example if the corporation had elected not to amortize
the premium, it would be required to report the sale of bond as follows:
| Sales price |
$12,375 |
| Basis of bond sold: |
|
Original Cost
|
12,500 |
| |
------- |
| Loss |
($ 125) |
- Definition of Bond
The term "bond" means any bond, debenture, note, or
certificate or other evidence of indebtedness issued by any corporation
and bearing interest and includes any like obligation issued by
any government or political subdivision thereof.
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