The Internal Revenue Service will issue regulations today designed to take the glitter off a newly popular bank savings certificate that allows depositors to collect interest anonymously.
These so-called honor bonds are not issued to an individual but merely to the "bearer," and banks neither record the name of the individual who purchases the certificate of deposit not the name of the individual who cashes it in with interest.
Only State National Bank of Rockville offers honor bonds in the metropolitan area.
When an individual opens a normal savings account or buys a certificate of deposit worth less than $100,000, the bank records the individual's name and will pay interest only to that individual. Simiarly, only the individual (or individuals, in the case of a joint account) can close the account.
Honor bonds are issued to the bearer and can change hands many times. The bank will pay off the account to whoever turns in the certifiacet of deposit at the end of the term - in the case of State National, one year.
The instruments are called honor bonds because banks do not report interest payments to the federal government; investors are on their honor to report the interest income on their federal tax forms.
On normal savings and certificate accounts at anks, S&Ls, or mutual savings banks, the institution sends both the saver and the Internal Revenue Service a form 1099 reporting the interest the account earned in the previous calendar year.
The IRS shortly will issue a rule requiring banks to record the names of those who purchase these bearer-only CDs and the names of those who redeem them.
Several other major savings certificated are issued in negotiable, bearer-type form, including many Treasury securities, certificates of deposits of more than $100,000 and commercial paper (which is essentially a corporate IOU).
These have been exempted from IRS reporting requirements because they often change hands 10 or 15 times between issuance and redemption and because corporations, the major purchasers of large CDS and commercial paper, often do not report their income to the government on a calendear-year basis but have fiscal years that differ from the calendar year.
Harmon Spolan, president of State National, said he is upset that the government has taken such an interest in the tax avoidance qualities of these bonds - which State National advertises as "numbered bonds."
Large investors - those with $10,000 to invest in Treasury bills or $100,000 to buys CDs or commercial paper - always have had the option of buying bearer-type, negotiable instruments, Spolan said. "Why should we presume that wealthy investors or corporations are honest while little investors are not?" he asked.
Federal officials reply that banks offering these accounts have played on the fact that the Internal Revenue Service does not receive any information on the owner of the certificate nor the amount of interest the account receives.
Spolan said in a telephone interview that individuals want private ownership for a variety of reasons other than to avoid paying taxes.
He said one woman bought a State National numbered bond - so called because they are issued by number rather than name - to hide her holding from husband who was abusing her.
If she put her money in a regular account, her "husband would have found out and probably killed her," Spolan maintained.
The State National certificates are issued in $100 minimums and pay 6 percent simple interest at maturity, which is one year. If the account is not cashed in at the end of a year, it is automatically renewed for another year. If a $100 bond were held for two years, the account would receive $12 interest. If it were held for 10 years, it would receive $60 interest.
Spolan said that in the month his bank has been offering the numbered bonds, response has been large, but he declined to say how many numbered bonds have been sold. He said the average investor buys $1,000 worth.
Federal investigators said honor bonds accounts are relatively new. A Federal Reserve Board official said he first became aware of them last October.
The Commerce, Consumer and Monetary Affairs Subcommittee of the House Government Operations Committee will hold hearings on honor bonds today. Rep. Benjamin S. Rosenthal (D-N.Y.) is chairman of the subcommittee.