QUESTION: Why do I pay interest when I buy a bond? I've never quite understood the reason for the slip I get from my broker.
ANSWER: A number of people have asked me this same question - probably because it doesn't seem logical on the face of it. But it is logical; let's see if I can make it clear with an example using simplified numbers.
We'll use a $1,000 bond paying six percent interest, with the interest paid on January 1 and July 1. Each semi-annual interest payment then will amount to $30 - equal to five dollars a month.
Assume you buy the bond on April 1, just midway between the interest payment dates. On July 1 you will get a check for $30, representing six months interest. But since you have owned the bond for only three months - from April 1 to July - your investment has only earned $15.
The previous owner of the bond - the person from whom you bought it - is also entitled to $15, equal to the interest earned from January 1 to April 1, the period he or she owned the bond.
But the corporate issuer of the bond won't split the payment; the entire six-month interest payment of $30 will be sent to the "owner of record" on July 1 (that's you).
So when you buy the bond, the broker adds to the price of the bond itself the $15 interest accured to the date of purchase. In turn, that $15 is paid to the seller of the bond as compensation for the three months interest he or she has earned but would not otherwise received.
Then on July 1 you will be issued a check for $30 - $15 for the interest you have earned since April 1, plus $15 to repay you for the accrued interest you had advanced to the previous owner.
When preparing your income tax return, you subtract the $15 accrued (but unearned) interest appearing on the broker's charge slip from the $30 shown on the Form 1099 as having been paid to you.
Thus you report as income only the net amount of $15 you had actually earned and received. And the previous owner reports as interest income the $15 he received, as shown on the sales slip from the broker.
Q: I have been putting money into an Individual Retirement Account since the program started. I recently started working for the federal government. Would you please explain what happens to my investment account now?
A: Since you are participating in the federal civil service retirement program during a part of 1978, you may not contribute any additional funds to your IRA for this year.
However, the money already in the account from prior years may remain; and any income earned by the account in 1978 (or succeeding years) is not subject to federal income tax (until it is withdrawn, of course).
Even though you make no deposit in 1978 and may not claim any deduction from income, you must continue to file an information statement with your federal tax return each year. For 1977 you would have used Form 5329; presumably the same form number will be used this year.
Q: Several years ago I bought shares of stock in a company that is no longer listed in the daily newspaper market reports. My broiler told me that there is no market for the stock. Can I claim a capital loss on those shares on my tax return?
A: Probably so. Stock that becomes worthless during the year is treated as if it had been sold for "zero" dollars on the last day of the year. You use the date (Dec. 31) to determine whether the loss is long-term or short-term.
Enter the details of the purchase and "sale" on Schedule D of your return. (Although it doesn't apply in your case, other readers should remember that since Jan. 1, 1978 property must be owned for more than 12 months to qualify for long-term treatment.)
But the fact that a stock is not actively traded does not necessarily show that it has no value. Try writing directly to the company for information. If you get no response, write to the Secretary of State in the state in which the company was incorporated; he may be able to provide evidence that the stock is worthless.
As a last report, discuss the problem with your broker. He may be willing to buy the shares from you for one dollar so that you may establish the loss for your tax return.
Incidentally, if you learn that the company went out of business in an earlier year, you can't take the loss in 1978. Instead, you must file an amended return (using IRS Form 1040X) for the year in which the stock became worthless.