The Internal Revenue Service yesterday issued its rules on tax treatment of the new All Savers certificates, and the Depository Institutions Deregulation Committee set the terms under which they can be sold.
IRS Commissioner Roscoe L. Egger Jr. said he hopes that the tax ruling -- as well as the enormous publicity given this past week to the controversy over bonus interest rate package deals -- will encourage sales of the certificates.
Under the Economic Recovery Act of 1981, individuals are entitled to earn up to $1,000 tax-free ($2,000 for joint returns) on one-year All Savers certificates purchased at banks, savings and loans, savings banks and credit unions. The certificates can be purchased between Oct. 1, 1981, and Dec. 31, 1982, but the tax exclusion may be taken only once. Maturing All Savers certificates cannot be renewed.
The certificates pay 70 percent of the average investment yield on 52-week Treasury bills. These usually are auctioned every four weeks. The investment yield is announced by the Treasury. The rate on new certificates will be changed each month according to auction results. However, once a certificate is issued, its yield remains fixed for one year.
Yesterday the DIDC issued additional rules for prospective buyers. The Recovery Act says that All Savers certificates must be offered in multiples of $500, and the DIDC yesterday authorized financial institutions also to offer them in lower and higher denominations. For example, a bank could decide to offer them in $100 or $1,000 deonominations. It also could decide to offer them in lots of $7,930.21 or $15,860.43, amounts which would yield interest of $1,000 and $2,000 tax-free on certificates with an interest rate of 12.61 percent.
Early withdrawal of all or part of the principal will result in a penalty equal to three months interest on the amount withdrawn. Also, the certificate holder loses his or her tax exemption on the entire All Savers certificate. Therefore, if early withdrawal is a possibility, an investor could purchase a number of certificates in different denominations to avoid losing the entire exemption.
Six-month money market certificates may be rolled over into All Savers certificates without penalty even if they have not matured. Other time deposits, such as a 30-month certificate, can be converted into All Savers certificates provided the amount of time left in the original certificate is less than one year. Also, the original certificate can be rolled over only if its interest rate is higher than that on the All Savers certificate. Other conditions may affect tax treatment of the certificates, so it is prudent to call the IRS before shifting, a DIDC spokesman said.
Withdrawals of earned interest on All Savers certificates are permitted, but an individual who withdraws interest during the deposit term will receive a lower total amount of interest because of the effect of compounding. Any excess interest above $1,000 for individuals or $2,000 for couples would be considered taxable for the year in which the certificate matures.
The coupon-equivalent yield on 52-week Treasury bills sold at yesterday's auction is 17.26 percent. That puts T-bills on a par with money market mutual funds, which averaged 17.2 percent last week, except that money market fund interest is fully taxable.
Investing in tax-free certificates is advantageous to persons with taxable income in the 30-percent-and-over bracket. That means gross income of more than $36,125 for married couples and of more than $20,875 for singles. Both are presumed to have typical deductions of 20 percent. This applies to federal income tax only and does not take into consideration any state or local taxes. All Savers certificates are tax-exempt in Maryland and Virginia, but not in the District.