Question: The Washington Post regularly prints information on the "discount rate" and the "real interest rate" on Treasury bills. Can you shed some light on the method used to compute the real interest rate? An illustration showing the computation would be helpful.
Answer: When you ask so nicely how can I refuse? Let's start by explaining that a T-bill is bought at a discount--that is, for an amount which is less than the face amount of the bill. When the face amount is repaid at maturity, the difference between the original cost and the redemption (or face) amount represents the interest earned.
We might define the discount rate as the difference between the face value and the purchase price, expressed as a percentage of the face value.
The real interest rate is that same difference between face value and purchase price expressed as a percentage of the purchase price--the amount you pay for the bill, which is also the actual amount of money you have invested.
Now we can look at the example you requested, using a $10,000 six-month T-bill to make the arithmetic easy. If you pay $9,550 for the bill, the discount is $10,000 minus $9,550 or $450.
Divide the $450 by the $10,000 face amount and you get 0.045--or 4 1/2 percent for the six-month period, equal to a 9 percent discount rate on an annual non-compounded basis.
But you are only investing $9,550, not the $10,000 face amount. So to get the true interest rate, divide the $450 interest you will receive at maturity by the $9,550 investment cost.
Punch those numbers into your calculator and you come up with .0471. Double that for the full year and you see your real interest rate is 9.42 percent non-compounded. On a discounted T-bill the real interest rate is always a little higher than the discount rate.
Q: During the year I have spent money for postage to mail deposits to banks and money market funds as well as state and federal income tax forms. May I count these expenditures as miscellaneous deductions on my tax returns?
A: Yes. The amounts involved may be small but the principle is valid. You have two different kinds of expenses here, which should be listed separately as miscellaneous deductions on Schedule A of your return.
The first category is investment expenses, which includes such things as fees for investment counseling, charges by a bank or broker to collect interest or dividends, transportation expense to your broker's office--and mailing costs for deposits, certificates, etc.
Like the expense of a safe deposit box, these are only deductible if related to the production of taxable income. Any costs incurred to produce income that is not taxable--like municipal bond interest-may not be deducted.
Tax assistance expenses are usually thought of as including tax counseling fees and a charge for preparation of your return. But you may add the cost of transportation to your tax preparer's office and any associated mailing costs.
E-bond alert. If you own any Series E savings bonds dating back to the early days of World War II you should check out the dates of issue now. Series E bonds issued from the beginning of the program until April 1952 reach final maturity 40 years after the issue date.
At that point two things happen: the bond stops earning interest; and all of the accrued interest (if you haven't been reporting it annually) is immediately subject to income tax even if you hang on to the bond and don't redeem it.
So bonds issued in any month through April 1943 should now be redeemed or exchanged for Series HH bonds. Accrued interest (not previously reported) on redeemed bonds is includable on your federal tax return in the year of redemption (but is exempt from state or local income tax).
If you exchange your Series E bonds for a Series HH bond, you may continue to defer tax liability on the accrued interest until the HH bond is redeemed. But the interest on the HH bond itself, which is paid semi-annually in cash, is taxable income in the year of receipt.