The Internal Revenue Service yesterday warned savers who rush to take advantage of widely ballyhooed advance bonus interest offered by banks on All Savers Certificates that they may risk losing their entire tax exemption on the certificates because the combined interest and longer maturity may violate tax law.
The bonus interest scheme has been extensively advertised in newspapers here and in New York.
An IRS spokesman said yesterday the agency has "serious doubts as to the tax consequences of investment packages issued by financial institutions that link high yield, short-term investments with the new All Savers Certificates."
A formal study of the situation is now under way at IRS and will be made public soon. However, after a high level meeting Friday night of IRS and Treasury officials, it was decided to issue a preliminarywarning yesterday morning.
"We felt we would be remiss if we remained silent until the official announcement and didn't issue some warning to the substantial number of people apparently rushing into these offers," said the IRS spokesman.
Terms for the tax-free All Savers Certificates are set by recently passed tax legislation. The law permits a $1,000 tax exemption for singles and a $2,000 exemption on joint returns for interest earned on the certificates, which have a one-year maturity and are pegged to 70 percent of the investment yield on one-year Treasury bills.
The first day the certificates can be sold is Oct. 1.
However, in an effort to make sure they get a share of the $250 billion expected to be deposited into these accounts, banks and savings institutions have been offering bonus interest to those willing to sign up more than a month in advance. Chase Manhattan Bank in New York offers a 40 percent annual interest rate premium. In the Washington area, advertisements have appeared in The Washington Post for 36 percent annual interest at Jefferson Federal Savings and Loan, Interstate Federal Savings and Loan and Columbia First Federal Savings and Loan, 25 percent at State National Bank and 21 percent at First American Bank, among others. First Women's Bank of Maryland is offering 30 percent.
These huge interest rates, which are based on the yields on unregulated retail repurchase agreements, last only until Oct. 1 when the regulated rate for All Savers Certificates goes into effect. The bonus interest is taxable in any case, whereas the interest on the certificates is not. But the IRS warns savers accepting the bonus that they may jeopardize the tax exemption on the certificates because the total interest paid will exceed the legal limit.
For example, a month's return on 36 percent annual interest is 3 percent. If the rate on All Savers is set at 12 percent, the combined interest payments would exceed the permissible rate of return. Moreover, if a customer agrees to the bonus payment now in return for converting to an All Savers Certificate on Oct. 1, the total amount of time his or her money will be on deposit at the bank or thrift institution will be 13 months or more.
Since the investment violates both the time and interest rate limits set by Congress, the IRS says the taxpayer may wind up losing the entire $1,000 ($2,000 for couples) tax exemption if he or she has deposited enough money to be eligible for the maximum exemption (about $10,000 for individuals and $20,000 for couples).
The advertisements have been running for less than a week here, but longer in New York where bank officials report doing a brisk business.
What happens if a customer has already invested in one of these offers in good faith, the IRS spokesman was asked. He replied that that did not change the taxpayer's position vis-a-vis the IRS. In other words, he said, the customer must deal directly with the bank to rescind the bonus interest agreement in order to save the exemption.