June 25, 1984
You inquire as to the Massachusetts income tax treatment of zero-coupon bonds issued by non-Massachusetts municipalities.
Holders of either corporate or government bonds issued after July 1, 1982, other than tax-exempt government obligations under I.R.C. § 103, must include in federal gross income the sum of the daily portions of original issue discount determined for each day the bond is held during the taxable year. Original issue discount is allocated over the life of the bond through a series of adjustments to the issue price for each bond period. (I.R.C. § 1232A(a)).
The holder of any obligation issued by a corporation after May 27, 1969 and before July 2, 1982, which is a capital asset in the hands of the holder, must include as interest in his federal gross income an amount equal to the ratable monthly portion of original issue discount multiplied by the number of complete months and any fractional part of a month he held the obligation during the taxable year. The ratable monthly portion of original discount is the original issue discount divided by the number of complete months from the date of original issue to the stated maturity date of such bond. (I.R.C. § 1232A(b)).
For corporate bonds issued before May 28, 1969 and for government bonds issued before July 2, 1982, (other than tax-exempt government obligations under I.R.C. § 103) the holder pays no federal income tax on the original issue discount until the year the bond is sold, exchanged or redeemed. If the bond is a capital asset and is held for more than one year, then an amount equal to the original issue discount is taxed as ordinary income. (I.R.C. § 1232(a)(2)(B)).
Original issue discount income inclusion rules apply only to bonds with a maturity date more than one year after the issue date. For bonds with a maturity date of one year or less, gain on sale or redemption will be treated as interest income to the extent of what would have been original issue discount. The holder's basis in a bond is increased by the amount of original issue discount included in his federal gross income. (I.R.C. § 1232A).
Federal gross income does not include interest on the obligations of a municipality, except for interest on certain industrial development bonds and arbitage bonds. (I.R.C. § 103(a)(1)).
Massachusetts gross income is federal gross income as defined under the Internal Revenue Code as amended on February 1, 1983 with certain modifications. (G.L. c. 62, §§ 1(e), 2(a)). Massachusetts gross income includes the interest on municipal obligations excluded under Section 103 of the Internal Revenue Code, other than interest from obligations issued by Massachusetts municipalities. (G.L. c. 62, § 2(a)(1)(A)).
Based upon the foregoing, it is ruled that the holder of a zero-coupon bond issued by a non-Massachusetts municipality must include in his Massachusetts gross income the amount which he would have included in his federal gross income had the zero-coupon bond been issued by a corporation. This amount should be included in Part A gross income and will be taxed at the rate of ten percent.
Very truly yours,
/s/Ira A. Jackson
Commissioner of Revenue