The IRS released a notice (Notice 2018-80
) announcing its intention to issue proposed regulations confirming that Section 451(b) will not apply to market discount as defined in Section 1278(a)(2).
Generally, when a taxpayer purchases a bond on a secondary market for less than its face amount, the taxpayer may have to account for “market discount,” defined in Section 1278 as the excess of the difference between the face amount, taking into account any original issue discount, and the taxpayer’s basis. Under Section 1276, a taxpayer is generally not required to include market discount in gross income until the taxpayer disposes of the bond for a gain or receives a partial payment of principal. For GAAP purposes, however, taxpayers may recognize market discount over the remaining term of the instrument.
The Tax Cuts and Jobs Act amended Section 451(b) to provide that, for accrual-method taxpayers, the “all-events test” is met with respect to any item of income no later than when the taxpayer takes that item of gross income into account as revenue for financial accounting purposes. Accordingly, Section 451(b) prevents taxpayers from deferring certain items of revenue beyond when they recognize such revenue for financial accounting purposes. Many taxpayers and practitioners were concerned that Section 451(b) would apply to force the recognition of market discount to match the GAAP rules, which would override the existing tax rules for the timing of market discount under Sections 1276 and 1278.
Notice 2018-80 clarifies the IRS’s intention to issue proposed regulations specifying that Section 451(b) does not apply to market discount. Instead, market discount will continue to be governed by Sections 1276 and 1278. The Notice further states that it is applicable as of Jan. 1, 2018.
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