Bond Market Discount Not Deemed Includable in Income Under New IRC §451(b)

In Notice 2018-80 the IRS stated that the agency plans to release proposed regulations that will provide market discount will not be deemed includable in income pursuant to new IRC §451(b) added to the law by the Tax Cuts and Jobs Act.

Market discount on a bond is governed by guidance found at IRC §1276.  The Notice describes this treatment:

Section 1276(a)(1) treats gain (if any) on the disposition of a market discount bond as ordinary income to the extent that the gain does not exceed the accrued market discount on the bond. Section 1276(a)(3) provides that any partial principal payment on a market discount bond is includible in gross income to the extent the payment does not exceed accrued market discount on the bond.

The Tax Cuts and Jobs Act added new IRC §451(b) that provides for “revenue conformity” for taxpayers using the all events test to determine the timing of revenue inclusion who have an applicable financial statement as defined in IRC §451(b)(3).  As the Notice describes this rule:

For an accrual method taxpayer, income is includible in gross income when all the events have occurred which fix the right to receive such income and the amount, thereof can be determined with reasonable accuracy (all events test). See § 451(b)(1)(C); § 1.451-1(a) of the Income Tax Regulations. Section 451(b)(1)(A) provides that the all events test is met with respect to an item of gross income no later than when the taxpayer takes that item of gross income into account as revenue for financial accounting purposes in an “applicable financial statement” as defined in section 451(b)(3). Section 451(b)(2) provides that the general rule in section 451(b)(1) does not apply to any item of gross income for which the taxpayer uses a special method of accounting, other than items accounted for under a provision of part V of subchapter P, which contains sections 1271 through 1288.

The last part of that description is what raised concerns about the applicability of IRC §451(b)’s conformity rule to market discount since that provision is contained in the range of special accounting methods not protected from the conformity rule.

The IRS has announced that market discount will not be includable in income under IRC §451(b).  As the Notice provides:

Taxpayers have requested guidance as to whether market discount is includible in income under section 451(b). The Treasury Department and the IRS intend to issue proposed regulations providing that accrued market discount is not includible in income under section 451(b). The guidance described in this notice will be applicable as of January 1, 2018.