RRA '93 does not affect bonds purchased at original issue regardless of the date of purchase or to bonds purchased on the secondary market prior to May 1, 1993. Also exempt from treating market discount as ordinary income are bonds issued before July 19, 1984.

For ordinary tax-exempt bonds (nonzero-coupon bonds), market discount is the difference between the stated redemption price and the price paid for the bond when purchased on the secondary market.

For stripped coupon tax-exempt bonds (zeros) purchased on the secondary market, market discount is the difference between the purchase price and the revised issue price. The revised issue price is defined as the original issue price plus accreted tax-exempt interest on the bond from date of issue to date of purchase using the "constant interest rate method" (compounding). The rate to be used for compounding is the yield rate of the bond when first issued. Revised issue prices are computed annually and are available from brokerage firms dealing in zeros.

A de minimus rule exempts treating market discount as ordinary income if the discount on the bond is one cent less than .0025 x the face value of the bond x the number of complete years between the bond's acquisition date and its maturity date. For example, the de minimus amount for a $1,000 face value bond with 10 complete years remaining to maturity is 1cent less than $25, i.e., $24.99.

Investors can elect to report market discount annually on a pro rata basis, but there are disadvantages for making such an election.

Investors in municipal bonds may have a portfolio of bonds falling into a variety of categories requiring different tax treatment. A recent bill introduced by Representative B. Cardin (D-MD) to repeal the complicated rules has a slim chance of passage according to the Public Securities Association.

The categories with explanations of the various types of municipal bonds are as follows:

1. Ordinary bonds or zeros bought at original issue and held to maturity. The discount on bonds in this class is tax exempt. At maturity the disposition is reported in Schedule D. The selling price and the basis are equal to the face amount of the bond. (IRC Sec. 1272(a)(2)(A); Rev. Rul. 72-587, 1971-2CB-74)

2. Ordinary bonds bought at original issue and called or sold prior to maturity. For obligations in this class issued prior to June 9, 1980, discount is amortized between the period held (earned) and the periods not held (unearned). For the period held, the discount is tax exempt. For the period not held, the discount is taxed as a capital gain. (Rev. Rul. 80-143, 1980-1CB-19)

Example: A 20-year, $1000 bond is bought for $900 and sold for $975 when 10 complete years remain until maturity. The discount of $100 is amortized at the rate of $5 per year. The Schedule D computation is as follows:

Sellingprice$975

Basis:

a)Cost$900

b)Earnedtaxexempt

interest/discountforthe

10-yearperiodheldat

$5peryear50

Totalbasis950

Capitalgain$25

(Note:Iftheabovebondissoldforlessthan$950,acapitalloss

willbesustainedequaltothedifferencebetween$950andthe

sellingprice.)

3. Zeros bought at original issue and sold prior to maturity. For zeros in this category, capital gain is realized to the extent that the selling price exceeds the revised issue price as of the date of sale. A capital loss is sustained if the selling price is less than the revised issue price. An adjustment is required to the revised issue price if the bond is sold on a date which differs from the date the revised issue price is published.

4. Ordinary bonds bought at a discount on the secondary market prior to May 1, 1993, and a) held to maturity or b) sold prior to maturity. For ordinary bonds in this category, capital gain is realized to the extent that the redemption price or sales price exceeds the bond cost. (Bonds purchased at a premium require amortization of the premium, over the period from purchase date to date of sale or call, to reduce its basis. If there is no call date, amortization is extended to the maturity date.)

5. Zeros bought on the secondary market prior to May 1, 1993, and held to maturity. Gain attributable to market discount on bonds in this category is capital gain.

Example: Investor buys a 20-year, $1,000 face value zero-coupon bond for $500 when 10 complete years remain to maturity. The revised issue price at the time of purchase is $560. The market discount is $60, which is taxed as capital gain. The computation for Schedule D is as follows:

Redemptionamountat

maturity$1,000

Basis:

a)Cost$500

b)Accretedtaxexempt

interestfrompurchase

datetodateofmaturity

($1,000-$560)440

Totalbasis940

Capitalgain(equaltomarket

discount)$60

6. Zeros bought on the secondary market prior to May 1, 1993, and sold prior to maturity. Gain attributable to market discount in this category is considered to be capital gain.

Example: Same facts as in 5 above, except the bond is sold for $800, five complete years from date of purchase. At time of sale the revised issue price is $750:

Sellingprice$800

Basis:

a)Cost$500

b)Accretedtaxexempt

interestforthefive-year

periodheldwhichis

thedifferencebetween

therevisedissue

priceattimeofsale

($750)andtimeof

purchase($560)190

Totalbasis690

Capitalgain$60discount+

($800-$750)$110

7. Ordinary bonds bought on the secondary market after April 30, 1993, and a) held to maturity or b) sold prior to maturity. For bonds bought after May 1, 1993, on the secondary market, market discount is ordinary income.

Example A: A 20-year bond is bought for $800 with 10 years remaining to maturity. At maturity the $200 discount is a Schedule B entry. Selling price is $1,000. Basis is $1,000 ($800 + $200). Gain or loss is zero.

Example B: Assume the same facts, except the bond is sold exactly five years from date of purchase for $950. The computation for Schedule D is as follows:

Sellingprice$950

Basis:

(a)Cost$800

(b)Accreteddiscount

forfiveyearsat$20per

yeartaxedinScheduleB100

Totalbasis900

Capitalgain$50

Example C: Same facts, except the bond is sold for $850:

Sellingprice$850

Basis:

(a)Cost$800

(b)Discounttaxed

inScheduleB100

Totalbasis900

Capitalloss($50)

(Note:Althoughtheoverallgainis$50,$100isordinaryincomeand

$50isacapitalloss).ThisinterpretationofRRA'93isbasedon

thestatementofthemanagersforH.R.2264toextendthesame

marketdiscountrulestotax-exemptbondsastheyapplytotaxable

bonds(exceptthatmarketdiscountontaxexemptsmaybereported

upondispositionratherthanannually).

8. Zeros bought on the secondary market after April 30, 1993, and held to maturity. Gain attributable to market discount is ordinary income.

Example: Investor buys a $1,000 20-year, zero-coupon bond for $500, when the revised issue price is $560, with 10 complete years remaining to maturity. The market discount of $60 is amortized over 10 years at $6 per year.

Redemptionamountat

maturity$1,000

Basis:

a)Cost$500

b)Tax-exemptinterest

($1,000-$560)440

c)Marketdiscount

toScheduleB

($560-$500)60

Totalbasis1,000

ScheduleDgain/loss-0-

9. Zeros bought on the secondary market after April 30, 1993, and sold prior to maturity. The gain attributable to market discount on the sale of a zero-coupon bond prior to maturity is ordinary income for bonds purchased on the secondary market after April 30, 1993.

Example A: Investor buys a $1,000 zero-coupon bond for $500, at which time 10 complete years remain to maturity. The revised issue price on date of purchase is $560. The discount is $60. The bond is sold five complete years after purchase for $850 at which time the revised issue price is $750:

Sellingprice$850

Basis:

a)Cost$500

b)Accreteddiscount

forfiveyearsat$6per

yeartaxedasordinary

incomeinScheduleB30

c)Accretedtax

exemptinterest

($750-$560)190

Totalbasis720

Capitalgain$130

Example B: Same facts, except that the bond is sold for $675. The discount is still ordinary income. A Schedule D loss of $45 is reported (selling price $675, basis $720). But see the note under example 7.