Can a New York resident deduct the amortization of premiums paid on out-of-state municipal bonds that pay federally tax-exempt interest?

Plain-English summary

George Lavenia bought municipal bonds issued by states other than New York (for example, bonds of the State of Washington) at a premium - meaning he paid more than the bonds' face value. Because those bonds pay interest that is exempt from federal income tax, federal law required him to amortize that premium each year, reducing his basis in the bonds, without allowing any corresponding federal deduction for the amortized amount.

For New York personal income tax purposes, Lavenia had to add back to his federal adjusted gross income the tax-exempt interest he received each year from those out-of-state municipal bonds, since New York taxes interest on other states' obligations even though the federal government does not. He asked whether he could also deduct the amortized bond premium in computing his New York tax. For tax year 1999, he had itemized his federal deductions but claimed the New York standard deduction rather than the New York itemized deduction.

The Department explained that a deduction for amortizable bond premium not allowed federally is available under Tax Law § 612(c)(10) only if the premium is attributable to a trade or business carried on by the taxpayer - and Lavenia's bonds were personal investments, not business assets. A second avenue, Tax Law § 615(d)(3), lets a taxpayer who elects the New York itemized deduction add the bond premium to itemized deductions without any trade-or-business requirement - but that avenue is only open to someone who actually elects the New York itemized deduction under § 615.

Because Lavenia did not elect the New York itemized deduction for 1999 and his bond premium was not tied to a trade or business, the Department concluded no deduction was allowed under either provision. He had to include the tax-exempt out-of-state bond interest in New York income under § 612(b)(1) with no offsetting deduction for the premium he amortized on those bonds.

What this means for you

Individuals who hold out-of-state tax-exempt municipal bonds

If you buy municipal bonds issued by another state at a premium and hold them as personal investments (not in a trade or business), New York will tax the interest you receive under Tax Law § 612(b)(1), and you generally cannot deduct the amortized bond premium under § 612(c)(10) - that provision is limited to premiums attributable to a trade or business.

Choosing between the standard and itemized deduction

The only way to capture a personal (non-business) amortizable bond premium in New York is to elect the New York itemized deduction under Tax Law § 615 and add the premium back under § 615(d)(3). If you take the New York standard deduction instead, as Lavenia did for 1999, that avenue is unavailable even if you itemized on your federal return.

Accountants and tax professionals

When a client holds premium municipal bonds from other states, check both whether the premium is trade-or-business related (§ 612(c)(10)) and whether the client elected the New York itemized deduction (§ 615(d)(3)) before concluding a bond-premium deduction is available - missing either condition means no deduction, regardless of the federal treatment.

Common questions

Q: Why does New York tax interest on municipal bonds from other states when the federal government doesn't?
A: Tax Law § 612(b)(1) requires a taxpayer to add back to federal adjusted gross income any interest on obligations of another state (or its political subdivisions) that was excluded from federal gross income, so this interest becomes New York taxable income even though it's federally tax-exempt.

Q: Can a taxpayer deduct the amortized premium paid on those bonds?
A: Only in limited circumstances. Tax Law § 612(c)(10) allows a subtraction for amortizable bond premium not deductible federally, but only if the premium is attributable to a trade or business carried on by the taxpayer. Personal investment bonds, like Lavenia's, don't qualify.

Q: Is there another way to deduct the premium if the bonds aren't a business asset?
A: Yes - Tax Law § 615(d)(3) allows a taxpayer who elects the New York itemized deduction to add the bond premium to itemized deductions, without any trade-or-business requirement. But this only applies if the taxpayer actually elects the New York itemized deduction under § 615.

Q: What happened because Lavenia took the standard deduction instead of itemizing for New York?
A: Because he did not elect the New York itemized deduction under § 615 for 1999, § 615(d)(3) could not apply, and because the bonds were not part of a trade or business, § 612(c)(10) could not apply either - so no deduction for the amortized bond premium was allowed.

Q: Does it matter that he itemized deductions on his federal return?
A: No. What matters for this deduction is the election made for New York purposes under § 615, not the taxpayer's federal itemization choice.

Citations and references

• Tax Law § 611(a) - defines New York taxable income of a resident individual as New York adjusted gross income less New York deduction and exemptions
• Tax Law § 612(a) - New York adjusted gross income starts from federal adjusted gross income, with New York modifications
• Tax Law § 612(b)(1) - requires adding back interest on obligations of other states not includible in federal adjusted gross income
• Tax Law § 612(c)(10) - allows subtracting amortizable bond premium not deductible federally, but only if attributable to a trade or business
• Tax Law § 613 - New York standard deduction applies unless the taxpayer elects the itemized deduction under § 615
• Tax Law § 615(a) - allows a resident individual who itemizes federally to elect the New York itemized deduction
• Tax Law § 615(d)(3) - allows adding amortizable bond premium to New York itemized deductions without a trade-or-business requirement
• IRC § 103 - excludes interest on state and local bonds from federal gross income, subject to exceptions
• IRC § 171 - governs amortizable bond premium, denying a deduction for premium on tax-exempt bonds
• IRC § 1012 - basis of property is generally its cost, including any premium paid
• IRC § 1016(a)(5) - requires basis reduction for amortized bond premium

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_2003.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a03_3i.pdf

Original ruling text

New York State Department of Taxation and Finance

Office of Tax Policy Analysis
Technical Services Division

TSB-A-03(3)I
Income Tax
June 11, 2003

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I021213A

On December 13, 2002, a Petition for Advisory Opinion was received from George Lavenia,
315 East 86th Street Apt. 4KE, New York, NY 10028.
The issue raised by Petitioner, George Lavenia, is whether a deduction is allowed, under
Article 22 of the Tax Law, for the amortization of bond premiums he paid on bonds as described
below.
Petitioner submits the following facts as the basis for this Advisory Opinion.
Petitioner purchased at a premium municipal bonds issued by states other than New York
State, such as bonds of the State of Washington. Because the bonds yielded tax exempt interest for
federal income tax purposes, Petitioner was required to amortize the premium. Each year, Petitioner
was required to reduce the basis in the bonds by the amortization for the year. However, such
amortized amount is not deductible in determining federal taxable income.
For New York State personal income tax purposes, Petitioner was required to add to his
federal adjusted gross income the interest income he received each year that was attributable to the
municipal bonds. The municipal bonds are not used by Petitioner in a trade or business.
For tax year 1999, Petitioner claimed itemized deductions for federal income tax purposes
and the standard deduction for New York personal income tax purposes.
Applicable Law
Section 611(a) of the Tax Law provides:
General. The New York taxable income of a resident individual shall be his
New York adjusted gross income less his New York deduction and New York
exemptions, as determined under this part.
Section 612(a) of the Tax Law provides:
General. The New York adjusted gross income of a resident individual
means his federal adjusted gross income as defined in the laws of the United States
for the taxable year, with the modifications specified in this section.
Section 612(b)(1) of the Tax Law contains a modification and provides that there shall be
added to federal adjusted gross income:

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Interest income on obligations of any state other than this state, or of a
political subdivision of any such other state unless created by compact or agreement
to which this state is a party, to the extent not properly includible in federal adjusted
gross income;
Section 612(c)(10) of the Tax Law contains a modification and provides that there shall be
subtracted from federal adjusted gross income:
Ordinary and necessary expenses paid or incurred during the taxable year for
(i) the production or collection of income which is subject to tax under this article
but exempt from federal income tax, or (ii) the management, conservation or
maintenance of property held for the production of such income, and the amortizable
bond premium for the taxable year on any bond the interest on which is subject to tax
under this article but exempt from federal income tax, to the extent that such
expenses and premiums are not deductible in determining federal adjusted gross
income and are attributable to a trade or business carried on by the taxpayer.
Section 613 of the Tax Law provides:
The New York deduction of a resident individual shall be his New York
standard deduction unless he elects to deduct his New York itemized deduction
under the conditions set forth in section six hundred fifteen.
Section 615(a) of the Tax Law provides:
General. If federal taxable income of a resident individual is determined by
itemizing deductions from his federal adjusted gross income, he may elect to deduct
his New York itemized deduction in lieu of his New York standard deduction. The
New York itemized deduction of a resident individual means the total amount of his
deductions from federal adjusted gross income, other than federal deductions for
personal exemptions, as provided in the laws of the United States for the taxable
year, with the modifications specified in this section, except as provided for under
subsection (f) of this section.
Section 615(d)(3) of the Tax Law contains a modification and provides that the total amount
of deductions from federal adjusted gross income shall be increased by:
[O]rdinary and necessary expenses paid or incurred during the taxable year
for (i) the production or collection of income which is subject to tax under this article
but exempt from federal income tax, or (ii) the management, conservation or
maintenance of property held for the production of such income, and the amortizable
bond premium for the taxable year on any bond the interest on which is subject to tax
under this article but exempt from federal income tax, to the extent that such

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expenses and premiums are not deductible in determining federal adjusted gross
income and are not subtracted from federal adjusted gross income pursuant to
paragraph (10) of subsection (c) of section six hundred twelve.
Section 103 of the Internal Revenue Code (IRC) provides, in part:
(a) Exclusion. Except as provided in subsection (b), gross income does not
include interest on any State or local bond.
(b) Exceptions. Subsection (a) shall not apply to
(1) Private activity bond which is not a qualified bond. Any private
activity bond which is not a qualified bond (within the meaning of section
141).
(2) Arbitrage bond. Any arbitrage bond (within the meaning of
section 148).
(3) Bond not in registered form, etc. Any bond unless such bond
meets the applicable requirements of section 149.
Section 171 of the IRC contains the provisions for amortizable bond premium, and provides,
in part:
(a) General rule. In the case of any bond, as defined in subsection (d), the
following rules shall apply to the amortizable bond premium (determined under
subsection (b)) on the bond:
(1) Taxable bonds. In the case of a bond (other than a bond the
interest on which is excludable from gross income), the amount of the
amortizable bond premium for the taxable year shall be allowed as a
deduction.
(2) Tax-exempt bonds. In the case of any bond the interest on which
is excludable from gross income, no deduction shall be allowed for the
amortizable bond premium for the taxable year.
(3) Cross reference. For adjustment to basis on account of
amortizable bond premium, see section 1016(a)(5).
(b) Amortizable bond premium.

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(1) Amount of bond premium. For purposes of paragraph (2), the amount of
bond premium, in the case of the holder of any bond, shall be determined
(A) with reference to the amount of the basis (for determining loss on
sale or exchange) of such bond,
(B)(i) with reference to the amount payable on maturity or on earlier
call date, in the case of any bond other than a bond to which clause (ii)
applies, or and [sic]
(ii) with reference to the amount payable on maturity (or if it results
in a smaller amortizable bond premium attributable to the period to earlier
call date, with reference to the amount payable on earlier call date), in the
case of any bond described in subsection (a)(1) which is acquired after
December 31, 1957, and
(C) with adjustments proper to reflect unamortized bond premium,
with respect to the bond, for the period before the date as of which subsection
(a) becomes applicable with respect to the taxpayer with respect to such
bond.
In no case shall the amount of bond premium on a convertible bond include
any amount attributable to the conversion features of the bond.
(2) Amount amortizable. The amortizable bond premium of the taxable year
shall be the amount of the bond premium attributable to such year. . . .
*

*

*

(e) Treatment as offset to interest payments.
regulations, in the case of any taxable bond

Except as provided in

(1) the amount of any bond premium shall be allocated among the
interest payments on the bond under rules similar to the rules of subsection
(b)(3), and
(2) in lieu of any deduction under subsection (a), the amount of any
premium so allocated to any interest payment shall be applied against (and
operate to reduce) the amount of such interest payment.
For purposes of the preceding sentence, the term “taxable bond” means any
bond the interest of which is not excludable from gross income.

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Section 1012 of the IRC contains the provisions for basis of property, and provides:
The basis of property shall be the cost of such property, except as otherwise
provided in this subchapter and subchapters C (relating to corporate distributions and
adjustments), K (relating to partners and partnerships), and P (relating to capital
gains and losses). . . .
Section 1016 of the IRC contains the provisions for adjustment to basis, and provides, in
part:
(a) General rule. Proper adjustment in respect of the property shall in all
cases be made
*

*

*

(5) in the case of any bond (as defined in section 171(d)) the interest on
which is wholly exempt from the tax imposed by this subtitle, to the extent of the
amortizable bond premium disallowable as a deduction pursuant to section 171(a)(2),
and in the case of any other bond (as defined in section 171(d)) to the extent of the
deductions allowable pursuant to section 171(a)(1) (or the amount applied to reduce
interest payments under section 171(e)(2)) with respect thereto;
Opinion
Pursuant to section 1012 of the IRC, when a premium is paid to buy a bond, the premium
is part of the basis of the bond. If the bond yields taxable interest, section 171(a)(1) of the IRC
allows a taxpayer a deduction for the amortizable bond premium for the taxable year. Section
171(e) of the IRC provides that the amount of the bond premium is allocated among the interest
payments on the bond, and in lieu of a deduction, the amount of the premium allocated to any
interest payment is allowed as an offset to the interest payments. This reduces the amount of interest
income otherwise includible in federal gross income. When a taxpayer amortizes the bond premium
over the life of the bond, the basis of the bond is correspondingly reduced by the amount of the
amortized bond premium pursuant to section 1016(a)(5) of the IRC. If the bond yields tax exempt
interest, a taxpayer must amortize the premium. However, section 171(a)(2) of the IRC provides
that this amortized amount is not allowed as a deduction in determining taxable income for the
taxable year. Further, each year the basis in the bond must be reduced by the amortization for the
year.
Pursuant to section 612(b)(1) of the Tax Law, a taxpayer is required to add to his federal
adjusted gross income interest income attributable to municipal bonds of other states that are exempt
for federal income tax purposes. No deduction is allowed in determining New York adjusted gross
income for the amortizable bond premium not deductible in determining federal adjusted gross
income unless the premium is attributable to a trade or business carried on by the taxpayer.

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However, pursuant to section 613 of the Tax Law, a resident individual is allowed a New York
standard deduction unless the taxpayer elects to deduct his or her New York itemized deduction
pursuant to section 615 of the Tax Law. If federal taxable income is determined by itemizing
deductions, section 615(d)(3) of the Tax Law allows taxpayers to increase the amount of federal
itemized deductions for amortizable bond premiums for the taxable year on any bond the interest
on which is subject to New York State personal income tax to the extent the premiums are not
deductible in determining federal adjusted gross income and are not subtracted from federal adjusted
gross income in determining New York adjusted gross income. Unlike section 612(c)(10) of the Tax
Law, the New York itemized deduction allowed pursuant to section 615(d)(3) of the Tax Law does
not require that the premium be attributable to a trade or business carried on by the taxpayer.
In this case, since Petitioner did not elect to deduct his New York itemized deduction
pursuant to section 615 of the Tax Law in determining his New York taxable income for tax
year 1999, no deduction is allowed pursuant to section 615(d)(3) of the Tax Law. Further, since the
premium paid is not attributable to a trade or business carried on by Petitioner, no deduction is
allowed in computing New York adjusted gross income pursuant to section 612(c)(10) of the Tax
Law for the amortizable bond premium for the municipal bonds of other states.

DATED: June 11, 2003

NOTE:

/s/
Jonathan Pessen
Tax Regulations Specialist IV
Technical Services Division

The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.