What is the De Minimis Tax Rule?

De Minimis tax rule, when translated means about minimal things, the concept was coined from a Latin expression de minimis non-curat lex. In taxation, the De Minimis tax rule is one that determines if discounts on municipal bonds should be subject to capital gains tax or income tax.

De Minimis Tax Rule

What is de minimis?

“De minimis non-curat lex” is Latin for “about minimal things.” Anything that is considered “de minimis” can be defined as something of little significance to be of any actual importance. In business and taxes, the IRS says de minimis has a similar meaning. In business, de minimis refers to benefits that employers provide to their employees that have such little significance, and therefore they don’t need to be taxed or accounted for.

The de minimis tax rule is used to determine if discounted securities get taxed at the normal income tax rate or capital gains tax rate after price appreciation.

The de minimis tax rule says that if someone’s securities were purchased at a discount under 0.25% of its face value for multiple years from the date purchased to its current maturity, then it’s considered “de minimis” (of too little significance) to be taxed under a market discount. In this situation, individuals need to tax the price appreciation as capital gains tax.

Key Considerations for Investors

In the declining or low-interest-rate environment for the past decade, bond values have been appreciating and investors didn’t need to worry much about the De Minimis Tax Rule as the majority of debt instruments were being traded at premiums or close to their face values. However, given the recent rate hikes, the bonds have started losing value and could fall below the De Minimis Tax threshold.

Here are some things to keep in mind:

  • Investors looking to avoid paying any tax on their municipal debt investments should definitely consider premium securities. This can help to avoid having to worry about the De Minimis Tax Rule and potentially put you into a higher tax bracket because your total discount can be subject to the ordinary income tax rate.
  • Although bonds purchased at a premium will decrease your coupon returns, they will still be more predictable and avoid unforeseen tax events.
  • As the short-term interest rates are rising, the yield curve is flattening and making the longer maturities less desirable amongst fixed-income investors. Furthermore, the discounting of the longer maturities paired with the De Minimis Tax Rule could make it difficult for these bondholders to sell their holdings, thus, bringing up some liquidity issues.
What Are Not Considered De Minimis Benefits

What is a De Minimis Benefits Example?

De Minimis benefits include a variety of products or services that employers may provide to employees, and which employees are not required to claim as part of their gross income. 

Examples of De Minimis benefits that may be excluded from the employee’s gross income include occasional benefits from the following areas:

  • Meals, meal vouchers, or meal money provided to employees working overtime
  • Refreshments purchased for staff meetings or to boost team spirit in the office
  • Award luncheons or dinners for employees
  • Personal use of company-owned resources, such as printers and copiers
  • Use of a company vehicle for commuting to/from work
  • Sporting event tickets or theater tickets provided by the employer
  • Gifts for an employee’s birthday or during the holiday season
  • Group term life insurance with annual employer-paid premiums that amount to less than $2,000 per employee.

As you may notice, many of these benefits qualify as De Minimis fringe because they are administered by the employer only occasionally—not on a regular basis or as part of the employee’s agreed compensation package.

What Are Not Considered De Minimis Benefits

The following are never de minimis, according to the IRS: 

  • Cash, including cash equivalents like gift cards except for infrequent meal money to allow overtime work.
  • Season tickets to theatres or sporting events.
  • Use of the employer’s apartment, vacation home, boat, or airplane.
  • Commuting use of an employer’s vehicle more than once a month.
  • Membership in a country club or athletic facility.

Notice the use of the word “occasional” in the list of de minimis benefits. A benefit is almost never de minimis if it’s provided routinely.

Example of the De Minimis Rule

Say you are looking at a 10-year municipal bond with a par value of 100 and five years left until maturity. The de minimis discount is 100 par value x 0.0025 x 5 years = 1.25.

You then subtract the 1.25 from the par value to get the de minimis cut-off amount, which in this example is 98.75 = 100 – 1.25. This is the lowest price at which the bond can be purchased for the IRS to treat the discount as a capital gain.

In this example, If the price of the discount bond you purchased is below 98.75 per 100 of par value you will be subject to ordinary income tax under the de minimis tax rule.

So, if you purchased this bond for $95, ordinary income tax will apply when the bond is redeemed at par since $95 is less than $98.75.

Another way to look at it is the market discount of 100 – 95 = 5 is higher than the de minimis amount of 1.25. Therefore, the profit on the sale of the bond is income, not capital gains.

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