Graveyard Bonds

I just had an idea I'll call "the graveyard bond". It's probably not new, being pretty obvious, but it's something I think I'll actually use tonight. And it has tax advantages that are potentially of great interest on Wall Street; if nobody's using graveyard bonds, I'd be curious as to why not. The idea is to defer interest income taxation. How, I'll get to after my graveyard story.

My church is setting up a graveyard. To do so, they've set up a separate entity, with its own accounts. Non-church graveyards must, by law, set aside a certain amount of money for perpetual maintenance. Church ones in Indiana don't, but as a matter of good financial stewardship, our church wants to follow the regulations voluntarily.

The hope is that the graveyard will be self-financing, or perhaps even profitable eventually. It looks like a good business project to me. The church, however, is short of capital (the church building itself has had its extension at a halt for a couple of years because of lack of funds to finish the interior). Thus, I was asked if I'd be willing to contribute some capital--- say, $20,000---to be repaid with interest once the graveyard had the cash flow to do so.

I'm willing, and I think it is not only a good project spiritually, but financially. I probably won't ask for interest, since I donate to the church anyway and it just complicated things to earn income from the church, pay it back as a donation, and take a deduction to cancel out the income for tax purposes. But I was thinking in the car about how I'd want to arrange it if

I just had an idea I'll call "the graveyard bond". It's probably not new, being pretty obvious, but it's something I think I'll actually use tonight. And it has tax advantages that are potentially of great interest on Wall Street; if nobody's using graveyard bonds, I'd be curious as to why not. The idea is to defer interest income taxation. How, I'll get to after my graveyard story.

My church is setting up a graveyard. To do so, they've set up a separate entity, with its own accounts. Non-church graveyards must, by law, set aside a certain amount of money for perpetual maintenance. Church ones in Indiana don't, but as a matter of good financial stewardship, our church wants to follow the regulations voluntarily.

The hope is that the graveyard will be self-financing, or perhaps even profitable eventually. It looks like a good business project to me. The church, however, is short of capital (the church building itself has had its extension at a halt for a couple of years because of lack of funds to finish the interior). Thus, I was asked if I'd be willing to contribute some capital--- say, $20,000---to be repaid with interest once the graveyard had the cash flow to do so.

I'm willing, and I think it is not only a good project spiritually, but financially. I probably won't ask for interest, since I donate to the church anyway and it just complicated things to earn income from the church, pay it back as a donation, and take a deduction to cancel out the income for tax purposes. But I was thinking in the car about how I'd want to arrange it if I wanted to keep the interest.

I hate fiddly little things on my taxes, so I don't like getting monthly interest payments, or even annual ones. I'd rather get my interest in one big balloon payment at the end, compounded appropriately. That also has the advantage of deferring taxes, because then the tax on ten years' interest would be paid at the end of the tenth year, and not at nine earlier periods.

But actually, it wouldn't work to just ask for my interest to all be paid out at the tenth year. The Internal Revenue Service long ago noticed that this would defer taxes. Thus, the rule is that even if the interest is not paid out until the tenth year, taxes on its annual value must be paid annually. Thus, if a 10-year bond is $10,000 and the interest rate is 5%, to be paid out all at the end so the bondholder gets his $10,000 back plus $500*10 = $5,000 interest at the end of ten years, the bondholder must pay taxes on $500 of income each of the ten years anyway, rather than on $5,000 at the end. This actually makes economic and legal sense, because the bondholder really *is* earning $500 each year; he's just letting the graveyard hold onto it for him. For taxes, what counts is the point in time at which somebody legally owes you money, not the time when he actually pays you.

These are called "zero-coupon" bonds, because you don't clip a coupon off each year and turn it in to collect your interest as in the old days, or even just have them mail you a check each as is done now. Instead, a company might issue a bond promising to pay the holder $10,000 in 20 years, and people would buy the bond for $6,000 today, which amounts to a lump sum interest payment of $4,000 at the end.