'Flower bonds' a way to ease estate taxes -- if they don't wilt

As certain issues of US Treasury bonds known as "flower bonds" mature and disappear, opportunities for significant estate-tax savings diminish. Flower bonds may be redeemed at par before their maturity date when offered in payment of federal estate taxes. Tax saving opportunities arise since the flower bonds trade at significant discounts, because of their usual 3 to 4 percent coupon rate. Thus, a bond a person may buy for $800 can be presented at par in payment of $1,000 of federal estate taxes.

A flower bond maturing in June 1983 with a coupon of 3 1/4 percent may be selling for a discount of 80. An oldster's estate planner looking ahead to the payment of federal estate taxes could buy 10 bonds for $8,000, ignoring commissions. Later, say in 1981, the 10 bonds could be used to pay off $10,000 due in estate taxes. Instead of maturing in 1983, the full value is available in 1981, but only for payment of estate taxes.

Changes in the tax law passed in 1976 imposed new rules for flower bonds and required the payment of capital-gain taxes on the difference between the cost basis and par -- or $2,000 in the example above. This requirement was removed as part of the 1980 Windfall Profits Act.

There is no time requirement for owning flower bonds prior to death. They may even be purchased on the day of death, and the transaction date determines the date of ownership. If the decedent should buy the flower bonds and pass on before settlement date, the bonds may still be included in the estate.

Now that the capital-gain tax on the difference between cost basis and par has been removed, interest in the bonds has picked up again. Bonds are no longer readily available, and brokers may spend days or weeks locating bonds for sale. Under these conditions of high demand and limited supply, one can expect the price to increase. The highest coupon rate payable on flower bonds is 4 1/4 percent for an issue maturing in May 1985. The advantage of buying flower bonds for an oldster's portfolio diminishes as the discount declines or the life expectancy increases. For every year one of the flower bonds is held, a loss results equivalent to the difference in coupon rate of the flower bond and the rate for some other US Treasury note or bond with a higher coupon. Thus, an uncalculable break-even point exists, and one could lose if the bonds were held several years.

In compiling the total decedent's estate, flower bonds must be included at par value for computing estate taxes. If the bonds are held in a portfolio and the owner outlives their maturity date, no estate-tax benefit results. If the bonds were bought at a discount, say 80 in the example earlier, and mature in one's portfolio, the capital gain between purchase price (cost basis) and par will be taxed like any other bond.