Publication 550 |
2000 Tax Year |
Interest Income
Words you may need to know (see Glossary):
- Accrual method
- Below-market loan
- Cash method
- Demand loan
- Forgone interest
- Gift loan
- Interest
- Nominee
- Original issue discount
- Private activity bond
- Term loan
This section discusses the tax treatment of different types of
interest income.
In general, any interest that you receive or that is credited to
your account and can be withdrawn is taxable income. (It does not have
to be entered in your passbook.) Exceptions to this rule are discussed
later.
Form
1099-INT.
Interest income is generally reported to you on Form
1099-INT, or a similar statement, by banks, savings and loans,
and other payers of interest. This form shows you the interest you
received during the year. Keep this form for your records. You do not
have to attach it to your tax return.
Report on your tax return the total amount of interest income that
you receive for the tax year. This includes amounts reported to you on
Form 1099-INT and amounts for which you did not receive a Form
1099-INT.
Nominees.
Generally, if someone receives interest as a nominee for you, that
person will give you a Form 1099-INT showing the interest
received on your behalf.
If you receive a Form 1099-INT that includes amounts
belonging to another person, see the discussion on nominee
distributions, later, under How To Report Interest Income.
Incorrect amount.
If you receive a Form 1099-INT that shows an incorrect amount
(or other incorrect information), you should ask the issuer for a
corrected form. The new Form 1099-INT you receive will be marked
"CORRECTED."
Form 1099-OID.
Reportable interest income may also be shown on Form
1099-OID, Original Issue Discount. For more
information about amounts shown on this form, see Original Issue
Discount (OID), later in this chapter. Exempt-interest dividends.
Exempt-interest dividends you receive from a regulated investment
company (mutual fund) are not included in your taxable income.
(However, see Information-reporting requirement, next.) You
will receive a notice from the mutual fund telling you the amount of
the exempt-interest dividends that you received. Exempt-interest
dividends are not shown on Form 1099-DIV or Form 1099-INT.
Information-reporting requirement.
Although exempt-interest dividends are not taxable, you must show
them on your tax return if you have to file. This is an
information-reporting requirement and does not change the
exempt-interest dividends to taxable income. See How To Report
Interest Income, later.
Note.
Exempt-interest dividends paid from specified private activity
bonds may be subject to the alternative minimum tax. See Form 6251 and
its instructions for more information about this tax. (Private
activity bonds are discussed later under State or Local
Government Obligations.)
Interest on VA dividends.
Interest on insurance dividends that you leave on deposit with the
Department of Veterans Affairs (VA) is not taxable. This includes
interest paid on dividends on converted United States Government Life
Insurance policies and on National Service Life Insurance policies.
Individual retirement arrangements (IRAs).
Interest on a Roth IRA or education IRA generally is not taxable.
Interest on a traditional IRA is tax deferred. You generally do not
include it in your income until you make withdrawals from the IRA. See
Publication 590
for more information.
Taxable Interest -- General
Taxable interest includes interest you receive from bank accounts,
loans you make to others, and other sources. The following are some
sources of taxable interest.
Dividends that are actually interest.
Certain distributions commonly called dividends are actually
interest. You must report as interest so-called "dividends" on
deposits or on share accounts in:
- Cooperative banks,
- Credit unions,
- Domestic building and loan associations,
- Domestic savings and loan associations,
- Federal savings and loan associations, and
- Mutual savings banks.
Money market funds.
Generally, amounts you receive from money market funds should be
reported as dividends, not as interest.
Money market certificates, savings certificates, and other
deferred interest accounts.
If you open any of these accounts, interest may be paid at fixed
intervals of 1 year or less during the term of the account. You
generally must include this interest in your income when you actually
receive it or are entitled to receive it without paying a substantial
penalty. The same is true for accounts that mature in 1 year or less
and pay interest in a single payment at maturity. If interest is
deferred for more than 1 year, see Original Issue Discount (OID),
later.
Interest subject to penalty for early withdrawal.
If you withdraw funds from a deferred interest account before
maturity, you may have to pay a penalty. You must report the total
amount of interest paid or credited to your account during the year,
without subtracting the penalty. See Penalty on early withdrawal
of savings under How To Report Interest Income,
later, for more information on how to report the interest and
deduct the penalty.
Money borrowed to invest in money market certificate.
The interest you pay on money borrowed from a bank or savings
institution to meet the minimum deposit required for a money market
certificate from the institution and the interest you earn on the
certificate are two separate items. You must report the total interest
you earn on the certificate in your income. If you itemize deductions,
you can deduct the interest you pay as investment interest, up to the
amount of your net investment income. See Interest Expenses
in chapter 3.
Example.
You deposited $5,000 with a bank and borrowed $5,000 from the bank
to make up the $10,000 minimum deposit required to buy a 6-month
money market certificate. The certificate earned $575 at maturity in
2000, but you received only $265, which represented the $575 you
earned minus $310 interest charged on your $5,000 loan. The bank gives
you a Form 1099-INT for 2000 showing the $575 interest you
earned. The bank also gives you a statement showing that you paid $310
interest for 2000. You must include the $575 in your income. If you
itemize your deductions on Schedule A (Form 1040), you can deduct
$310, subject to the net investment income limit.
Gift for opening account.
If you receive noncash gifts or services for making deposits or for
opening an account in a savings institution, you may have to report
the value as interest.
For deposits of less than $5,000, gifts or services valued at more
than $10 must be reported as interest. For deposits of $5,000 or more,
gifts or services valued at more than $20 must be reported as
interest. The value is determined by the cost to the financial
institution.
Example.
You open a savings account at your local bank and deposit $800. The
account earns $20 interest. You also receive a $15 calculator. If no
other interest is credited to your account during the year, the Form
1099-INT you receive will show $35 interest for the year. You
must report $35 interest income on your tax return.
Interest on insurance dividends.
Interest on insurance dividends left on deposit with an insurance
company that can be withdrawn annually is taxable to you in the year
it is credited to your account. However, if you can withdraw it only
on the anniversary date of the policy (or other specified date), the
interest is taxable in the year that date occurs.
Prepaid insurance premiums.
Any increase in the value of prepaid insurance premiums, advance
premiums, or premium deposit funds is interest if it is applied to the
payment of premiums due on insurance policies or made available for
you to withdraw.
U.S. obligations.
Interest on U.S. obligations, such as U.S. Treasury bills, notes
and bonds, issued by any agency or instrumentality of the United
States is taxable for federal income tax purposes.
Interest on tax refunds.
Interest you receive on tax refunds is taxable income.
Interest on condemnation award.
If the condemning authority pays you interest to compensate you for
a delay in payment of an award, the interest is taxable.
Installment sale payments.
If a contract for the sale or exchange of property provides for
deferred payments, it also usually provides for interest payable with
the deferred payments. That interest is taxable when you receive it.
If little or no interest is provided for in a deferred payment
contract, part of each payment may be treated as interest. See
Unstated Interest in Publication 537.
Interest on annuity contract.
Accumulated interest on an annuity contract you sell before its
maturity date is taxable.
Usurious interest.
Usurious interest is interest charged at an illegal rate. This
interest is taxable unless state law automatically changes it to a
payment on the principal.
Interest income on frozen deposits.
Exclude from your gross income interest on frozen deposits. A
deposit is frozen if, at the end of the year, you cannot withdraw any
part of the deposit because:
- The financial institution is bankrupt or insolvent, or
- The state in which the institution is located has placed
limits on withdrawals because other financial institutions in the
state are bankrupt or insolvent.
The amount of interest you must exclude is the interest that was
credited on the frozen deposits minus the sum of:
- The net amount you withdrew from these deposits during the
year, and
- The amount you could have withdrawn as of the end of the
year (not reduced by any penalty for premature withdrawals of a time
deposit).
If you receive a Form 1099-INT for interest income on
deposits that were frozen at the end of 2000, see Frozen deposits
under How To Report Interest Income for information
about reporting this interest income exclusion on your 2000 tax
return.
The interest you exclude must be reported in the later tax year
when you can withdraw it from your account.
Example.
$100 of interest was credited on your frozen deposit during the
year. You withdrew $80 but could not withdraw any more as of the end
of the year. You must include $80 in your income for the year. You
must exclude $20.
Bonds traded flat.
If you buy a bond when interest has been defaulted or when the
interest has accrued but has not been paid, that interest is not
income and is not taxable as interest if paid later. When you receive
a payment of that interest, it is a return of capital that reduces the
remaining cost basis. Interest that accrues after the date of
purchase, however, is taxable interest income for the year received or
accrued. See Bonds Sold Between Interest Dates, later in
this chapter. Below-Market Loans
If you make a below-market gift or demand loan, you must report as
interest income any forgone interest (defined later) from that loan.
The below-market loan rules and exceptions are described in this
section. For more information, see section 7872 of the Internal
Revenue Code and its regulations.
If you receive a below-market loan, you may be able to deduct the
forgone interest, as well as any interest that you actually paid, but
not if it is personal interest.
Loans subject to the rules.
The rules for below-market loans apply to:
- Gift loans,
- Pay-related loans,
- Corporation-shareholder loans,
- Tax avoidance loans, and
- Loans to qualified continuing care facilities (made after
October 11, 1985) under a continuing care contract.
A pay-related loan is any below-market loan between an employer and
an employee or between an independent contractor and a person for whom
the contractor provides services.
A tax avoidance loan is any below-market loan where the avoidance
of federal tax is one of the main purposes of the interest
arrangement.
Forgone interest.
For any period, forgone interest is:
- The amount of interest that would be payable for that period
if interest accrued on the loan at the applicable federal rate and was
payable annually on December 31, minus
- Any interest actually payable on the loan for the
period.
Applicable federal rate.
Applicable federal rates are published by the IRS each month in the
Internal Revenue Bulletin. You can also contact the IRS to
get these rates. See chapter 5
for the telephone number to call.
Rules for below-market loans.
The rules that apply to a below-market loan depend on whether the
loan is a gift loan, demand loan, or term loan.
Gift and demand loans.
A gift loan is any below-market loan where the forgone interest is
in the nature of a gift.
A demand loan is a loan payable in full at any time upon demand by
the lender. A demand loan is a below-market loan if no interest is
charged or if interest is charged at a rate below the applicable
federal rate.
A demand loan or gift loan that is a below-market loan is generally
treated as an arm's-length transaction in which the lender is treated
as having made:
- A loan to the borrower in exchange for a note that requires
the payment of interest at the applicable federal rate, and
- An additional payment to the borrower in an amount equal to
the forgone interest.
The borrower is generally treated as transferring the
additional payment back to the lender as interest. The lender must
report that amount as interest income.
The lender's additional payment to the borrower is treated as a
gift, dividend, contribution to capital, pay for services, or other
payment, depending on the substance of the transaction. The borrower
may have to report this payment as taxable income, depending on its
classification.
These transfers are considered to occur annually, generally on
December 31.
Term loans.
A term loan is any loan that is not a demand loan. A term loan is a
below-market loan if the amount of the loan is more than the present
value of all payments due under the loan.
A lender who makes a below-market term loan other than a gift loan
is treated as transferring an additional lump-sum cash payment to the
borrower (as a dividend, contribution to capital, etc.) on the date
the loan is made. The amount of this payment is the amount of the loan
minus the present value, at the applicable federal rate, of all
payments due under the loan. An equal amount is treated as original
issue discount (OID). The lender must report the annual part of the
OID as interest income. The borrower may be able to deduct the OID as
interest expense. See Original Issue Discount (OID), later.
Exceptions to the below-market loan rules.
Exceptions to the below-market loan rules are discussed here.
Exception for loans of $10,000 or less.
The rules for below-market loans do not apply to any day on which
the total outstanding amount of loans between the borrower and lender
is $10,000 or less. This exception applies only to:
- Gift loans between individuals if the gift loan is not
directly used to buy or carry income-producing assets, and
- Pay-related loans or corporation-shareholder loans if the
avoidance of federal tax is not a principal purpose of the interest
arrangement.
This exception does not apply to a term loan described in (2) above
that previously has been subject to the below-market loan rules. Those
rules will continue to apply even if the outstanding balance is
reduced to $10,000 or less.
Age exception for loans to continuing care facilities.
Loans to qualified continuing care facilities under continuing care
contracts are not subject to the rules for below-market loans for the
calendar year if the lender or the lender's spouse is 65 or older at
the end of the year. For 2000, this exception applies only to the part
of the total outstanding loan balance that is $139,700 or less.
Exception for loans without significant tax effect.
Loans are excluded from the below-market loan rules if their
interest arrangements do not have a significant effect on the federal
tax liability of the borrower or the lender. These loans include:
- Loans made available by the lender to the general public on
the same terms and conditions that are consistent with the lender's
customary business practice,
- Loans subsidized by a federal, state, or municipal
government that are made available under a program of general
application to the public,
- Certain employee-relocation loans,
- Certain loans from a foreign person, unless the interest
income would be effectively connected with the conduct of a U.S. trade
or business and would not be exempt from U.S. tax under an income tax
treaty,
- Gift loans to a charitable organization, contributions to
which are deductible, if the total outstanding amount of loans between
the organization and lender is $250,000 or less at all times during
the tax year, and
- Other loans on which the interest arrangement can be shown
to have no significant effect on the federal tax liability of the
lender or the borrower.
For a loan described in (6) above, all the facts and circumstances
are used to determine if the interest arrangement has a significant
effect on the federal tax liability of the lender or borrower. Some
factors to be considered are:
- Whether items of income and deduction generated by the loan
offset each other,
- The amount of these items,
- The cost to you of complying with the below-market loan
rules, if they were to apply, and
- Any reasons other than taxes for structuring the transaction
as a below-market loan.
If you structure a transaction to meet this exception, and one of
the principal purposes of structuring the transaction in that way is
the avoidance of federal tax, the loan will be considered a
tax-avoidance loan and this exception will not apply.
Limit on forgone interest for gift loans of $100,000 or less.
For gift loans between individuals, if the outstanding loans
between the lender and borrower total $100,000 or less, the forgone
interest to be included in income by the lender and deducted by the
borrower is limited to the amount of the borrower's net investment
income for the year. If the borrower's net investment income is $1,000
or less, it is treated as zero. This limit does not apply to a loan if
the avoidance of federal tax is one of the main purposes of the
interest arrangement.
Effective dates.
These rules apply to term loans made after June 6, 1984, and to
demand loans outstanding after that date.
U.S. Savings Bonds
This section provides tax information on U.S. savings bonds. It
explains how to report the interest income on these bonds and how to
treat transfers of these bonds.
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For other information on these notes and bonds, call the Bureau of
the Public Debt at (202) 874-4000, or write to the
following address.
Bureau of the Public Debt
Attn: Customer Information
P.O. Box 1328
Parkersburg, WV 26106-1328
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Or, on the Internet, visit:
www.publicdebt.treas.gov
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Accrual method taxpayers.
If you use an accrual method of accounting, you must report
interest on U.S. savings bonds each year as it accrues. You cannot
postpone reporting interest until you receive it or until the bonds
mature.
Cash method taxpayers.
If you use the cash method of accounting, as most individual
taxpayers do, you generally report the interest on U.S. savings bonds
when you receive it. But see the discussion of Series EE and
series I bonds, below.
Series HH bonds.
These bonds are issued at face value. Interest is paid twice a year
by direct deposit to your bank account. If you are a cash method
taxpayer, you must report interest on these bonds as income in the
year you receive it.
Series HH bonds were first offered in 1980. Before 1980,
series H bonds were issued. Series H bonds are treated the
same as series HH bonds. If you are a cash method taxpayer, you must
report the interest when you receive it.
Series H bonds have a maturity period of 30 years. Series HH bonds
mature in 20 years.
Series EE and series I bonds.
Interest on these bonds is payable when you redeem the bonds. The
difference between the purchase price and the redemption value is
taxable interest.
Series EE bonds were first offered in July 1980. They have a
maturity period of 30 years. Before July 1980, series E bonds
were issued. The original 10-year maturity period of series E
bonds has been extended to 40 years for bonds issued before December
1965 and 30 years for bonds issued after November 1965. Series EE and
series E bonds are issued at a discount. The face value is payable to
you at maturity.
Series I bonds were first offered in 1998. These are
inflation-indexed bonds issued at their face amount with a maturity
period of 30 years. The face value plus accrued interest is payable to
you at maturity.
If you use the cash method of reporting income, you can report the
interest on series EE, series E, and series I bonds in either of the
following ways.
- Method 1. Postpone reporting the interest until
the earlier of the year you cash or dispose of the bonds or the year
in which they mature. (However, see Savings bonds traded,
later.) Note. Series E bonds issued in 1960 and 1970
matured in 2000. If you have used method 1, you generally must report
the interest on these bonds on your 2000 return.
- Method 2. Choose to report the increase in
redemption value as interest each year.
You must use the same method for all series EE, series E, and
series I bonds you own. If you do not choose method 2 by reporting the
increase in redemption value as interest each year, you must use
method 1.
If you plan to cash your bonds in the same year that you will pay
for higher educational expenses, you may want to use method 1 because
you may be able to exclude the interest from your income. To learn
how, see Education Savings Bond Program, later.
Change from method 1.
If you want to change your method of reporting the interest from
method 1 to method 2, you can do so without permission from the IRS.
In the year of change you must report all interest accrued to date and
not previously reported for all your bonds.
Once you choose to report the interest each year, you must continue
to do so for all series EE, series E, and series I bonds you own and
for any you get later, unless you request permission to change, as
explained next.
Change from method 2.
To change from method 2 to method 1, you must request permission
from the IRS. Permission for the change is automatically granted if
you send the IRS a statement that meets all the following
requirements.
- You have typed or printed at the top, "Change in
Method of Accounting Under Section 6.01 of the Appendix of Rev. Proc.
99-49" (or later update).
- It includes your name and social security number under the
label in (1).
- It identifies the savings bonds for which you are requesting
this change.
- It includes your agreement to:
- Report all interest on any bonds acquired during or after
the year of change when the interest is realized upon disposition,
redemption, or final maturity, whichever is earliest, and
- Report all interest on the bonds acquired before the year of
change when the interest is realized upon disposition, redemption, or
final maturity, whichever is earliest, with the exception of the
interest reported in prior tax years.
- It includes your signature.
You must attach this statement to your tax return for the year
of change, which you must file by the due date (including extensions).
You can have an automatic extension of 6 months from the due date
of your return (including extensions) to file the statement with an
amended return. To get this extension, you must have filed your
original return by the due date (including extensions). At the top of
the statement, write "Filed Pursuant to Reg.
301.9100-2."
By the date you file the original statement, you must also send a
copy to the address below.
Commissioner of Internal Revenue
Attention: CC:DOM:IT&A (Automatic Rulings Branch)
P.O. Box 7604
Benjamin Franklin Station
Washington, DC 20044.
If you use a private delivery service, send the copy to the
Commissioner of Internal Revenue, Attention: CC:DOM:IT&A
(Automatic Rulings Branch), 1111 Constitution Avenue, NW, Washington,
DC 20224.
Instead of filing this statement, you can request permission to
change from method 2 to method 1 by filing Form 3115. In
that case, follow the form instructions for an automatic change. No
user fee is required.
Co-owners.
If a U.S. savings bond is issued in the names of co-owners, such as
you and your child or you and your spouse, interest on the bond is
generally taxable to the co-owner who bought the bond.
Table 1-2 Who Pays Tax on U.S. Savings Bond Interest
One co-owner's funds used.
If you used your funds to buy the bond, you must pay the tax on the
interest. This is true even if you let the other co-owner redeem the
bond and keep all the proceeds. Under these circumstances, since the
other co-owner will receive a Form 1099-INT at the time of
redemption, the other co-owner must provide you with another Form
1099-INT showing the amount of interest from the bond that is
taxable to you. The co-owner who redeemed the bond is a "nominee."
See Nominee distributions under How To Report Interest
Income, later, for more information about how a person who is a
nominee reports interest income belonging to another person.
Both co-owners' funds used.
If you and the other co-owner each contribute part of the bond's
purchase price, the interest is generally taxable to each of you, in
proportion to the amount each of you paid.
Community property.
If you and your spouse live in a community property state and hold
bonds as community property, one-half of the interest is considered
received by each of you. If you file separate returns, each of you
generally must report one-half of the bond interest. For more
information about community property, see Publication 555,
Community Property.
Table 1-2.
These rules are also shown in Table 1-2.
Child as only owner.
Interest on U.S. savings bonds bought for and registered only in
the name of your child is income to your child, even if you paid for
the bonds and are named as beneficiary. If the bonds are series EE,
series E, or series I bonds, the interest on the bonds is income to
your child in the earlier of the year the bonds are cashed or disposed
of or the year the bonds mature, unless your child chooses to report
the interest income each year.
Choice to report interest each year.
The choice to report the accrued interest each year can be made
either by your child or by you for your child. This choice is made by
filing an income tax return that shows all the interest earned to
date, and by stating on the return that your child chooses to report
the interest each year. Either you or your child should keep a copy of
this return.
Unless your child is otherwise required to file a tax return for
any year after making this choice, your child does not have to file a
return only to report the annual accrual of U.S. savings bond interest
under this choice. However, see Tax on investment income of a
child under age 14, earlier, under General Information.
Neither you nor your child can change the way you report the interest
unless you request permission from the IRS, as discussed earlier under
Change from method 2.
Ownership transferred.
If you bought series E, series EE, or series I bonds entirely
with your own funds and had them reissued in your co-owner's
name or beneficiary's name alone, you must include in your gross
income for the year of reissue all interest that you earned on these
bonds and have not previously reported. But, if the bonds were
reissued in your name alone, you do not have to report the interest
accrued at that time.
This same rule applies when bonds (other than bonds held as
community property) are transferred between spouses or incident to
divorce.
Example.
You bought series EE bonds entirely with your own funds. You did
not choose to report the accrued interest each year. Later, you
transfer the bonds to your former spouse under a divorce agreement.
You must include the deferred accrued interest, from the date of the
original issue of the bonds to the date of transfer, in your income in
the year of transfer. Your former spouse includes in income the
interest on the bonds from the date of transfer to the date of
redemption.
Purchased jointly.
If you and a co-owner each contributed funds to buy series E,
series EE, or series I bonds jointly and later have the
bonds reissued in the co-owner's name alone, you must include in your
gross income for the year of reissue your share of all the interest
earned on the bonds that you have not previously reported. At the time
of reissue, the former co-owner does not have to include in gross
income his or her share of the interest earned that was not reported
before the transfer. This interest, however, as well as all interest
earned after the reissue, is income to the former co-owner.
This income-reporting rule also applies when the bonds are reissued
in the name of your former co-owner and a new co-owner. But the new
co-owner will report only his or her share of the interest earned
after the transfer.
If bonds that you and a co-owner bought jointly are
reissued to each of you separately in the same proportion as your
contribution to the purchase price, neither you nor your co-owner has
to report at that time the interest earned before the bonds were
reissued.
Example 1.
You and your spouse each spent an equal amount to buy a $1,000
series EE savings bond. The bond was issued to you and your spouse as
co-owners. You both postpone reporting interest on the bond. You later
have the bond reissued as two $500 bonds, one in your name and one in
your spouse's name. At that time neither you nor your spouse has to
report the interest earned to the date of reissue.
Example 2.
You bought a $1,000 series EE savings bond entirely with your own
funds. The bond was issued to you and your spouse as co-owners. You
both postponed reporting interest on the bond. You later have the bond
reissued as two $500 bonds, one in your name and one in your spouse's
name. You must report half the interest earned to the date of reissue.
Transfer to a trust.
If you own series E, series EE, or series I bonds and transfer them
to a trust, giving up all rights of ownership, you must include in
your income for that year the interest earned to the date of transfer
if you have not already reported it. However, if you are considered
the owner of the trust and if the increase in value both before and
after the transfer continues to be taxable to you, you can continue to
defer reporting the interest earned each year. You must include the
total interest in your income in the year you cash or dispose of the
bonds or the year the bonds finally mature, whichever is earlier.
The same rules apply to previously unreported interest on series EE
or series E bonds if the transfer to a trust consisted of series HH or
series H bonds you acquired in a trade for the series EE or series E
bonds. See Savings bonds traded, later.
Decedents.
The manner of reporting interest income on series E, series EE, or
series I bonds, after the death of the owner, depends on the
accounting and income-reporting method previously used by the
decedent.
Decedent who reported interest each year.
If the bonds transferred because of death were owned by a person
who used an accrual method, or who used the cash method and had chosen
to report the interest each year, the interest earned in the year of
death up to the date of death must be reported on that person's final
return. The person who acquires the bonds includes in income only
interest earned after the date of death.
Decedent who postponed reporting interest.
If the transferred bonds were owned by a decedent who had used the
cash method and had not chosen to report the interest each year, and
who had bought the bonds entirely with his or her own funds, all
interest earned before death must be reported in one of the following
ways.
- The surviving spouse or personal representative (executor,
administrator, etc.) who files the final income tax return of the
decedent can choose to include on that return all of the interest
earned on the bonds before the decedent's death. The person who
acquires the bonds then includes in income only interest earned after
the date of death.
- If the choice in (1) is not made, the interest earned up to
the date of death is income in respect of the decedent. It should not
be included in the decedent's final return. All of the interest earned
both before and after the decedent's death is income to the person who
acquires the bonds. If that person uses the cash method and does not
choose to report the interest each year, he or she can postpone
reporting it until the year the bonds are cashed or disposed of or the
year they mature, whichever is earlier. In the year that person
reports the interest, he or she can claim a deduction for any federal
estate tax that was paid on the part of the interest included in the
decedent's estate.
For more information on income in respect of a decedent, see
Publication 559,
Survivors, Executors, and Administrators.
Example 1.
Your uncle, a cash method taxpayer, died and left you a $1,000
series EE bond. He had bought the bond for $500 and had not chosen to
report the interest each year. At the date of death, interest of $200
had accrued on the bond and its value of $700 was included in your
uncle's estate. Your uncle's executor chose not to include the $200
accrued interest in your uncle's final income tax return. The $200 is
income in respect of the decedent.
You are a cash method taxpayer and do not choose to report the
interest each year as it is earned. If you cash the bond when it
reaches maturity value of $1,000, you report $500 interest
income--the difference between maturity value of $1,000 and the
original cost of $500. For that year, you can deduct (as a
miscellaneous itemized deduction not subject to the 2%-of-adjusted-
gross-income limit) any federal estate tax paid because the $200
interest was included in your uncle's estate.
Example 2.
If, in Example 1, the executor had chosen to include the
$200 accrued interest in your uncle's final return, you would report
only $300 as interest when you cashed the bond at maturity. $300 is
the interest earned after your uncle's death.
Example 3.
If, in Example 1, you make or have made the choice to
report the increase in redemption value as interest each year, you
include in gross income for the year you acquire the bond all of the
unreported increase in value of all series E, series EE, and series I
bonds you hold, including the $200 on the bond you inherited from your
uncle.
Example 4.
When your aunt died, she owned series H bonds that she had acquired
in a trade for series E bonds. You were the beneficiary of these
bonds. Your aunt used the cash method and did not choose to report the
interest on the series E bonds each year as it accrued. Your aunt's
executor chose not to include any interest earned before your aunt's
death on her final return.
The income in respect of the decedent is the sum of the unreported
interest on the series E bonds and the interest, if any, payable on
the series H bonds but not received as of the date of your aunt's
death. You must report any interest received during the year as income
on your return. The part of the interest that was payable but not
received before your aunt's death is income in respect of the decedent
and may qualify for the estate tax deduction. For information on when
to report the interest on the series E bonds traded, see Savings
bonds traded, later.
Savings bonds distributed from a retirement or profit-sharing
plan.
If you acquire a U.S. savings bond in a taxable distribution from a
retirement or profit-sharing plan, your income for the year of
distribution includes the bond's redemption value (its cost plus the
interest accrued before the distribution). When you redeem the bond
(whether in the year of distribution or later), your interest income
includes only the interest accrued after the bond was distributed. To
figure the interest reported as a taxable distribution and your
interest income when you redeem the bond, see Worksheet for
savings bonds distributed from a retirement or profit-sharing plan
under How To Report Interest Income, later.
Savings bonds traded.
If you postponed reporting the interest on your series EE or series
E bonds, you did not recognize taxable income when you traded the
bonds for series HH or series H bonds, unless you received cash in the
trade. (You cannot trade series I bonds for series HH bonds.) Any cash
you received is income up to the amount of the interest earned on the
bonds traded. When your series HH or series H bonds mature, or if you
dispose of them before maturity, you report as interest the difference
between their redemption value and your cost. Your cost is the sum of
the amount you paid for the traded series EE or series E bonds plus
any amount you had to pay at the time of the trade.
Example 1.
You own series E bonds with accrued interest of $523 and a
redemption value of $2,723 and have postponed reporting the interest.
You trade the bonds for $2,500 in series HH bonds and $223 in cash.
You must report the $223 as taxable income in the year of the trade.
Example 2.
The facts are the same as in Example 1. You hold the
series HH bonds until maturity, when you receive $2,500. You must
report $300 as interest income in the year of maturity. This is the
difference between their redemption value, $2,500, and your cost,
$2,200 (the amount you paid for the series E bonds). (It is also the
difference between the accrued interest of $523 on the series E bonds
and the $223 cash received on the trade.)
Choice to report interest in year of trade.
You can choose to treat all of the previously unreported accrued
interest on series EE or series E bonds traded for series HH bonds as
income in the year of the trade. If you make this choice, it is
treated as a change from method 1. See Change from method 1
under Series EE and series I bonds, earlier.
Form 1099-INT for U.S. savings bond interest.
When you cash a bond, the bank or other payer that redeems it must
give you a Form 1099-INT if the interest part of the payment you
receive is $10 or more. Box 3 of your Form 1099-INT should show
the interest as the difference between the amount you received and the
amount paid for the bond. However, your Form 1099-INT may show
more interest than you have to include on your income tax return. For
example, this may happen if any of the following are true.
- You chose to report the increase in the redemption value of
the bond each year. The interest shown on your Form 1099-INT
will not be reduced by amounts previously included in income.
- You received the bond from a decedent. The interest shown on
your Form 1099-INT will not be reduced by any interest reported
by the decedent before death, or on the decedent's final return, or by
the estate on the estate's income tax return.
- Ownership of the bond was transferred. The interest shown on
your Form 1099-INT will not be reduced by interest that accrued
before the transfer.
- You were named as a co-owner and the other co-owner
contributed funds to buy the bond. The interest shown on your Form
1099-INT will not be reduced by the amount you received as
nominee for the other co-owner. (See Co-owners, earlier in
this section, for more information about the reporting requirements.)
- You received the bond in a taxable distribution from a
retirement or profit-sharing plan. The interest shown on your Form
1099-INT will not be reduced by the interest portion of the
amount taxable as a distribution from the plan and not taxable as
interest. (This amount is generally shown on Form 1099-R,
Distributions From Pensions, Annuities, Retirement or
Profit-Sharing Plans, IRAs, Insurance Contracts, etc., for the
year of distribution.)
For more information on including the correct amount of interest on
your return, see U.S. savings bond interest previously reported
or Nominee distributions under How To Report
Interest Income, later.
Interest on U.S. savings bonds is exempt from state and local
taxes. The Form 1099-INT you receive will indicate the amount
that is for U.S. savings bonds interest in box 3. Do not include this
income on your state or local income tax return.
Education Savings Bond Program
You may be able to exclude from income all or part of the interest
you receive on the redemption of qualified U.S. savings bonds during
the year if you pay qualified higher educational expenses during the
same year. This exclusion is known as the Education Savings Bond
Program.
If you are married, you can qualify for this exclusion only if you
file a joint return with your spouse.
Form 8815.
Use Form 8815, Exclusion of Interest From Series EE and I U.S.
Savings Bonds Issued After 1989, to figure your exclusion.
Attach the form to your Form 1040 or Form 1040A.
Qualified U.S. savings bonds.
A qualified U.S. savings bond is a series EE bond issued after
1989 or a series I bond. The bond must be issued either in your
name (sole owner) or in your and your spouse's names (co-owners). You
must be at least 24 years old before the bond's issue date.
The date a bond is issued may be earlier than the date the bond is
purchased because bonds are issued as of the first day of the month in
which they are purchased.
Beneficiary.
You can designate any individual (including a child) as a
beneficiary of the bond.
Verification by IRS.
If you claim the exclusion, the IRS will check it by using bond
redemption information from the Department of Treasury.
Qualified expenses.
Qualified higher educational expenses are tuition and fees required
for you, your spouse, or your dependent (for whom you claim an
exemption) to attend an eligible educational institution.
Qualified expenses include any contribution you make to a qualified
state tuition program or to an education IRA. For information about
state tuition programs and education IRAs, see Publication 970,
Tax Benefits for Higher Education.
Qualified expenses do not include expenses for room and board or
for courses involving sports, games, or hobbies that are not part of a
degree program.
Eligible educational institutions.
These institutions include most public, private, and nonprofit
universities, colleges, and vocational schools that are accredited and
are eligible to participate in student aid programs run by the
Department of Education.
Reduction for certain benefits.
You must reduce your qualified higher educational expenses by
certain benefits the student may have received. These benefits
include:
- Qualified scholarships that are exempt from tax (see
Publication 520,
Scholarships and Fellowships, for
information on qualified scholarships), and
- Any other nontaxable payments (other than gifts, bequests,
or inheritances) received for educational expenses, such as:
- Veterans' educational assistance benefits,
- Benefits under a qualified state tuition program, or
- Certain employer-provided educational assistance
benefits.
Effect of other tax benefits.
Do not include in your qualified expenses any expense used to:
- Figure an education credit on Form 8863, or
- Figure how much of a distribution from an education IRA you
can exclude from your income.
For information about education credits or education IRAs, see
Publication 970.
Amount excludable.
If the total proceeds (interest and principal) from the qualified
U.S. savings bonds you redeem during the year are not more than your
qualified higher educational expenses for the year, you can exclude
all of the interest. If the proceeds are more than the expenses, you
can exclude only part of the interest.
To determine the excludable amount, multiply the interest part of
the proceeds by a fraction. The numerator (top part) of the fraction
is the qualified higher educational expenses you paid during the year.
The denominator (bottom part) of the fraction is the total proceeds
you received during the year.
Example.
In February 2000, Mark and Joan, a married couple, cashed a
qualified series EE U.S. savings bond they bought in November 1992.
They received proceeds of $7,564, representing principal of $5,000 and
interest of $2,564. In 2000, they paid $4,000 of their daughter's
college tuition. They are not claiming an education credit for that
amount, and they do not have an education IRA. They can exclude $1,356
($2,564 x ($4,000 x $7,564)) of interest in 2000. They
must pay tax on the remaining $1,208 ($2,564 - $1,356) interest.
Figuring the interest part of the proceeds ( Form 8815, line
6).
To figure the amount of interest to report on Form 8815, line 6,
use the Line 6 Worksheet in the Form 8815 instructions.
If you previously reported any interest from savings bonds cashed
during 2000, use the Alternate Line 6 Worksheet below
instead.
Alternate Line 6
Worksheet |
1. |
Enter the amount from Form 8815, line 5 |
|
2. |
Enter the face value of all post-1989 series EE
bonds cashed in 2000 |
|
3. |
Multiply line 2 above by 50% (.50) |
|
4. |
Enter the face value of all series I bonds
cashed in 2000. |
|
5. |
Add lines 3 and 4 |
|
6. |
Subtract line 5 from line 1 |
|
7. |
Enter the amount of interest reported as income
in previous years |
|
8. |
Subtract line 7 from line 6. Enter the result
here and on Form 8815, line 6 |
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Modified adjusted gross income limit.
The interest exclusion is limited if your modified adjusted gross
income (modified AGI) is:
- $54,100 to $69,100 for taxpayers filing single or head of
household, and
- $81,100 to $111,100 for married taxpayers filing jointly, or
for a qualifying widow(er) with dependent child.
You do not qualify for the interest exclusion if your modified
AGI is equal to or more than the upper limit for your filing status.
Modified AGI.
Modified AGI, for purposes of this exclusion, is adjusted gross
income (line 20 of Form 1040A or line 34 of Form 1040) figured before
the interest exclusion, and modified by adding back any:
- Foreign earned income exclusion,
- Foreign housing exclusion or deduction,
- Exclusion of income for bona fide residents of American
Samoa,
- Exclusion for income from Puerto Rico,
- Exclusion for adoption benefits received under an employer's
adoption assistance program, and
- Deduction for student loan interest.
Use the worksheet in the instructions for line 9, Form 8815, to
figure your modified AGI. If you claim any of the items (1) -
(6) listed above, add the amount of the exclusion or deduction to the
amount on line 5 of the worksheet, and enter the total on Form 8815,
line 9, as your modified AGI.
Royalties included in modified AGI.
Because the deduction for interest expenses attributable to
royalties and other investments is limited to your net investment
income (see Investment Interest in chapter 3),
you cannot
figure the deduction until you have figured this interest exclusion.
Therefore, if you had interest expenses attributable to royalties and
deductible on Schedule E (Form 1040), you must make a special
computation of your deductible interest without regard to this
exclusion to figure the net royalty income included in your modified
AGI.
You can use a "dummy" Form 4952, Investment Interest
Expense Deduction, to make the special computation. On this
form, include in your net investment income your total interest income
for the year from series EE and I U.S. savings bonds. Use the
deductible interest amount from this form only to figure your modified
AGI. Do not attach this form to your tax return.
After you figure this interest exclusion, use a separate Form 4952
to figure your actual deduction for investment interest expenses, and
attach that form to your return.
Recordkeeping.
If you claim the interest
exclusion, you must keep a written record of the qualified U.S.
savings bonds you redeem. Your record must include the serial number,
issue date, face value, and total redemption proceeds (principal and
interest) of each bond. You can use Form
8818, Optional Form To
Record Redemption of Series EE and I U.S. Savings Bonds Issued After
1989, to record this information. You should also keep bills,
receipts, canceled checks, or other documentation that shows you paid
qualified higher educational expenses during the year.
U.S. Treasury Bills,
Notes, and Bonds
Treasury bills, notes, and bonds are direct debts (obligations) of
the U.S. Government.
Interest income from Treasury bills, notes, and bonds is subject to
federal income tax, but is exempt from all state and local income
taxes. You should receive Form 1099-INT showing the amount of
interest (in box 3) that was paid to you for the year.
Payments of principal and interest generally will be credited to
your designated checking or savings account by direct deposit through
the TREASURY DIRECT system.
Treasury bills.
These bills generally have a 13-week, 26-week, or 52-week maturity
period. They are issued at a discount in the amount of $1,000 and
multiples of $1,000. The difference between the discounted price you
pay for the bills and the face value you receive at maturity is
interest income. Generally, you report this interest income when the
bill is paid at maturity. See Discount on Short-Term Obligations
under Discount on Debt Instruments, later.
If you reinvest your Treasury bill at its maturity in a new
Treasury bill, note, or bond, you will receive payment for the
difference between the proceeds of the maturing bill (par amount less
any tax withheld) and the purchase price of the new Treasury security.
However, you must report the full amount of the interest income on
each of your Treasury bills at the time it reaches maturity.
Treasury notes and bonds.
Treasury notes have maturity periods of more than 1 year, ranging
up to 10 years. Maturity periods for Treasury bonds are longer than 10
years. Both of these Treasury issues generally are issued in
denominations of $1,000 to $1 million. Both notes and bonds generally
pay interest every 6 months. Generally, you report this interest for
the year paid. When the notes or bonds mature, you can redeem these
securities for face value.
Treasury notes and bonds are usually sold by auction with
competitive bidding. If, after compiling the competitive bids, a
determination is made that the purchase price is less than the face
value, you will receive a refund for the difference between the
purchase price and the face value. This amount is considered original
issue discount. However, the original issue discount rules (discussed
later) do not apply if the discount is less than one-fourth of 1%
(.0025) of the face amount multiplied by the number of full years from
the date of original issue to maturity. See De minimis OID
under Original Issue Discount (OID), later. If the
purchase price is determined to be more than the face amount, the
difference is a premium. (See Bond Premium Amortization in
chapter 3.)
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For other information on these notes and bonds, call the Bureau of
the Public Debt at (202) 874-4000, or write to the
following address.
Bureau of the Public Debt
Attn: Customer Information
P.O. Box 1328
Parkersburg, WV 26106-1328
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Or, on the Internet, visit:
www.publicdebt.treas.gov
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Treasury Inflation-Indexed Securities.
These securities pay interest twice a year at a fixed rate, based
on a principal amount that is adjusted to take into account inflation
and deflation. For the tax treatment of these securities, see
Inflation-Indexed Debt Instruments under Original
Issue Discount (OID), later.
Retirement, sale, or redemption.
For information on the retirement, sale, or redemption of U.S.
government obligations, see Capital or Ordinary Gain or Loss
in chapter 4.
Also see Nontaxable Trades in chapter 4
for information about trading U.S. Treasury obligations for certain
other designated issues.
Bonds Sold Between Interest Dates
If you sell a bond between interest payment dates, part of the
sales price represents interest accrued to the date of sale. You must
report that part of the sales price as interest income for the year of
sale.
If you buy a bond between interest payment dates, part of the
purchase price represents interest accrued before the date of
purchase. When that interest is paid to you, treat it as a return of
your capital investment, rather than interest income, by reducing your
basis in the bond. See Accrued interest on bonds under
How To Report Interest Income, later in this chapter, for
information on reporting the payment.
Insurance
Life insurance proceeds paid to you as beneficiary of the insured
person are usually not taxable. But if you receive the proceeds in
installments, you must usually report part of each installment payment
as interest income.
For more information about insurance proceeds received in
installments, see Publication 525.
Interest option on insurance.
If you leave life insurance proceeds on deposit with an insurance
company under an agreement to pay interest only, the interest paid to
you is taxable.
Annuity.
If you buy an annuity with life insurance proceeds, the annuity
payments you receive are taxed as pension and annuity income, not as
interest income. See Publication 939,
General Rule for Pensions
and Annuities, for information on taxation of pension and
annuity income.
State or Local
Government Obligations
Interest you receive on an obligation issued by a state or local
government is generally not taxable. The issuer should be able to tell
you whether the interest is taxable. The issuer should also give you a
periodic (or year-end) statement showing the tax treatment of the
obligation. If you invested in the obligation through a trust, a fund,
or other organization, that organization should give you this
information.
Even if interest on the obligation is not subject to income tax,
you may have to report capital gain or loss when you sell it. Estate,
gift, or generation-skipping tax may also apply to other dispositions
of the obligation.
Tax-Exempt Interest
Interest on a bond used to finance government operations generally
is not taxable if the bond is issued by a state, the District of
Columbia, a U.S. possession, or any of their political subdivisions.
Political subdivisions include:
- Port authorities,
- Toll road commissions,
- Utility services authorities,
- Community redevelopment agencies, and
- Qualified volunteer fire departments (for certain
obligations issued after 1980).
There are other requirements for tax-exempt bonds. Contact the
issuing state or local government agency or see sections 103 and 141
through 150 of the Internal Revenue Code and the related regulations.
Obligations that are not bonds. Interest on a state or
local government obligation may be tax exempt even if the obligation
is not a bond. For example, interest on a debt evidenced only by an
ordinary written agreement of purchase and sale may be tax exempt.
Also, interest paid by an insurer on default by the state or political
subdivision may be tax exempt.
Registration requirement.
A bond issued after June 30, 1983, generally must be in registered
form for the interest to be tax exempt.
Indian tribal government.
Bonds issued after 1982 by an Indian tribal government are treated
as issued by a state. Interest on these bonds is generally tax exempt
if the bonds are part of an issue of which substantially all of the
proceeds are to be used in the exercise of any essential government
function. However, interest on private activity bonds (other than
certain bonds for tribal manufacturing facilities) is taxable.
Original issue discount.
Original issue discount (OID) on tax-exempt state or local
government bonds is treated as tax-exempt interest.
For information on the treatment of OID when you dispose of a
tax-exempt bond, see Tax-exempt state and local government bonds
under Discounted Debt Instruments in chapter 4.
Stripped bonds or coupons.
For special rules that apply to stripped tax-exempt obligations,
see Stripped Bonds and Coupons under Original Issue
Discount (OID), later.
Information reporting requirement.
If you must file a tax return, you are required to show any
tax-exempt interest you received on your return. This is an
information-reporting requirement only. It does not change tax-exempt
interest to taxable interest. See Reporting tax-exempt interest
under How To Report Interest Income, later in this chapter. That discussion also explains what to do if you receive a Form
1099-INT for tax-exempt interest.
Taxable Interest
Interest on some state or local obligations is taxable.
Federally guaranteed bonds.
Interest on federally guaranteed state or local obligations issued
after 1983 is generally taxable. This rule does not apply
to interest on obligations guaranteed by the following U.S. Government
agencies.
- Bonneville Power Authority (if the guarantee was under the
Northwest Power Act as in effect on July 18, 1984).
- Department of Veterans Affairs.
- Federal Home Loan Mortgage Corporation.
- Federal Housing Administration.
- Federal National Mortgage Association.
- Government National Mortgage Corporation.
- Resolution Funding Corporation.
- Student Loan Marketing Association.
Mortgage revenue bonds.
The proceeds of these bonds are used to finance mortgage loans for
homebuyers. Generally, interest on state or local government home
mortgage bonds issued after April 24, 1979, is taxable unless the
bonds are qualified mortgage bonds or qualified veterans' mortgage
bonds.
Arbitrage bonds.
Interest on arbitrage bonds issued by state or local governments
after October 9, 1969, is taxable. An arbitrage bond is a bond, any
portion of the proceeds of which is expected to be used to buy (or to
replace funds used to buy) higher yielding investments. A bond is
treated as an arbitrage bond if the issuer intentionally uses any part
of the proceeds of the issue in this manner.
Private activity bonds.
Interest on a private activity bond that is not a qualified bond
(defined below) is taxable. Generally, a private activity bond is part
of a state or local government bond issue that meets both of the
following requirements.
- More than 10% of the proceeds of the issue is to be used for
a private business use.
- More than 10% of the payment of the principal or interest
is:
- Secured by an interest in property to be used for a private
business use (or payments for this property), or
- Derived from payments for property (or borrowed money) used
for a private business use.
Also, a bond is generally considered a private activity bond if
the amount of the proceeds to be used to make or finance loans to
persons other than government units is more than 5% of the proceeds or
$5 million (whichever is less).
Qualified bond.
Interest on a private activity bond that is a qualified bond is tax
exempt. A qualified bond is an exempt-facility bond (including an
enterprise zone facility bond), qualified student loan bond, qualified
small issue bond (including a tribal manufacturing facility bond),
qualified redevelopment bond, qualified mortgage bond, qualified
veterans' mortgage bond, or qualified 501(c)(3) bond (a bond issued
for the benefit of certain tax-exempt organizations).
Interest that you receive on these tax-exempt bonds (except
qualified 501(c)(3) bonds), if issued after August 7, 1986, generally
is a "tax preference item" and may be subject to the alternative
minimum tax. See Form 6251 and its instructions for more information.
Enterprise zone facility bonds.
Interest on certain private activity bonds issued by a state or
local government to finance a facility used in an empowerment zone or
enterprise community is tax exempt. For information on these bonds,
see Publication 954.
Market discount.
Market discount on a tax-exempt bond is not tax-exempt. If you
bought the bond after April 30, 1993, you can choose to accrue the
market discount over the period you own the bond and include it in
your income currently, as taxable interest. See Market Discount
Bonds under Discount on Debt Instruments, later. If
you do not make that choice, or if you bought the bond before May 1,
1993, any gain from market discount is taxable when you dispose of the
bond.
For more information on the treatment of market discount when you
dispose of a tax-exempt bond, see Discounted Debt Instruments
under Capital or Ordinary Gain or Loss in chapter 4.
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