Taxable interest includes interest you receive from bank accounts, loans you make to others, and interest from most other sources. The following are some other 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, and interest is 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 made a deposit in a deferred interest account that has a term of 1 year or less, and you paid a penalty because you withdrew funds before the end of the term, you must include in income all the interest shown in box 1 of the Form 1099-INT you receive. You can deduct the entire penalty shown in box 2 on line 30 of Form 1040, even if it is more than your interest income.

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 of Publication 550.

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 1999, 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 1999 showing the $575 interest you earned. The bank also gives you a statement showing that you paid $310 interest for 1999. 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.
The fair market value of gifts or services you receive for making long-term deposits or for opening an account in a savings institution is interest. Report it in income in the year you receive it.

Example.
You open a savings account at your local bank. The account earns $20 interest. You also receive a $10 calculator. If no other interest is credited to your account during the year, the Form 1099-INT you receive will show $30 interest income for the year.

Interest on insurance dividends.
Interest on insurance dividends 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.

Treasury 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.

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 notes and bonds generally pay interest every 6 months. Generally, you report this interest for the year paid. For more information, see U.S. Treasury Bills, Notes, and Bonds in Publication 550.

For other information on Treasury notes or bonds, write to:
 

Bureau of the Public Debt
Attn: Customer Information
P.O. Box 1328
Parkersburg, WV 26106-1328

Or, on the Internet, visit:

www. publicdebt.treas.gov

For information on series EE and series HH savings bonds, see U.S. Savings Bonds, later.

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 paying 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 contract, part of each payment may be treated as interest. See Unstated Interest and Original Issue Discount in Publication 537, Installment Sales.

Interest on annuity contract.
Accumulated interest on an annuity contract you sell before its maturity date is taxable.

Usurious interest.
Usurious interest is taxable unless state law automatically changes it to a payment on the principal. Usurious interest is interest charged at an illegal rate.

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. Nor is it included in the amount to be reported as tax-exempt interest. See chapter 18.

Interest income on frozen deposits.
Exclude from your gross income interest credited on frozen deposits. A deposit is frozen if, at the end of the year, you cannot withdraw any part of the deposit because:

1. The financial institution is bankrupt or insolvent, or
2. The state where 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:

1. The net amount you withdrew from these deposits during the year, and
2. 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 1999, see Frozen deposits under How To Report Interest Income in chapter 1 of Publication 550, for information about reporting this interest income exclusion on your 1999 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. Your net amount withdrawn was $80. You must exclude $20. You must include $80 in your income for the year.

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 in which received or accrued. See Bonds Sold Between Interest Dates, later, for more information.

Below-market loans.
A below-market loan is a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate. See Rules for below-market loans in chapter 1 of Publication 550 for more information.

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.

For other information on U.S. savings bonds, write to:
 

Bureau of the Public Debt
Attn: Customer Information
P.O. Box 1328
Parkersburg, WV 26106-1328

Or, on the Internet, visit:

www.publicdebt.treas.gov

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. The cash method of accounting is explained in chapter 1 under Accounting Methods.

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 the bonds mature. Accrual methods of accounting are explained in chapter 1 under Accounting Methods.

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 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.

1. Method 1.
   Postpone reporting the interest until the earlier of the year you cash or dispose of the bonds or the year they mature. (However, see Savings bonds traded, later.) Note.
   Series E bonds issued in 1959 and 1969 matured in 1999. If you have used method 1, you generally must report the interest on these bonds on your 1999 return.
2. 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 education 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.

1. You have typed or printed at the top, "Change in Method of Accounting Under Section 6.01 of the Appendix of Rev. Proc. 98-60 (or later update)."
2. It includes your name and social security number under the label in (1).
3. It identifies the savings bonds for which you are requesting this change.
4. It includes your agreement to:
   1. 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
   2. 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.
5. It includes a statement that you agree to all the terms and conditions of Revenue Procedure 98-60 (or later update).
6. 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
Attn: 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, 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.

Table 8-1. Who Pays Tax on U.S. Bond Interest

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.

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 in chapter 1 of Publication 550, 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 purchase price, interest on the bond 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 must report one-half of the bond interest. For more information about community property, see Publication 555, Community Property.

Table 8-1.
These rules are also shown in Table 8-1.

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 incident to divorce.

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 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. 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.

1. 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.
2. If the choice in (1) is not made, the interest earned up to the date of death is income in respect of a 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 any of it until the year the bonds are cashed or disposed of or the year they finally mature, whichever is earlier. In the year that person reports the interest, he or she can claim a deduction for any federal estate tax paid that was for the part of the interest included in the decedent's estate.

For more information on income in respect of a decedent, see chapter 4.

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 to the extent 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.
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.

Choice to report interest in year of trade.
You can choose to treat all of the previously unreported accrued interest on the 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 bonds 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.

1. 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.
2. 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.
3. 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.
4. 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 chapter, for more information about the reporting requirements.)
5. 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.)

You must report your interest income even if you did not get a Form 1099-INT.

For information on including the correct amount of interest on your return for (1), (2), (3), and (4) above, see How To Report Interest Income, later. Publication 550 includes examples showing how to report these amounts.

If you received a taxable distribution of bonds from a retirement or profit-sharing plan ((5), above), see How To Report Interest Income in Publication 550 for information on how to report the interest.

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 bond interest in box 3. Do not include this amount 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 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 (payable on death).

Verification by IRS.
If you claim the exclusion, IRS will check it by using bond redemption information from Department of the Treasury records.

Qualified expenses.
Qualified higher educational expenses are tuition and fees required for you, your spouse, or your dependent (for whom you can 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.

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 and nonprofit universities and colleges and certain vocational schools that are eligible to participate in student aid programs.

Reduction for certain benefits.
You must reduce your qualified higher educational expenses by certain benefits the student may have received. These benefits include:

1. Qualified scholarships that are exempt from tax (see chapter 13 for information on qualified scholarships), and
2. Any other nontaxable payments (other than gifts, bequests, or inheritances) received for educational expenses, such as:
   1. Veterans' educational assistance benefits,
   2. Benefits under a qualified state tuition program, or
   3. Certain employer-provided educational assistance benefits.

Effect of other tax benefits.
Do not include in your qualified expenses any expenses used to:

1. Claim an education credit on Form 8863, or
2. Figure how much of a distribution from an education IRA you can exclude from your income.

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 1999, Mark and Joan, a married couple, cashed a qualified series EE U.S. savings bond they bought in November 1992. They received proceeds of $7,132, representing principal of $5,000 and interest of $2,132. In 1999, 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 $1,196 ($2,132 � ($4,000 � $7,132)) of interest in 1999. They must pay tax on the remaining $936 ($2,132 - $1,196) interest.

Modified adjusted gross income limit.
The interest exclusion is limited if your modified adjusted gross income (modified AGI) is:

• $53,100 to $68,100 for taxpayers filing single or head of household, and
• $79,650 to $109,650 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, for purposes of this exclusion, is adjusted gross income (line 18 of Form 1040A or line 33 of Form 1040) figured before the interest exclusion, and modified by adding back any:

1. Foreign earned income exclusion,
2. Foreign housing exclusion or deduction,
3. Exclusion of income for bona fide residents of American Samoa,
4. Exclusion for income from Puerto Rico,
5. Exclusion for adoption benefits received under an employer's adoption assistance program, and
6. 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 exclusion or deduction items 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.

If you have investment interest expense incurred to earn royalty income, see Education Savings Bond Program in chapter 1 of Publication 550.

Recordkeeping. If you claim the interest exclusion, you must keep a written record of the qualified U.S. savings bonds that you redeem. Your record must include the serial number, issue date, face value, and the total redemption proceeds 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 keep this information. You should also keep bills, receipts, canceled checks, or other documentation that shows you paid qualified higher educational expenses during the year.

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 in chapter 1 of Publication 550 for information on reporting the payment.

Insurance

Life insurance proceeds paid to you as beneficiary of the insured person are not usually taxable. But if you receive the proceeds in installments, you must usually report a part of each installment payment as interest income.

For more information about insurance proceeds received in installments, see Publication 525, Taxable and Nontaxable Income.

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 chapter 11 for information on pension and annuity income.

Original Issue Discount (OID)

Original issue discount (OID) is a form of interest. You generally include the OID in your income as it accrues over the term of the debt instrument, whether or not you receive any payments from the issuer.

A debt instrument, such as a bond, note, or other evidence of indebtedness, generally has OID when the instrument is issued for a price that is less than its stated redemption price at maturity. The amount of OID is the difference between the stated redemption price at maturity and the issue price.

All instruments that pay no interest before maturity are presumed to be issued at a discount. Zero coupon bonds are one example of these instruments.

The OID accrual rules generally do not apply to short-term obligations (those with a fixed maturity date of 1 year or less from date of issue). See Discount on Short-Term Obligations in Publication 550.

De minimis OID.
You can treat the discount as zero if it is less than one-fourth of 1% (.0025) of the stated redemption price at maturity multiplied by the number of full years from the date of original issue to maturity. This small discount is known as "de minimis " OID.

Example 1.
You bought a 10-year bond, with a stated redemption price at maturity of $1,000, issued at $980 and having OID of $20. One-fourth of 1% of $1,000 (stated redemption price) times 10 (the number of full years from the date of original issue to maturity) equals $25. Because the $20 discount is less than $25, the OID is treated as zero. (If you hold the bond at maturity, you will recognize $20 ($1,000 - $980) of capital gain.)

Example 2.
The facts are the same as in Example 1, except that the bond was issued at $950. The OID is $50. Because the $50 discount is more than the $25 figured in Example 1, you must include the OID in income as it accrues over the term of the bond.

Debt instrument bought after original issue.
If you buy a debt instrument with de minimis OID at a premium, the discount is not includible in income. If you buy a debt instrument with de minimis OID at a discount, the discount is reported under the market discount rules. See Market Discount Bonds in chapter 1 of Publication 550.

Exceptions to reporting OID.
The OID rules discussed in this chapter do not apply to the following debt instruments.

1. Tax-exempt obligations. (However, see Stripped tax-exempt obligations under Stripped Bonds and Coupons in chapter 1 of Publication 550).
2. U.S. savings bonds.
3. Short-term debt instruments (those with a fixed maturity date of not more than 1 year from the date of issue).
4. Obligations issued by an individual before March 2, 1984.
5. Loans between individuals, if all the following are true.
   1. The lender is not in the business of lending money.
   2. The amount of the loan, plus the amount of any outstanding prior loans, is $10,000 or less.
   3. Avoiding any federal tax is not one of the principal purposes of the loan.

Form 1099-OID.
The issuer of the debt instrument (or your broker, if you held the instrument through a broker) should give you Form 1099-OID, Original Issue Discount, or a similar statement, if the total OID for the calendar year is $10 or more. Form 1099-OID will show, in box 1, the amount of OID for the part of the year that you held the bond. It also will show, in box 2, other interest that you must include in your income. A copy of Form 1099-OID will be sent to the IRS. Do not file your copy with your return. Keep it for your records.

In most cases, you must report the entire amount in boxes 1 and 2 of Form 1099-OID as interest income. But see Refiguring OID shown on Form 1099-OID, later in this discussion, for more information.

Nominee.
If someone else is the holder of record (the registered owner) of an OID instrument that belongs to you and receives a Form 1099-OID on your behalf, that person must give you a Form 1099-OID.

Refiguring OID shown on Form 1099-OID.
You must refigure the OID shown in box 1 of Form 1099-OID if either of the following apply.

1. You bought the debt instrument after its original issue and paid a premium or an acquisition premium.
2. The debt instrument is a stripped bond or a stripped coupon (including certain zero coupon instruments).

For information about figuring the correct amount of OID to include in your income, see Figuring OID on Long-Term Debt Instruments in Publication 1212.

Form 1099-OID not received.
If you had OID for the year but did not receive a Form 1099-OID, see Publication 1212, which lists total OID on certain debt instruments. If your debt instrument is not listed in Publication 1212, consult the issuer for information about the OID that accrued for the year.

Refiguring periodic interest shown on Form 1099-OID.
If you disposed of a debt instrument or acquired it from another holder during the year, see Bonds Sold Between Interest Dates, earlier, for information about the treatment of periodic interest that may be shown in box 2 of Form 1099-OID for that instrument.

Certificates of deposit (CDs).
If you buy a CD with a maturity of more than 1 year, you must include in income each year a part of the total interest due and report it in the same manner as other OID.

This also applies to similar deposit arrangements with banks, building and loan associations, etc., including:

• Time deposits,
• Bonus plans,
• Savings certificates,
• Deferred income certificates,
• Bonus savings certificates, and
• Growth savings certificates.

Bearer CDs.
These are not issued in the depositor's name and are transferable from one individual to another.

Banks must provide the IRS and the person redeeming the bearer certificate with a Form 1099-INT.

CDs issued after 1982 generally must be in registered form. For more information about this requirement, see Bearer Obligations under Capital Gains and Losses in chapter 4 of Publication 550.

More information.
See chapter 1 of Publication 550 for more information about OID and related topics, such as market discount bonds.

State or Local Government Obligations

Generally, interest on obligations used to finance government operations is not taxable if the obligations are issued by a state, the District of Columbia, a possession of the United States, or any of their political subdivisions. This includes interest on certain obligations issued after 1982 by an Indian tribal government treated as a state.

Interest on arbitrage bonds issued by state or local governments after October 9, 1969, and interest on private activity bonds generally is taxable.

For more information on whether such interest is taxable or tax exempt, see State or Local Government Obligations in chapter 1 of Publication 550.

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.

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