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 usually not 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 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 generally has OID when the instrument is issued for a price that is less than its stated redemption price at maturity. 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 chapter 1 of 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 with 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 between the same individuals, 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 and has information that will help you figure OID. If your debt instrument is not listed in Publication 1212, consult the issuer for further information about the accrued OID 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.   CDs issued after 1982 generally must be in registered form. Bearer CDs are CDs that are not in registered form. They 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 a bearer CD with a Form 1099-INT.

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.

When To Report Interest Income

When to report your interest income depends on whether you use the cash method or an accrual method to report income.

Cash method.   Most individual taxpayers use the cash method. If you use this method, you generally report your interest income in the year in which you actually or constructively receive it. However, there are special rules for reporting the discount on certain debt instruments. See U.S. Savings Bonds and Original Issue Discount, earlier.

Example.   On September 1, 2000, you loaned another individual $2,000 at 12%, compounded annually. You are not in the business of lending money. The note stated that principal and interest would be due on August 31, 2002. In 2002, you received $2,508.80 ($2,000 principal and $508.80 interest). If you use the cash method, you must include in income on your 2002 return the $508.80 interest you received in that year.

Constructive receipt.   You constructively receive income when it is credited to your account or made available to you. You do not need to have physical possession of it. For example, you are considered to receive interest, dividends, or other earnings on any deposit or account in a bank, savings and loan, or similar financial institution, or interest on life insurance policy dividends left to accumulate, when they are credited to your account and subject to your withdrawal. This is true even if they are not yet entered in your passbook.

You constructively receive income on the deposit or account even if you must:

1. Make withdrawals in multiples of even amounts,
2. Give a notice to withdraw before making the withdrawal,
3. Withdraw all or part of the account to withdraw the earnings, or
4. Pay a penalty on early withdrawals, unless the interest you are to receive on an early withdrawal or redemption is substantially less than the interest payable at maturity.

Accrual method.   If you use an accrual method, you report your interest income when you earn it, whether or not you have received it. Interest is earned over the term of the debt instrument.

Example.   If, in the previous example, you use an accrual method, you must include the interest in your income as you earn it. You would report the interest as follows: 2000, $80; 2001, $249.60; and 2002, $179.20.

Coupon bonds.   Interest on coupon bonds is taxable in the year the coupon becomes due and payable. It does not matter when you mail the coupon for payment.

How To Report Interest Income

Generally, you report all of your taxable interest income on line 8a, Form 1040; line 8a, Form 1040A; or line 2, Form 1040EZ.

You cannot use Form 1040EZ if your interest income is more than $1,500. Instead, you must use Form 1040A or Form 1040.

Form 1040A.   You must complete Part I of Schedule 1 (Form 1040A) if you file Form 1040A and any of the following are true.

1. Your taxable interest income is more than $1,500.
2. You are claiming the interest exclusion under the Education Savings Bond Program (discussed earlier).
3. You received interest from a seller-financed mortgage, and the buyer used the property as a home.
4. You received a Form 1099-INT for tax- exempt interest.
5. You received a Form 1099-INT for U.S. savings bond interest that includes amounts you reported before 2002.
6. You received, as a nominee, interest that actually belongs to someone else.
7. You received a Form 1099-INT for interest or frozen deposits.

List each payer's name and the amount of interest income received from each payer on line 1. If you received a Form 1099-INT or Form 1099-OID from a brokerage firm, list the brokerage firm as the payer.

You cannot use Form 1040A if you must use Form 1040, as described next.

Form 1040.   You must use Form 1040 instead of Form 1040A or Form 1040EZ if:

1. You forfeited interest income because of the early withdrawal of a time deposit,
2. You received or paid accrued interest on securities transferred between interest payment dates,
3. You had a financial account in a foreign country, unless the combined value of all foreign accounts was $10,000 or less during all of 2002 or the accounts were with certain U.S. military banking facilities,
4. You acquired taxable bonds after 1987 and choose to reduce interest income from the bonds by any amortizable bond premium (see Bond Premium Amortization in chapter 3 of Publication 550), or
5. You are reporting OID in an amount more or less than the amount shown on Form 1099-OID.

Schedule B.   You must complete Part I of Schedule B (Form 1040) if you file Form 1040 and any of the following apply.

1. Your taxable interest income is more than $1,500.
2. You are claiming the interest exclusion under the Education Savings Bond Program (discussed earlier).
3. You had a foreign account.
4. You received interest from a seller-financed mortgage, and the buyer used the property as a home.
5. You received a Form 1099-INT for tax-exempt interest.
6. You received a Form 1099-INT for U.S. savings bond interest that includes amounts you reported before 2002.
7. You received, as a nominee, interest that actually belongs to someone else.
8. You received a Form 1099-INT for interest on frozen deposits.
9. You received a Form 1099-INT for interest on a bond that you bought between interest payment dates.
10. Statement (4) or (5) in the preceding list is true.

On line 1, Part I, list each payer's name and the amount received from each. If you received a Form 1099-INT or Form 1099-OID from a brokerage firm, list the brokerage firm as the payer.

Form 1099-INT.   Your taxable interest income, except for interest from U.S. savings bonds and Treasury obligations, is shown in box 1 of Form 1099-INT. Add this amount to any other taxable interest income you received. You must report all of your taxable interest income even if you do not receive a Form 1099-INT.

If you forfeited interest income because of the early withdrawal of a time deposit, the deductible amount will be shown on Form 1099-INT in box 2. See Penalty on early withdrawal of savings in chapter 1 of Publication 550.

Box 3 of Form 1099-INT shows the amount of interest income you received from U.S. savings bonds, Treasury bills, Treasury notes, and Treasury bonds. Add the amount shown in box 3 to any other taxable interest income you received, unless part of the amount in box 3 was previously included in interest income. If part of the amount shown in box 3 was previously included in your interest income, see U.S. savings bond interest previously reported, later.

Box 4 of Form 1099-INT (federal income tax withheld) will contain an amount if you were subject to backup withholding. Report the amount from box 4 on Form 1040EZ, line 7, on Form 1040A, line 39, or on Form 1040, line 62 (federal income tax withheld).

Box 5 of Form 1099-INT shows investment expenses you may be able to deduct as an itemized deduction. See chapter 3 of Publication 550 for more information about investment expenses.

U.S. savings bond interest previously reported.   If you received a Form 1099-INT for U.S. savings bond interest, the form may show interest you do not have to report. See Form 1099-INT for U.S. savings bonds interest, earlier, under U.S. Savings Bonds.

On line 1, Part I of Schedule B (Form 1040), or on line 1, Part I of Schedule 1 (Form 1040A), report all the interest shown on your Form 1099-INT. Then follow these steps.

1. Several lines above line 2, enter a subtotal of all interest listed on line 1.
2. Below the subtotal write U.S. Savings Bond Interest Previously Reported and enter amounts previously reported or interest accrued before you received the bond.
3. Subtract these amounts from the subtotal and enter the result on line 2.

More information.   For more information about how to report interest income, see chapter 1 of Publication 550 or the instructions for the form you must file.

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