Interest Income

Terms you may need to know (see Glossary):

Accrual method

Below-market loan Cash method Demand loan Forgone interest Gift loan Interest Mutual fund Nominee Original issue discount Private activity bond

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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In general, any interest that you receive or that is credited to your account and can be withdrawn is taxable income. Exceptions to this rule are discussed later.

Form 1099-INT. Interest income generally is reported to you on Form 1099-INT, or a similar statement, by banks, savings and loan associations, 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 interest income you receive for the tax year. See Form 1099-INT, Instructions for Recipient, to see whether you need to adjust any of the amounts reported to you.

Interest not reported on Form 1099-INT. You must report all your interest income even if you do not receive a Form 1099-INT. For example, you may receive distributive shares of interest from partnerships or S corporations. This interest is reported to you on Schedule K-1 (Form 1065) and Schedule K-1 (Form 1120-S).

Nominees. Generally, if someone receives interest as a nominee, that person must give you a Form 1099-INT showing the interest received on your behalf.

If you receive a Form 1099-INT and interest as a nominee for another person, see the discussion on Nominee distributions, later.

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 should be denoted “Corrected.”

Form 1099-OID. Interest income may also be shown on Form 1099-OID. See Original Issue Discount (OID), for more information.

Exempt-interest dividends. Form 1099-DIV, box 12, shows exempt-interest dividends from a mutual fund or other regulated investment company (RIC) paid to you during the calendar year. See the Instructions for Form 1040 or 1040-SR for where to report. Form 1099-DIV, box 13, shows exempt-interest dividends subject to the alternative minimum tax (AMT). This amount is included in box 12. See the Instructions for Form 6251.

Interest on VA dividends. Interest on insurance dividends left 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). Although interest earned from your IRA is generally not taxed in the

year earned, it isn't tax-exempt interest. Tax on your traditional IRA is generally deferred until you take a distribution. Don't report this interest on your return as tax-exempt interest. You don't include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s). You also don't include distributions from your Roth IRA that you roll over tax free into another Roth IRA. You may have to include part of other distributions in your income. See Pub. 590-B 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 the 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.

The “dividends” will be shown as interest income on Form 1099-INT.

Money market funds. Money market funds are offered by non-bank financial institutions such as mutual funds and stock brokerage houses, and pay dividends. Generally, amounts you receive from money market funds should be reported as dividends, not as interest.

Certificates of deposit and other deferred interest ac- counts. If you buy a certificate of deposit or open a deferred interest account, 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, later, for more information on how to report the interest and deduct the penalty.

Money borrowed to invest in certificate of deposit. The interest you pay on money borrowed from a bank or savings institution to meet the minimum deposit required for a certificate of deposit from the institution and the

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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 purchase a $10,000 certificate of deposit by borrowing $5,000 from the bank and adding an additional $5,000 of your funds. The certificate earned $575 at maturity in 2025, 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 2025 showing the $575 interest you earned. The bank also gives you a statement showing that you paid $310 interest for 2025. 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, the value may be reported to you as interest income on Form 1099-INT and you may have to report it on your tax return.

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, and obligations 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. Generally, 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 and Original Issue Dis- count (OID) in Pub. 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 is taxable as interest 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, or may become, 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, or may become, 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 at the end of the year (not reduced by any penalty for premature withdrawals of a time deposit).

See Frozen deposits if you receive a Form 1099–INT showing interest income on deposits that were frozen at the end of the tax year.

The interest you exclude is treated as credited to your account in the following year. You must include it in income in the year you can withdraw it.

Example. $100 of interest was credited on your frozen deposit during the year. You withdrew $80 but could not withdraw any more at the end of the year. You must include $80 in your income and exclude $20 from your income for the year. You must include the $20 in your income for the year you can withdraw it.

Bonds traded flat. If you buy a bond at a discount when interest has been defaulted or when the interest has accrued but has not been paid, the transaction is described as trading a bond flat. The defaulted or unpaid 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 of your bond. 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.

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Below-Market Loans

Generally, a “below-market loan” means any loan if (a) in the case of a demand loan, interest is payable on the loan at a rate less than the applicable federal rate, or (b) in the case of a term loan, the amount loaned exceeds the present value (using a discount rate equal to the applicable federal rate) of all payments due under the loan. (See Code section 7872 for details.) Section 7872 may consider the borrower to pay the lender any forgone interest and the lender to pay that foregone interest to the borrower. Thus, the lender may be compelled to recognize that foregone interest as income and the borrower may be able to deduct that foregone interest as an expense if the loan proceeds are used for business or investment. The nature of the forgone interest that section 7872 considers the lender to return to the borrower depends on the relationship between lender and borrower. It may be considered a gift, an investment, compensation, etc.

Loans subject to the rules. The rules for below-market loans apply to:

• Gift loans,

• Compensation-related loans,

• Corporation-shareholder loans,

• Tax avoidance loans, and

• Certain loans made to qualified continuing care facilities under a continuing care contract.

A compensation-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. The Internal Revenue Bulletin is available through IRS.gov/IRB . You also can find applicable federal rates in the Index of Applicable Federal Rates (AFR) Rulings at IRS.gov/applicable-federal-rates .

See chapter 5, How To Get Tax Help, for other ways to get this information.

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 generally is 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 generally is 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 an 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 Dis- count (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:

1. Gift loans between individuals if the gift loan is not directly used to buy or carry income-producing assets, and

2. Compensation-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 term loans. The general below-market loan rules will continue to apply even if the outstanding balance is reduced to $10,000 or less.

Exception for loans to continuing care facilities. Loans to qualified continuing care facilities under continuing care contracts are not subject to the rules for

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below-market loans for the calendar year if the lender or the lender's spouse is age 65 or older at the end of the year. For the definitions of qualified continuing care facility and continuing care contract, see Internal Revenue Code 7872(g)(4) and (h).

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:

1. 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;

2. Loans subsidized by a federal, state, or municipal government that are made available under a program of general application to the public;

3. Certain employee-relocation loans;

4. Certain loans to or from a foreign person;

5. 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

6. 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 that structure 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.

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.

U.S. savings bonds currently offered to individuals include Series EE bonds and Series I bonds.

Note: For information about U.S. savings bonds, go to www.treasurydirect.gov/savings-bonds/ . Also, go to www.treasurydirect.gov/contact-us/ and click on a topic to find answers to your questions by email.

If you prefer, write to:

Treasury Retail Securities Services P.O. Box 9150 Minneapolis, MN 55480-9150

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. See Reporting options for cash method taxpay- ers, later.

Series H and HH bonds. The United States Treasury sold HH savings bonds from 1980 through August 2004. HH savings bonds earn interest for up to 20 years You can no longer buy an HH savings bond. All HH bonds reached final maturity and stopped earning interest in August 2024. (See TreasuryDirect.gov/savings-bonds/hh-bonds/ .)

Certain HH bonds weren’t available for cash only. To buy those HH bonds, you had to trade in another security you had bought earlier. In making the exchange, you may have used interest the original security had earned to help pay for the HH bond. If you used an old bond to buy more than one HH bond, the interest you used to buy the bonds was divided proportionately among the HH bonds. You had a choice then for the tax on that interest: pay it then, or wait and pay it later (defer it). Interest that you decided to pay later is “deferred interest.” If your HH bond has deferred interest, you see the amount identified on the front of the bond. You don't have to report deferred interest on your federal income tax return until you are filing your return for the year in which the first of these events occurs: you cash the HH bond; the HH bond stops earning interest; the HH bond is reissued to show a change in ownership that is a taxable event. (See TreasuryDirect.gov/ savings-bonds/hh-bonds/hh-bonds-tax-information .)

Series H bonds were issued before 1980. All Series H bonds have matured and are no longer earning interest.

In addition to the twice-a-year interest payments, most H/HH bonds also have a deferred interest component. The reporting of this as income is addressed later in this chapter.

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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 E and EE bonds. Series E bonds were issued before 1980. All Series E bonds have matured and are no longer earning interest. Series EE bonds were first offered in January 1980 and have a maturity period of 30 years; they were offered in paper (definitive) form until 2012. Paper Series EE and Series E bonds were issued at a discount and increase in value as they earn interest. Electronic (book-entry) Series EE bonds were first offered in 2003. They are issued at face value and increase in value as they earn interest. For all Series E and Series EE bonds, the purchase price plus all accrued interest is payable to you at redemption.

Series I bonds. Series I bonds were first offered in 1998. These are inflation-indexed bonds issued at face value with a maturity period of 30 years. Series I bonds increase in value as they earn interest. The face value plus all accrued interest is payable to you at redemption.

Reporting options for cash method taxpayers. 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 in which they mature. (However, see Savings bonds traded , later.)

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 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.

Tip: If you plan to cash your bonds in the same year 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 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 the following number at the top: “131.”

2. It includes your name and social security number under “131.”

3. It includes the year of change (both the beginning and ending dates).

4. It identifies the savings bonds for which you are requesting this change.

5. It includes your agreement to:

a. 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

b. 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.

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 for the year of change (excluding extensions) to file the statement with an amended return. On the statement, type or print “Filed pursuant to section 301.9100-2.” To get this extension, you must have filed your original return for the year of the change by the due date (including extensions). See also Revenue Procedure 2015-13, Section 6.03(4).

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 generally is 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, the co-owner who redeemed the bond will receive a Form 1099-INT at the time of redemption and must provide you with another Form 1099-INT showing the amount of interest from the bond taxable to you. The co-owner who redeemed the bond is a “nominee.” See Nominee distribu- tions , 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 generally is 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

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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 Pub. 555.

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 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 unearned income of certain children , 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 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.

Table 1-2. Who Pays the Tax on U.S. Savings Bond Interest

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. The former co-owner does not have to include in gross income at the time of reissue 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. However, 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 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

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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 (decedent), depends on the accounting and income-reporting methods 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 chosen not 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 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 the decedent and should not be included in the decedent's final return. All interest earned both before and after the decedent's death (except any part reported by the estate on its income tax return) is income to the person who acquires the bonds. If that person uses the cash method and chooses not 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 paid on the part of the interest included in the decedent's estate.

For more information on income in respect of a decedent, see Pub. 559.

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 chosen not 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 report the interest each year as it is earned. If you cash the bond when it reaches a value of $1,000, you report $500 interest income—the difference between the value of $1,000 and the original cost of $500.

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. $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 HH bonds that she had acquired in a trade for Series EE 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 EE 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 EE bonds and the interest, if any, payable on the Series HH 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 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 EE 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 distrib- uted from a retirement or profit-sharing plan , later.

Savings bonds traded. Prior to September 2004, you could trade (exchange) Series E or EE bonds for Series H or HH bonds. At the time of the trade, you had the choice to postpone (defer) reporting the interest which had been

Publication 550 (2025) Chapter 1 Investment Income 13

earned on your Series E or EE bonds until the Series H or HH bonds received in the trade were redeemed or matured. Any cash you received in the transaction was income up to the amount of the interest that had accrued on the Series E or EE bonds. The amount of income that you chose to postpone reporting was recorded on the face of the Series H or HH bonds as “Deferred Interest”. This amount is also equal to the difference between the redemption value of the Series H or HH bonds and your cost. Your cost is the sum of the amount you paid for the exchanged Series E or EE bonds plus any amount you had to pay at the time of the transaction.

Example. You traded Series EE bonds that cost you $2,200 (on which you postponed reporting the interest) for $2,500 in Series HH bonds and $223 in cash. At the time of the trade, the Series EE bonds had accrued interest of $523 and a redemption value of $2,723.

You reported the $223 as taxable income on your tax return.

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 EE bonds).

Note: The $300 amount that is reportable upon redemption or maturity may be found on the face of the Series HH bond as “Deferred Interest.” If more than one Series HH bond is received in the exchange, the total amount of interest postponed/deferred in the transaction is divided proportionately among the Series HH bonds.

Choice to report interest in year of trade. You could have chosen to treat all of the previously unreported accrued interest on Series EE bonds traded for Series HH bonds as income in the year of the trade. If you made this choice, it is treated as a change from method 1. See Change from method 1, earlier.

Note: If you chose to report all of the previously unreported interest in the year of the trade, then there would be the no “Deferred Interest” recorded on the face of the new bond.

Note: The subsequent annual interest earnings on the Series HH bonds received in the exchange would be paid and reported annually by Treasury regardless of whether the previously accrued interest was further deferred or reported in the year of the exchange.

Form 1099-INT for U.S. savings bond interest. You may receive a Form 1099-INT when you redeem a bond. Form 1099-INT, box 3, 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, 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 generally is shown on Form 1099-R, for the year of distribution.)

Note: Treasury reporting process for electronic bonds is more refined. If Treasury is aware that the transfer of an electronic savings bond is a reportable event, then the transferor will receive a 1099-INT for the year of the transfer for the interest accrued up to the time of the transfer. When the transferee later disposes of the bond (redemption, maturity, or further transfer), the transferee will receive a 1099-INT showing interest accrued reduced by the amount reported to the transferor at the time of the original transfer.

For more information on including the correct amount of interest on your return, see U.S. savings bond interest pre- viously reported or Nominee distributions , later.

Tip: Interest on U.S. savings bonds is exempt from state and local taxes.

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 education expenses during the same year. This exclusion is known as the Education Savings Bond Program. For taxable years beginning in 2025, the exclusion under § 135, regarding income from United States savings bonds for taxpayers who pay qualified higher education expenses, begins to phase out for modified adjusted gross income above $149,250 for joint returns and $99,500 for all other returns. The exclusion is completely phased out for modified adjusted gross income of $179,250 or more for joint returns and $114,500 or more for all other returns.

You do not qualify for this exclusion if your filing status is married filing separately.

Form 8815. Use Form 8815 to figure your exclusion.

14 Chapter 1 Investment Income Publication 550 (2025)

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 you and your spouse's names (co-owners). You must be at least 24 years old before the bond's issue date. For example, a bond bought by a parent and issued in the name of his or her child under age 24 does not qualify for the exclusion by the parent or child.

Caution: The issue date of bond may be earlier than the date the bond is purchased because the issue date assigned to a bond is the first day of the month in which it is 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 to attend an eligible educational institution.

Qualified expenses include any contribution you make to a qualified tuition program or to a Coverdell education savings account. For information about these programs, see Pub. 970.

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 or certificate granting program.

Eligible educational institutions. These institutions include most public, private, and nonprofit universities, colleges, and vocational schools that are accredited and 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 all of the following tax-free benefits.

1. Tax-free part of scholarships and fellowships.

2. Expenses used to figure the tax-free portion of distributions from a Coverdell ESA.

3. Expenses used to figure the tax-free portion of distributions from a qualified tuition program.

4. Any tax-free payments (other than gifts or inheritances) received as educational assistance, such as:

a. Veterans' educational assistance benefits,

b. Qualified tuition reductions, or

c. Employer-provided educational assistance.

5. Any expense used in figuring the American Opportunity and lifetime learning credits.

See Pub. 970 for more information about these benefits.

Amount excludable. If the total proceeds (interest and principal) from the qualified U.S. savings bonds you re

deem during the year are not more than your adjusted qualified higher educational expenses for the year, you may be able to exclude all of the interest. If the proceeds are more than the expenses, you may be able to 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. Max and Helene are married, and paid $5,000 in January 2009 for a $10,000 denomination Series EE U.S. savings bond. They cashed the bond for $6,148 ($5,000 [price] + $1,148 [interest]) and paid $4,000 of college tuition for their child, Ari, in January 2025. Max and Helene can exclude $746.90 ($1,148 × ($4,000 ÷ $6,148)) of interest on their 2025 joint income tax return.

U.S. Treasury Bills, Notes, and Bonds

Treasury bills, notes, and bonds are direct debts (obligations) of the U.S. government.

Taxation of interest. 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 interest (in box 3) paid to you for the year.

Treasury bills. These bills generally have a 4-, 8-, 13-, 26-, or 52-week maturity period. They are generally issued at a discount in the amount of $100 and multiples of $100. 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. If you paid a premium for a bill (more than face value), you generally report the premium as a section 171 deduction when the bill is paid at maturity. See Discount on Short-Term Obligations , 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 by the time it reaches maturity.

Treasury notes and bonds. Treasury notes have maturity periods of at least 1 year, ranging up to 10 years. Maturity periods for Treasury bonds are generally longer than 10 years. Both generally are issued in denominations of $100 to $1 million and pay interest every 6 months. You report this interest for the year paid. When the notes or bonds mature, you can redeem these securities for face value or use the proceeds from the maturing note or bond to reinvest in another note or bond of the same type and term.

Treasury notes and bonds are sold by auction. Two types of bids are accepted: competitive bids and

Publication 550 (2025) Chapter 1 Investment Income 15

noncompetitive bids. If you make a competitive bid and 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 do not apply if the discount is less than one-fourth of 1% (0.0025) of the face amount, multiplied by the number of full years from the date of original issue to maturity. See De minimis 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.)

Note: For other information on these notes or bonds, write to:

Treasury Retail Securities Services P.O. Box 9150 Minneapolis, MN 55480–9150

Or, on the Internet, visit www.treasurydirect.gov

Treasury inflation-protected securities (TIPS). These securities pay interest twice a year at a fixed rate, based on a principal amount adjusted to take into account inflation and deflation. For the tax treatment of these securities, see Inflation-Indexed Debt Instruments, 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 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, later in this chapter, for information on reporting the payment.

Insurance

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

For more information about insurance proceeds received in installments, see Pub. 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 from a nonqualified plan, not as interest income. See Pub. 939.

State or Local Government Obligations

Interest you receive on an obligation issued by a state or local government generally is not taxable. The issuer should be able to tell you whether the interest is taxable, as well as 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.

Caution: Even if interest on the obligation is not subject to income tax, you may have to report a capital gain or loss when you sell it. Estate, gift, or generation-skipping tax may 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. territory, or any of their political subdivisions. Political subdivisions may include:

• Port authorities,

• Toll road commissions,

• Utility service 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.

Note: 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 (including tribal economic development bonds issued after February 17, 2009) are treated as issued by a state. Interest on these bonds are generally tax exempt if the bonds are part of an issue where substantially, all proceeds are to be used in the

16 Chapter 1 Investment Income Publication 550 (2025)

exercise of any essential government function. However, the proceeds of a tribal economic development bond issued after February 17, 2009, are not required to be used in the exercise of an essential government function in order for the bond to receive tax-exempt treatment. Interest on private activity bonds (other than certain bonds for tribal manufacturing facilities) is taxable.

Original issue discount. OID on tax-exempt state or local government bonds are 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 lo- cal government bonds in chapter 4.

Stripped bonds or coupons. For special rules that apply to stripped tax-exempt obligations, see Stripped Bonds and Coupons, 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 in- terest , later in this chapter.

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 generally is 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, in effect on July 18, 1984).

• Department of Veterans Affairs.

• Federal home loan banks. (The guarantee must be made after July 30, 2008, in connection with the original bond issue during the period beginning on July 30, 2008, and ending on December 31, 2010 (or a renewal or extension of a guarantee so made), and the bank must meet safety and soundness requirements.)

• Federal Home Loan Mortgage Corporation.

• Federal Housing Administration.

• Federal National Mortgage Association.

• Government National Mortgage Corporation.

• Resolution Funding Corporation.

• Student Loan Marketing Association.

Tax credit bonds. Use Form 8912 to claim the credit for the following tax credit bonds.

• Clean Renewable Energy Bond (CREB).

• New Clean Renewable Energy Bond (NCREB).

• Qualified Energy Conservation Bond (QECB).

• Qualified Zone Academy Bond (QZAB).

• Qualified School Construction Bond (QSCB).

• Build America Bond (BAB).

Generally, in lieu of or in addition to, receiving periodic interest payments from the issuer, the holder of the bond is allowed an income tax credit. The credit compensates the holder for lending money to the issuer and functions as interest paid on the bond.

See the Instructions for Form 8912 for details and instructions.

Mortgage revenue bonds. The proceeds of these bonds are used to finance mortgage loans for home buyers. 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 of which any portion of the proceeds 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 that meets both the following requirements.

1. More than 10% of the proceeds of the issue is to be used for a private business use.

2. More than 10% of the payment of the principal or interest is:

a. Secured by an interest in property to be used for a

private business use (or payments for this property), or

b. Derived from payments for property (or borrowed

money) used for a private business use.

Also, a bond generally is considered a private activity bond if 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, a New York Liberty bond, a Midwestern disaster area bond, a Hurricane Ike disaster area bond, a Gulf Opportunity Zone bond treated as an exempt-facility bond, or any recovery zone facility bond), qualified student loan bond, qualified small issue bond (including a tribal manufacturing facility bond), qualified redevelopment bond, qualified mortgage bond (including a Gulf Opportunity Zone bond, a Midwestern disaster area bond, or a Hurricane Ike disaster area bond treated as a qualified mortgage bond), qualified veterans' mortgage bond, or qualified 501(c)(3) bond (a bond issued for the benefit of certain tax-exempt organizations).

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Interest you receive on these tax-exempt bonds, if issued after August 7, 1986, generally is a “tax preference item” and may be subject to the AMT. See Form 6251 and its instructions for more information.

The interest on the following bonds is not a tax preference item and is not subject to the AMT.

• Qualified 501(c)(3) bonds.

• New York Liberty bonds.

• Gulf Opportunity Zone bonds.

• Midwestern disaster area bonds.

• Hurricane Ike disaster area bonds.

• Exempt facility bonds for qualified residential rental projects issued after July 30, 2008.

• Qualified mortgage bonds issued after July 30, 2008.

• Qualified veterans' mortgage bonds issued after July 30, 2008.

Qualified bonds issued in 2009 or 2010. The interest on any qualified bond issued in 2009 or 2010 is not a tax preference item and is not subject to the AMT. For this purpose, a refunding bond (whether a current or advanced refunding) is treated as issued on the date the refunded bond was issued (or on the date the original bond was issued in the case of a series of refundings). However, this rule does not apply to any refunding bond issued to refund any qualified bond issued during 2004 through 2008 or after 2010.

Qualified bonds issued after December 31, 2010. A portion of the interest on specified private activity bonds issued after December 31, 2010, may be a tax preference item subject to the AMT. The tax preference status will apply to the portion of the interest that remains after reducing it by deductions that would be allowed if the interest were taxable.

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.

New York Liberty bonds. New York Liberty bonds are bonds issued after March 9, 2002, to finance the construction and rehabilitation of real property in the designated “Liberty Zone” of New York City. Interest on these bonds is tax exempt.

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, 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 Dis- counted Debt Instruments , later.