{"id":175793,"date":"2020-09-09T18:29:00","date_gmt":"2020-09-09T22:29:00","guid":{"rendered":"https:\/\/ibkrcampus.com\/trading-lessons\/taxation-of-interest\/"},"modified":"2026-06-26T14:52:21","modified_gmt":"2026-06-26T18:52:21","slug":"taxation-of-interest","status":"publish","type":"trading-lessons","link":"https:\/\/www.interactivebrokers.com\/campus\/trading-lessons\/taxation-of-interest\/","title":{"rendered":"Taxation of Interest"},"content":{"rendered":"\n

New to Interactive Brokers?<\/strong><\/p>\n\n\n\n

\n
Open Account<\/a><\/div>\n<\/div>\n\n\n

<\/p>\n\n\n

Savings interest<\/h3>\nWe are all familiar with the traditional savings account. Generally, these accounts bear minimal interest\nand traditionally form the foundation of any nest egg.\n
    \n \t
  • Interest on these accounts is taxable annually.<\/li>\n \t
  • If held or owned by a minor, the income from their savings accounts, subject to certain\nlimitations, is included on their parent’s tax return.<\/li>\n \t
  • As of 2018, there is no longer a “kiddie” tax; rather, children’s unearned income is taxed at the\ntax rates for trusts and estates.<\/li>\n \t
  • These rates are higher than individual income tax rates.<\/li>\n<\/ul>\n

    Certificates of Deposit<\/h4>\n
      \n \t
    • Certificates of Deposit (CDs) are issued by banks for a set period from 3 months to 2 years.<\/li>\n \t
    • In general, they bear higher interest than savings accounts.<\/li>\n \t
    • However, there is a trade-off that they cannot be accessed without penalty before the end of\nthe term.<\/li>\n \t
    • Interest on CD’s is taxable as ordinary income when paid – which is at the end of the term of\ntheir certificate.<\/li>\n<\/ul>\n

      Commercial paper<\/h4>\n
        \n \t
      • Commercial paper is similar to a CD, however it is most often issued by businesses to cover their\nshort-term cash needs.<\/li>\n \t
      • Generally, commercial paper is short-term, as short as overnight, and usually does not exceed 9\nmonths.<\/li>\n \t
      • Sold at a discount in large denominations, there can be an active marketplace for these\ninstruments.<\/li>\n \t
      • The interest is taxed as ordinary income at the maturity of the instrument.<\/li>\n<\/ul>\n

        US Treasury Bills<\/h4>\n
          \n \t
        • US Treasury Bills are issued at a discount determined by the marketplace, which reflects current\ninterest rates when sold (auctioned) by the government.<\/li>\n \t
        • The longest duration of US Treasury Bills is one year.<\/li>\n \t
        • US Treasury Bills pay interest at Maturity and no gain or loss is claimed on the difference\nbetween the issuance price (discounted price) and the face value (redemption price); rather,\ngains are derived from interest income.<\/li>\n \t
        • Interest is claimed for tax purposes at the maturity of the Bill and is taxed as ordinary income.<\/li>\n<\/ul>\n

          US Treasury notes<\/h4>\n
            \n \t
          • US Treasury notes are obligations of the federal government used to finance the shorter-term\ncash needs of the government.<\/li>\n \t
          • Notes are issued in 2,3,5,7, and 10-year durations and there is an active secondary market for\nUS Treasury notes.<\/li>\n \t
          • Treasury notes are issued at auction where the rate is set based upon demand.<\/li>\n \t
          • Interest is paid every six months on these securities and is taxed as ordinary income for Federal\npurposes.<\/li>\n \t
          • However, US Treasury interest is not subject to state tax in any state.<\/li>\n<\/ul>\n

            US Treasury Bonds<\/h4>\n
              \n \t
            • US Treasury Bonds are essentially the same as US Treasury Notes except that they are longer in\nduration, running for 10-30 years and, on rare occasions, 40 years.<\/li>\n \t
            • Treasury bonds pay interest every six months.<\/li>\n \t
            • Interest is taxable as ordinary income when received.<\/li>\n \t
            • Again, Treasury bonds are subject only to Federal tax. They are not subject to state tax.<\/li>\n \t
            • US Treasury securities generally yield lower interest than their corporate counterparts.<\/li>\n \t
            • This is for two primary reasons \u2013\n1) the lower risk involved in holding an obligation of the US government and\n2) The income earned is not subject to state income taxes.<\/li>\n<\/ul>\n

              Municipal Bonds<\/h4>\n
                \n \t
              • Municipal bonds – bonds issued by state and local governments and certain governmental\nauthorities.<\/li>\n \t
              • These bonds vary in term. Generally, they are similar to US Treasury obligations as they are\nissued by the state, local or agency requiring the funds, however, there is a wider variance in\nyield as the credit quality of the state, locality or agency determines the risk.<\/li>\n \t
              • Municipal bonds are Federally tax exempt and bonds issued by your state of residence, or a\nlocality or agency within the state, are also state tax exempt.<\/li>\n \t
              • If you hold bonds from “out of state” then interest paid on those bonds is subject to state tax in\nyour residence state.<\/li>\n<\/ul>\n

                Alternative Minimum Tax (AMT)<\/h4>\n
                  \n \t
                • Certain Municipal Bonds – those issued to finance a private activity – yield income that, for\nAlternative Minimum Tax (AMT) purposes, are subject to Federal tax.<\/li>\n \t
                • These are bonds that are issued for items that are beyond the scope of government, such as\npublic housing.<\/li>\n \t
                • If, as a taxpayer, you are subject to the AMT these types of bonds may not return as much as\npossible for you.<\/li>\n \t
                • However, the bonds have a greater yield because of the increased risk.<\/li>\n<\/ul>\n

                  What is Bond Premium and Discount?<\/h4>\n
                    \n \t
                  • Bonds are often issued at a premium or discount to their face value. Additionally, market\nfluctuations can create bond premiums or discounts.<\/li>\n \t
                  • Bond premiums occur when a bond is issued or purchased for a value greater than face value\n(effectively lowering the yield). Bond discount is the opposite.<\/li>\n \t
                  • Bond discounts occur when a bond is sold for less than face value (effectively raising the yield).<\/li>\n<\/ul>\n

                    Amortization & Tax Exempt Securities<\/h4>\n
                      \n \t
                    • Taxpayers may choose to amortize the premium (that is, spread the premium over the life of the\nbond). This does not reduce current income for tax purposes but reduces the cost basis of the\nbond.<\/li>\n \t
                    • Bond discounts can also be amortized over the life of the bond, thereby reducing annual capital\ngain.<\/li>\n \t
                    • The amortization of discount does not change current income, it again adjusts the tax basis of\nthe bond.<\/li>\n \t
                    • This does not necessarily mean that there is no gain or loss on the sale of a bond. The\namortization of the interest premium or discount would eliminate any gain or loss upon\nmaturity. However, if a bond was sold in the marketplace before maturity there may be a gain\nor loss.<\/li>\n \t
                    • A change in the rating of the bond issuer may cause a market fluctuation separate from interest\npremium\/discount.<\/li>\n \t
                    • The tax rules surrounding amortization of premium and discount are more complex for tax\nexempt securities such as municipal bonds, however, careful research of the tax rules should be\ndone in this area.<\/li>\n<\/ul>\n

                      Original Issue Discount (OID)<\/h4>\n
                        \n \t
                      • Original Issue Discount, or OID, takes many forms, however, the simplest is the zero-coupon\nbond.<\/li>\n \t
                      • These bonds do not pay interest but accrue interest – similar to amortization – over the life of\nthe instrument.<\/li>\n \t
                      • Interest is recognized for tax purposes as ordinary income- as it is earned, not when it is paid.<\/li>\n \t
                      • The cost value of the instrument is increased each year to recognize this interest. For example,\nif a $100,000 face bond is sold at a discount to yield $1,000 interest, or 10% over its life, then\nthe initial purchase of the bond would be $90,000. Each year $1,000 of interest would be taxed\nand that value would be added to the cost of the bond.<\/li>\n \t
                      • Some convertible preferred stocks, which are truly stocks in ownership structures but act as\nbonds, also carry OID.<\/li>\n<\/ul>","protected":false},"excerpt":{"rendered":"

                        The main topics of this lesson are: Savings Interest; Certificates of Deposit; Commercial Paper; US Treasury Bills, Notes & Bonds; Municipal Bonds; Alternative Minimum Tax (AMT); and Original Issue Discount (OID). 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