Accrued interest is interest that has been earned but not yet paid. If you own a bond, you likely receive interest payments periodically, usually every three or six months. An interest calculator shows that every day you own the bond, you earn another day’s worth of interest, which accrues to your benefit until you receive your periodic payment. Unless you happen to buy a bond on its interest payment date, the bond will contain a certain amount of accrued interest on your purchase date, and that accrued interest will be added to the purchase price, creating the “dirty price.”
All the accrued interest, meaning interest from the last payment date to the day before your purchase, rightly belongs to the bond seller, not you. By paying for the accrued interest in your purchase, you provide the money to pay off the seller’s accrued interest. On the next payment date, you’ll receive the full interest amount, which makes you whole for the upfront payment of accrued interest. You need to report the accrued interest you paid at purchase, because it is taxable to the seller, not you.
Reporting Accrued Interest
The first step in reporting accrued interest is receiving a copy of IRS Form 1099-INT for each of the bonds you held during the year that provided at least $10 of interest. The form reports the bond’s interest you received and the accrued interest, if any, you paid during the year. Transfer the bond information, including the seller’s name and the amount of taxable interest, to Schedule B of Form 1040. If the bond had accrued interest, enter a separate line on Schedule B for the accrued interest amount under the seller name of “Nominee Distribution,” and write in “Accrued Interest” adjacent to the amount. When you total the amount column, subtract the accrued interest entries. Subtract out interest earned on U.S. savings bonds, and the result represents your taxable interest amount, which you transfer to Form 1040.
Exceptions to Reporting
You may not have to complete Schedule B if you received less than $1,500 in taxable interest for the year. Notwithstanding this threshold, you must use Schedule B if certain circumstances apply, including having accrued interest. If you must file Schedule B, you need to include all taxable interest above $0.50 you received, even if you didn’t receive a copy of 1099-INT. Do not report tax-free interest on Schedule B, as it is reported directly on Form 1040.
2018 Tax Law
The taxes you save by reporting accrued interest depends on your marginal tax rate for ordinary income. There are seven tax rates in 2018, ranging from 10 percent to 37 percent. Your tax rate depends on your filing status and income level. For example, suppose you had $1,000 of taxable interest income in 2018, of which $200 was accrued interest. By reporting the accrued interest, you reduce your taxable income by $200. If you are in the 10 percent bracket, your savings is $20, whereas those in the 37 percent bracket save $74 in taxes.
2019 Tax Law
The tax rates in 2018 and 2019 are the same, but the 2019 tax brackets have expanded due to inflation. For example, in 2018 the 10 percent bracket tops out at $9,525 of taxable income, and is $500,000 for the 35 percent bracket. The corresponding amounts for 2019 are $9,700 and $510,300, respectively.
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