A bond is a debt security. It is an I.O.U. of sorts. When you buy a bond you are loaning money to the bond's issuer in exchange for the promise of regular interest payments and a return of the face value of the bond upon maturity. Corporate bonds share those traits with government bonds and municipal bonds, but there is a significant difference in how the interest on corporate bonds is taxed.
While the interest on government bonds is exempt from state and local income taxes, and the interest on municipal bonds is typically exempt from federal income taxes, the interest on corporate bonds is not exempt from taxation at any level. Any interest you receive from a corporate bond is taxable as income on your federal, state and local income tax return.
The issuer that paid you interest on your corporate bond should provide you with a Form 1099-INT detailing how much interest you received for the tax year, regardless of how much interest you earned. You are required to report any interest you received when you file your federal income tax return, regardless of whether you received a Form 1099-INT or not.
Use the information supplied on Form 1099-INT to complete your tax returns. In most cases, if your total interest income for the year from all sources, including corporate bonds, bank accounts, money market accounts and similar investments, was less than $1,500 you can report the total amount on Form 1040EZ, 1040A or 1040. If your interest was $1,500 or more you will need to complete Schedule B, and you will not be able to use Form 1040EZ. Add your corporate bond interest to your other taxable income, such as wages, salaries, dividends and self-employment income to determine your total income.
If you buy shares of a corporate bond fund, you are considered to be part owner of each bond held by the fund. Interest payments that are made to the bond fund are typically combined with capital gains and passed on to you in the form of a dividend. You must include any portion of the dividend that resulted from interest payments as interest when you file your federal income tax return.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.