Yes, bonds do pay interest, and for most bonds the amount and timing are set in writing before you buy. A standard $1,000 bond with a 5% coupon pays $50 a year, usually as two $25 installments six months apart. The rate, the payment dates, and the maturity date all sit in a contract called the bond indenture, which binds the issuer the way a stock dividend never binds a company. Miss a coupon and it’s a default with legal consequences, not a business decision.
Two numbers drive the math. Par value is the face value printed on the bond, typically $1,000 for corporate and government issues.1Legal Information Institute. Par Value The coupon rate is a percentage applied to that face value. A 4% coupon on a $1,000 bond produces $40 a year, every year, regardless of what rates do in the market after you buy.
When the Payments Actually Arrive
Semiannual is the default. U.S. Treasury bonds and notes pay half the annual coupon every six months, and most investment-grade corporate bonds follow the same rhythm.2TreasuryDirect. Understanding Pricing and Interest Rates A bond paying $60 a year sends $30 in one fixed month and $30 six months later. Those dates are set at issuance.
Some bonds pay monthly, which is common for mortgage-backed securities and certain income-oriented corporates. Annual payments show up in some international issues but are rare in the U.S. market. More frequent payments let you reinvest sooner, though for most individual holders the compounding effect is modest.
Each bond has a record date that determines who gets the upcoming payment. If you own the bond on that date, the coupon is yours; sell before it and the buyer collects.3Investor.gov. Ex-Dividend Dates – When Are You Entitled to Stock and Cash Dividends The ex-interest date usually falls a business day or two earlier and marks the first day the bond trades without the right to the next coupon.
Bonds That Don’t Pay a Fixed Coupon
Not every bond hands you the same check every six months. Floating-rate notes tie their payments to a benchmark, most often the Secured Overnight Financing Rate (SOFR), plus a fixed spread. A note quoted as “SOFR + 2%” pays whatever SOFR is at each reset, typically quarterly, plus two percentage points. The payments shift with rates.
Step-up bonds sit between fixed and floating. The coupon starts low and rises on a schedule locked into the indenture. A step-up might pay 3% for the first three years and 5% after that, with the full schedule known when you buy.
Zero-Coupon Bonds and Phantom Income
Zero-coupon bonds skip periodic payments altogether. You buy at a deep discount and receive the full par value at maturity. Pay $700 for a bond that matures at $1,000, and the $300 spread is your interest.
The IRS won’t wait until maturity to tax that $300. The discount is treated as original issue discount (OID), and OID accrues as taxable interest each year.4Internal Revenue Service. Guide to Original Issue Discount (OID) Instruments You owe federal income tax on the annual accrual even though no cash has changed hands. Your broker reports the taxable amount on Form 1099-OID.5Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID Holding zeros inside a tax-deferred account like an IRA avoids the current tax bill on that annual accrual.
Accrued Interest When You Buy Between Payments
Bonds keep earning interest between coupon dates. If you buy on the secondary market partway through a payment period, you pay the seller for the interest that has already built up. This is called accrued interest and compensates the seller for the days they held the bond.
Say a bond pays $30 every six months and you buy three months into the period. You’d owe the seller about $15 in accrued interest on top of the market price. When the full $30 coupon lands in your account, you keep all of it, but on a net basis you’ve only earned $15. Market prices quoted for bonds are usually “clean” prices that exclude this figure; the “dirty” price you actually pay at settlement adds it back.
Your 1099-INT will show the full coupon as interest income. You subtract the accrued interest you paid at purchase on Schedule B, listing the total interest received and then entering “Accrued Interest” as a subtraction.6Internal Revenue Service. Publication 550 – Investment Income and Expenses Tax lands only on what you actually earned.
How Bond Interest Is Taxed
Bond interest is gross income under 26 U.S.C. § 61, which lists interest as a taxable category.7Office of the Law Revision Counsel. 26 USC 61 – Gross Income Defined For most corporate and federal government bonds, that interest is taxed at ordinary income rates. It stacks on top of your other income and is taxed at whatever bracket the combined total lands you in.8Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
Regular coupon payments come to you on Form 1099-INT, and OID appears on Form 1099-OID.5Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID Both forms typically arrive by early February for the prior tax year. Skipping bond interest on your return, even small amounts, can draw IRS penalties.
Higher-income holders face an extra 3.8% net investment income tax on the lesser of net investment income or the amount by which modified adjusted gross income exceeds a threshold.9Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax Bond interest counts as net investment income. The thresholds are $200,000 for single filers and $250,000 for joint filers, and they don’t adjust for inflation, so the tax reaches more people each year.10Internal Revenue Service. Topic No. 559 – Net Investment Income Tax Tax-exempt municipal bond interest is excluded from the NIIT calculation.
Municipal Bonds
Interest on bonds issued by state and local governments is generally excluded from federal gross income under 26 U.S.C. § 103.11Office of the Law Revision Counsel. 26 USC 103 – Interest on State and Local Bonds A 3.5% municipal in the hands of someone in the 32% federal bracket delivers roughly the same after-tax return as a taxable bond paying 5.15%. That math is why munis fill so many high-income portfolios despite lower stated coupons.
The exclusion has edges. Tax-exempt interest still has to be reported on your federal return, because the IRS uses it in eligibility calculations for other benefits and credits. Most states tax interest on out-of-state municipal bonds while exempting their own, so a high-tax state can chew through much of the federal advantage if you buy across state lines. Interest on certain private activity bonds, which fund projects like airports and some housing developments, is a tax preference item for the alternative minimum tax and gets added back into the AMT calculation if AMT applies to you.12Office of the Law Revision Counsel. 26 USC 57 – Items of Tax Preference Qualified 501(c)(3) bonds and certain housing bonds are exempt from that AMT treatment.
Treasury Securities
Interest on U.S. Treasury bonds, notes, and bills is fully subject to federal income tax but exempt from state and local income tax by federal law.13Office of the Law Revision Counsel. 31 USC 3124 – Exemption From Taxation The higher your state’s income tax rate, the more that exemption is worth relative to a corporate bond paying the same coupon.
The Market Discount Trap
Buy a bond on the secondary market for less than its face value and the gap between your purchase price and par is market discount. When you sell or the bond matures, the gain tied to that discount is taxed as ordinary income, not as a capital gain.14Office of the Law Revision Counsel. 26 USC 1276 – Disposition Gain Representing Accrued Market Discount Treated as Ordinary Income Ordinary rates can run considerably higher than long-term capital gains rates, so the classification matters.
A de minimis rule provides some relief. If the discount is smaller than one-quarter of one percent of face value times the number of complete years remaining to maturity, it’s treated as zero for tax purposes and any gain gets capital gains treatment instead.15Office of the Law Revision Counsel. 26 USC 1278 – Definitions and Special Rules On a $1,000 bond with 10 years to maturity, the threshold is $25. Buy at $976 and the discount is market discount taxed as ordinary income. Buy at $978 and you’re inside the safe harbor.
You can also elect to recognize market discount as it accrues each year rather than in a lump at disposition. That avoids the ordinary income spike at sale but means paying tax annually on income you haven’t yet collected.
What Happens If the Issuer Doesn’t Pay
Indentures typically include a grace period before a missed coupon becomes a formal default. A common provision gives the issuer 30 calendar days after the due date to cure the shortfall. If the money still isn’t there, the trustee named in the indenture can declare a default and begin enforcement for all bondholders.
From that point, consequences move quickly. Bondholders, usually through the trustee, can demand immediate repayment of the principal, enforce any collateral, or push the issuer into bankruptcy. Most defaults end up in restructuring talks before liquidation, with the issuer proposing modified terms and bondholders voting on the package. Recovery depends on where your bonds sit in the capital structure. Secured holders have historically recovered a larger share than unsecured or subordinated ones, who can end up with far less than face value.