Accrued interest is taxable, but when you owe the tax depends on the investment. If you are a typical individual taxpayer using the cash method, you report interest in the year you receive it or the year it is credited to an account you can draw on. Several common investments break that pattern and force you to pay tax on interest that has accrued but hasn’t been paid out yet: original issue discount bonds, Treasury Inflation-Protected Securities, and in some cases market discount bonds. A few others, like U.S. savings bonds and municipal bonds, go the other direction and let you defer or skip federal tax entirely.
The sections below walk through each situation so you can tell which rule applies to the interest sitting on your statement.
The Default Rule for Individual Taxpayers
Most individuals file on the cash method. Under that method, interest income lands on your return for the year the money shows up, whether that means a coupon payment deposited in your brokerage account or interest the bank posts to your savings account.1Internal Revenue Service. Publication 538 – Accounting Periods and Methods
You cannot avoid tax simply by refusing to collect money you are entitled to. The constructive receipt doctrine treats income as received once it is credited to your account or set apart for you without any substantial limitation.2GovInfo. 26 CFR 1.451-2 – Constructive Receipt of Income Interest the bank credits to a savings account or a certificate of deposit is taxable that year, even if you never withdraw it. That rule covers most multi-year CDs: because a typical early withdrawal penalty only forfeits some interest and doesn’t reach into principal, it isn’t a substantial enough restriction to delay taxation.
Genuine barriers do postpone the tax. If a bank fails and insolvency proceedings lock up your funds, or a CD imposes a penalty severe enough to eat into principal, interest may not be constructively received until the restriction lifts. These situations are uncommon.
Accrual-method taxpayers, mostly businesses, are on a different track. They report interest as it is earned on the books, whether or not any cash has changed hands.
When You Owe Tax on Interest You Haven’t Received
Two kinds of bonds break the cash-method rule for individuals and generate what investors often call phantom income.
Original Issue Discount Bonds
A bond has original issue discount when it is issued at a price below its face value. Zero-coupon bonds are the clearest example: you might pay $600 for a bond that pays $1,000 at maturity, and the $400 difference is interest the issuer will effectively pay you at the end.
Federal law requires holders of OID instruments to include accrued OID in gross income every year they hold the bond, regardless of whether they use the cash or accrual method.3Office of the Law Revision Counsel. 26 USC 1272 – Current Inclusion in Income of Original Issue Discount The annual amount is calculated using a constant yield method based on the bond’s yield to maturity, which means the taxable portion gets a little larger each year.4eCFR. 26 CFR 1.1272-1 – Current Inclusion of OID in Income You will see this amount reported to you on Form 1099-OID.
Each dollar of OID you report also raises your basis in the bond. When the bond finally matures and you collect the face value, the built-up basis means little or no additional gain, so you aren’t taxed a second time on the same money.
TIPS and Inflation Adjustments
Treasury Inflation-Protected Securities work the same way for the inflation portion. The bond’s principal adjusts upward with inflation, and the annual adjustment is reported on Form 1099-OID as taxable income for that year even though you won’t collect the adjusted principal until maturity. On a $10,000 TIPS bond, 3% inflation means tax on $300 of principal increase that year, on top of the small cash coupon the bond actually pays. This is why many investors hold TIPS inside IRAs or other tax-advantaged accounts.
Bonds Bought Between Interest Payment Dates
Secondary-market bond purchases bring their own wrinkle. When you buy a bond between scheduled coupon dates, part of what you pay the seller is reimbursement for interest that has accrued since the last payment. That amount is called purchased accrued interest.
At the next coupon date, the issuer sends the full interest payment to you, the new owner. A slice of that payment is really just a return of the money you handed the seller at purchase. The seller reports the accrued portion as their taxable income for the year; you subtract it from the interest you report.5Internal Revenue Service. Publication 550 – Investment Income and Expenses – Section: Accrued Interest on Bonds Skip the subtraction and you pay tax on money that was really part of your purchase price.
The IRS does not make this correction for you. Your brokerage statement should show the accrued interest paid at purchase, and the adjustment is made on Schedule B when you file.
Market Discount Bonds
Market discount is different from OID. It arises when you buy a bond on the secondary market for less than its face value (or less than the adjusted issue price, for a bond that was also issued at a discount). The discount came from market conditions after issue, not from the original terms.
By default, you do not pay tax on market discount every year. Instead, when you sell or redeem the bond, any gain is treated as ordinary income to the extent of the accrued market discount, taxed at your regular rate rather than the lower long-term capital gains rate.6Office of the Law Revision Counsel. 26 USC 1276 – Disposition Gain Representing Accrued Market Discount Treated as Ordinary Income The accrued portion is typically figured on a straight-line basis using the number of days you held the bond relative to the total days from your purchase to maturity.
A small-discount exception applies. If the market discount is less than 0.25% of face value times the number of full years remaining to maturity when you bought it, the discount is treated as zero and any gain is capital gain.7Office of the Law Revision Counsel. 26 USC 1278 – Definitions and Special Rules
You can also elect to include market discount in income each year as it accrues, treating the annual amount as interest. The election smooths out a future lump of ordinary income into smaller annual pieces and preserves certain interest deductions on debt used to carry the bond.
U.S. Savings Bonds
Series EE and Series I savings bonds give you a choice. The default lets you defer all interest until you redeem the bond, sell it, or hit final maturity, whichever comes first.8Internal Revenue Service. Topic No. 403, Interest Received For a bond held for decades, that means decades of deferral.
You can instead elect to report the interest annually as it accrues. Once made, the election applies to every savings bond you own and every one you later acquire, and it is binding for all future years unless the IRS lets you switch back.9Office of the Law Revision Counsel. 26 USC 454 – Obligations Issued at Discount Annual reporting can make sense if you are in a low bracket now and expect to be in a higher one later, or if you simply prefer not to face a large lump at redemption.
If savings bonds are redeemed to pay qualified higher education expenses, some or all of the interest may be excluded from income under a separate statute, subject to income limits.10Office of the Law Revision Counsel. 26 USC 135 – Income From United States Savings Bonds Used to Pay Higher Education Tuition and Fees The exclusion is claimed on Form 8815.
Municipal Bond Interest
Interest on bonds issued by state and local governments is generally excluded from federal gross income.11Office of the Law Revision Counsel. 26 USC 103 – Interest on State and Local Bonds That covers both regular coupon interest and the accrued interest that passes between buyer and seller on a secondary-market trade.
The exclusion extends to OID on tax-exempt municipal bonds too. The annual OID accrual increases your basis but is not federally taxable.12Office of the Law Revision Counsel. 26 USC 1288 – Treatment of Original Issue Discount on Tax-Exempt Obligations
A few caveats. Capital gains on municipal bonds are fully taxable, so you still need accurate basis tracking at sale. Interest from certain private activity municipal bonds can be taxable at the federal level and is often a preference item for the alternative minimum tax. State treatment of out-of-state municipal interest varies.
Accrued Interest When a Bondholder Dies
Interest that accrued before death but was never taxed does not disappear. It becomes income in respect of a decedent, taxable to whoever receives the right to collect it.13Office of the Law Revision Counsel. 26 USC 691 – Recipients of Income in Respect of Decedents
Savings bonds have a planning quirk here. If the decedent deferred reporting interest under the default rule, the executor filing the final return can elect to include all pre-death interest on that final return.14Internal Revenue Service. Publication 559 – Survivors, Executors, and Administrators – Section: U.S. Savings Bonds Acquired From Decedent Without that election, the accumulated interest becomes the beneficiary’s problem when the bond is redeemed or matures. A beneficiary who ends up paying income tax on inherited accrued interest may also be entitled to a deduction for the portion of federal estate tax attributable to that interest.
How to Report Accrued Interest on Your Return
Financial institutions report most interest on Form 1099-INT. Box 1 is taxable interest credited or made available during the year, and Box 8 is tax-exempt interest from municipal bonds. Box 8 isn’t taxed federally, but the figure still feeds other calculations, including whether Social Security benefits become taxable.15Internal Revenue Service. About Form 1099-INT, Interest Income
OID and TIPS inflation adjustments come on Form 1099-OID. Box 1 shows the OID amount includible in your gross income for the year, which can be much larger than any cash you actually received.16Internal Revenue Service. About Form 1099-OID An issuer may combine stated interest and OID on a single 1099-OID rather than issue both forms.17Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID
Adjustments on Schedule B
When a 1099-INT includes purchased accrued interest that is not really your income, you make the correction on Schedule B of Form 1040. List the full amount from the 1099-INT, then below the subtotal enter “Accrued Interest” and subtract the amount paid to the seller at purchase.5Internal Revenue Service. Publication 550 – Investment Income and Expenses – Section: Accrued Interest on Bonds
A similar adjustment covers nominee interest. If a joint account reports all the interest under your name but some of it belongs to another person, report the full amount, then subtract the nominee share with the label “Nominee Distribution.”18Internal Revenue Service. Publication 550 – Investment Income and Expenses – Section: Nominee Interest You then issue a 1099-INT to the actual owner if the amount meets the reporting threshold.
What Happens If You Don’t Report It
The IRS receives copies of every 1099-INT and 1099-OID your institutions file, and its matching programs flag returns where reported interest doesn’t line up with the information returns. Missing interest is one of the easiest discrepancies for the agency to catch.
If the omission results in underpaid tax, the accuracy-related penalty for negligence is 20% of the underpayment. The IRS specifically treats failing to include income shown on an information return as an example of negligence.19Internal Revenue Service. Accuracy-Related Penalty That is on top of the tax itself and interest for paying late. OID and TIPS create extra risk here because the taxable amount may not match any cash you received, which makes the number easy to miss.
Backup withholding is a separate mechanism. If you fail to give a financial institution a correct taxpayer identification number, or the IRS notifies the institution that you have previously underreported interest, the institution must withhold 24% of your interest payments before paying out the balance.20Internal Revenue Service. Publication 15 (2026), Circular E, Employer’s Tax Guide – Section: Backup Withholding You get the withheld amount back only through filing a return and claiming it as a payment.