The tax treatment of accrued interest at the federal level generally makes it ordinary income, but the year you report it, and sometimes whether you owe anything at all, depends on your accounting method, the type of debt instrument, and whether special rules apply. Most individuals report interest when they actually receive it or can freely draw on it. Corporations and other accrual-basis taxpayers report it as it builds up. Layered on top are rules for original issue discount, bonds bought between coupon dates, family loans, savings bonds, forgiven balances, and interest that survives the person who earned it.
When Accrued Interest Counts as Taxable Income
Cash-basis taxpayers, which covers most individuals, report interest when they receive it or when it becomes available without meaningful restrictions. The IRS calls that second trigger constructive receipt. Interest a bank credits to your savings account on December 31 is taxable that year even if you never move the money.1eCFR. 26 CFR 1.451-2 – Constructive Receipt of Income The same applies to a CD where interest is credited and you could withdraw it.
Financial institutions report interest payments of $10 or more to you and the IRS on Form 1099-INT.2Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID Fail to give the payer a correct taxpayer identification number and the institution must send 24% of your interest to the IRS as backup withholding.3Internal Revenue Service. Publication 505 (2026), Tax Withholding and Estimated Tax You claim the withheld amount as a credit on your return.
Accrual-basis taxpayers, including many corporations, report interest as it is earned regardless of when cash changes hands. Two taxpayers holding identical bonds can report on different timelines based solely on which method they use.
Bonds Bought Between Interest Dates
When you buy a bond on the secondary market between coupon dates, part of the price represents interest that accrued before you owned it. That portion belongs to the seller for tax purposes. The seller reports the accrued interest up to the sale date as interest income, and the buyer treats the accrued portion of the purchase price as a return of capital, not a taxable payment.4Internal Revenue Service. Publication 550, Investment Income and Expenses
The headache arrives with the first coupon payment. Your Form 1099-INT will show the full coupon, which overstates your actual taxable interest. To correct this, list the full 1099-INT amount on Schedule B of your Form 1040, then subtract the accrued interest you paid at purchase by entering “Accrued Interest” as a subtraction below it.5Internal Revenue Service. Instructions for Schedule B (Form 1040) Skip that step and you pay tax on someone else’s income.
Market Discount
Buy a bond on the secondary market for less than its remaining face value and the gap is called market discount. When you later sell or redeem the bond, gain up to the accrued market discount is taxed as ordinary income rather than as capital gain.6GovInfo. 26 USC 1276 – Disposition Gain Representing Accrued Market Discount Treated as Ordinary Income The discount accrues ratably over the remaining life of the bond, or under a constant-yield method if you elect it. The constant-yield election is irrevocable for that bond.
Original Issue Discount Bonds
When a bond is issued for less than its face value, the spread is treated as interest that accrues over the bond’s life. A zero-coupon bond is the clearest example. Buy one for $900 that will pay $1,000 at maturity and federal law requires you to report a portion of the $100 as interest income every year you hold it.7Office 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 rather than a straight-line split, so the reported OID grows slightly each year as your adjusted basis rises. Each year’s reported OID gets added to your basis, and at maturity the basis equals the face value, so redemption itself creates no additional tax.
This is where taxpayers get burned. Because no cash arrives until maturity or sale, reporting the income feels wrong. The IRS does not care about cash flow, and skipping this phantom income can trigger an accuracy-related penalty of 20% of the underpayment.8Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
Below-Market and Family Loans
Lend money to a family member interest-free or below the IRS’s applicable federal rate and the code treats you as if you charged the market rate. The forgone interest is a gift from lender to borrower and simultaneously interest income deemed retransferred back to the lender.9Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates Both sides face tax consequences for interest nobody paid.
The rules cover gift loans, employer-employee loans, corporation-shareholder loans, and any loan structured to avoid tax. Two exceptions keep smaller loans out of reach:
- Gift loans between individuals totaling $10,000 or less on any given day are exempt, unless the loan is used to buy income-producing assets.
- For gift loans between individuals that do not exceed $100,000, imputed interest income is capped at the borrower’s net investment income. If the borrower’s net investment income is $1,000 or less, it is treated as zero, effectively eliminating the imputed income.
A parallel $10,000 de minimis rule applies separately to compensation-related and corporation-shareholder loans. Cross the thresholds and the IRS imputes interest at the applicable federal rate, giving the lender phantom interest income even though no check was written.
US Savings Bond Interest
Series EE and I savings bonds let you choose your reporting timing. You can defer interest until you cash the bond or it matures, or elect to report the interest annually as it accrues. Deferral is the default. Annual reporting can make sense if you expect to be in a lower bracket now than at redemption.
Switching from deferral to annual reporting does not need IRS permission, but the switch applies to every savings bond registered under your Social Security number. In the switch year, you report that year’s interest plus all interest accrued in every prior year you held the bonds. Moving from annual reporting back to deferral requires filing Form 3115.10TreasuryDirect. Tax Information for EE and I Bonds
When you cash the bond, TreasuryDirect issues a Form 1099-INT for the full lifetime interest. If you reported annually, subtract the amounts you already picked up in earlier years so nothing gets taxed twice.
Education Exclusion
Savings bond interest can be excluded entirely if you use the proceeds for qualified higher education expenses for yourself, your spouse, or your dependents. The bonds must be Series EE or I, issued after 1989, and you must have been at least 24 when the bond was issued. Qualified expenses cover tuition and fees but not room and board. For 2025, the exclusion phases out starting at modified AGI of $99,500 for single filers and $149,250 for joint filers. Married couples filing separately cannot use the exclusion. You claim it on Form 8815.11Internal Revenue Service. Exclusion of Interest From Series EE and I US Savings Bonds Issued After 1989
Interest That Is Federally Exempt
Interest on state and local government bonds, commonly called municipal bonds, is excluded from federal gross income.12Office of the Law Revision Counsel. 26 USC 103 – Interest on State and Local Bonds The exemption covers the interest itself and any accrued interest you pay when buying a muni between coupon dates. Certain private activity bonds, arbitrage bonds, and bonds not issued in registered form fall outside the exemption.
The exemption runs in the other direction for federal debt. Interest on US Treasury bills, notes, bonds, and savings bonds is exempt from state and local income taxes.13Office of the Law Revision Counsel. 31 USC 3124 – Exemption From Taxation The federal tax still applies.
The Net Investment Income Tax
High earners face an additional 3.8% tax on net investment income, which includes interest of nearly every kind. The Net Investment Income Tax applies when modified adjusted gross income exceeds $200,000 for single filers, $250,000 for joint filers, or $125,000 for married filing separately, and it hits the lesser of your net investment income or the amount your MAGI exceeds the threshold.14Internal Revenue Service. Topic No. 559, Net Investment Income Tax The thresholds do not adjust for inflation.
Estates and trusts hit NIIT far sooner. It applies to undistributed net investment income above the dollar threshold where the top estate and trust bracket begins, $16,000 for 2026. Even modest interest in a trust can trigger the tax if it stays undistributed.
Estimated Tax on Interest Income
Interest from bonds, savings accounts, and private loans usually arrives without any tax withheld. If you expect to owe $1,000 or more after withholding and refundable credits, quarterly estimated payments are generally required.15Internal Revenue Service. Estimated Tax for Individuals (Form 1040-ES)
You avoid the underpayment penalty by meeting either safe harbor: pay at least 90% of the current year’s tax, or at least 100% of the prior year’s tax. If your prior-year AGI exceeded $150,000, or $75,000 for married filing separately, the second safe harbor rises to 110%.
Miss both and the IRS charges interest on each quarterly shortfall. The rate for the first quarter of 2026 is 7%, compounded daily, and the IRS resets it quarterly.16Internal Revenue Service. Interest Rates Remain the Same for the First Quarter of 2026 If your interest income lands unevenly, the annualized income installment method on Form 2210 lets you base each quarter’s required payment on income actually received during that period.17Internal Revenue Service. Instructions for Form 2210
Forgiven Accrued Interest
When a lender cancels a debt, the forgiven amount, including accrued but unpaid interest, generally counts as taxable income to the borrower. The tax code defines gross income to include income from discharge of indebtedness.18Office of the Law Revision Counsel. 26 USC 61 – Gross Income Defined Lenders that cancel $600 or more must report the amount to you and the IRS on Form 1099-C.19Internal Revenue Service. About Form 1099-C, Cancellation of Debt For 2026, the forgiven amount is taxed at ordinary rates ranging from 10% to 37%.
Exceptions That Erase the Tax
Several exceptions can reduce or eliminate the tax on forgiven interest:
- Deductibility exception. If you would have been entitled to deduct the interest when paid, forgiving it creates no taxable income. A business borrower who would have deducted the interest owes nothing when it is canceled.20Office of the Law Revision Counsel. 26 USC 108 – Income From Discharge of Indebtedness
- Bankruptcy. Debt discharged in a Title 11 case is excluded entirely.
- Insolvency. If your liabilities exceed the fair market value of your assets immediately before the discharge, you exclude the forgiven amount up to the extent of the insolvency. You claim the exclusion on Form 982.
- Qualified farm indebtedness and qualified real property business debt have their own exclusions and eligibility rules.
For personal debts like credit card balances, where the interest would not have been deductible, forgiven interest is fully taxable unless bankruptcy or insolvency applies. Many people whose debts are forgiven are in fact insolvent at the time and do not realize they qualify.
Student Loan Forgiveness After 2025
The American Rescue Plan Act temporarily excluded most student loan forgiveness from federal income tax, but that provision expired on December 31, 2025. Starting in 2026, borrowers whose federal student loan balances are forgiven under an income-driven repayment plan will generally owe income tax on the discharged amount, including any accrued interest folded into the balance.21Taxpayer Advocate Service. What to Know About Student Loan Forgiveness and Your Taxes Public Service Loan Forgiveness, Teacher Loan Forgiveness, and discharges for death or total and permanent disability remain permanently exempt. The insolvency exclusion on Form 982 remains available.
Accrued Interest When the Owner Dies
When someone dies with interest earned but not yet received, the tax liability does not vanish. The code calls it income in respect of a decedent, or IRD, and whoever ultimately collects the payment owes income tax on it.22Office of the Law Revision Counsel. 26 USC 691 – Recipients of Income in Respect of Decedents If the estate collects the interest, it reports the income on Form 1041. If the interest passes directly to a beneficiary, that person reports it on Form 1040.23Internal Revenue Service. About Form 1041, US Income Tax Return for Estates and Trusts
The dividing line is the date of death. Interest that accrued before death is IRD and carries the decedent’s deferred tax liability. Interest that accrued after death is ordinary income to the new owner under normal rules. Documenting the date-of-death value of each bond or account during estate administration is what makes that split possible.
The IRD Deduction
IRD items face a double hit: they inflate the gross estate for federal estate tax purposes and are then taxed again as income when collected. The code offsets this by letting the person reporting the IRD deduct the portion of federal estate tax attributable to those items.24eCFR. 26 CFR 1.691(c)-1 – Deduction for Estate Tax Attributable to Income in Respect of a Decedent The deduction is claimed as a miscellaneous itemized deduction on Schedule A and is not subject to any floor or phase-out. A tax professional generally handles the allocation, because the calculation requires the estate tax figures with and without the IRD items in the gross estate.