Dividends that are actually interest.

Certain distributions commonly called dividends are actually interest. You must report as interest so-called “dividends” on deposits or on share accounts in:

Money market funds.

Money market funds are offered by nonbank financial institutions such as mutual funds and stock brokerage houses, and pay dividends. Generally, amounts you receive from money market funds should be reported as dividends, not as interest.

Certificates of deposit and other deferred interest accounts.

If you buy a certificate of deposit or open a deferred interest account, interest may be paid at fixed intervals of 1 year or less during the term of the account. You generally must include this interest in your income when you actually receive it or are entitled to receive it without paying a substantial penalty. The same is true for accounts that mature in 1 year or less and pay interest in a single payment at maturity. If interest is deferred for more than 1 year, see Original Issue Discount (OID), later.

Interest subject to penalty for early withdrawal.

If you withdraw funds from a deferred interest account before maturity, you may have to pay a penalty. You must report the total amount of interest paid or credited to your account during the year without subtracting the penalty. See Penalty on early withdrawal of savings, later, for more information on how to report the interest and deduct the penalty.

Money borrowed to invest in certificate of deposit.

The interest you pay on money borrowed from a bank or savings institution to meet the minimum deposit required for a certificate of deposit from the institution and the interest you earn on the certificate are two separate items. You must report the total interest you earn on the certificate in your income. If you itemize deductions, you can deduct the interest you pay as investment interest, up to the amount of your net investment income. See Interest Expenses in chapter 3.

Gift for opening account.

If you receive noncash gifts or services for making deposits or for opening an account in a savings institution, the value may be reported to you as interest income on Form 1099-INT and you may have to report it on your tax return.

For deposits of less than $5,000, gifts or services valued at more than $10 must be reported as interest. For deposits of $5,000 or more, gifts or services valued at more than $20 must be reported as interest. The value is determined by the cost to the financial institution.

Interest on insurance dividends.

Interest on insurance dividends left on deposit with an insurance company that can be withdrawn annually is taxable to you in the year it is credited to your account. However, if you can withdraw it only on the anniversary date of the policy (or other specified date), the interest is taxable in the year that date occurs.

Prepaid insurance premiums.

Any increase in the value of prepaid insurance premiums, advance premiums, or premium deposit funds is interest if it is applied to the payment of premiums due on insurance policies or made available for you to withdraw.

U.S. obligations.

Interest on U.S. obligations, such as U.S. Treasury bills, notes, and bonds, and obligations issued by any agency or instrumentality of the United States is taxable for federal income tax purposes.

Interest on tax refunds.

Interest you receive on tax refunds is taxable income.

Interest on condemnation award.

If the condemning authority pays you interest to compensate you for a delay in payment of an award, the interest is taxable.

Installment sale payments.

If a contract for the sale or exchange of property provides for deferred payments, it also usually provides for interest payable with the deferred payments. Generally, that interest is taxable when you receive it. If little or no interest is provided for in a deferred payment contract, part of each payment may be treated as interest. See Unstated Interest and Original Issue Discount (OID) in Pub. 537.

Interest on annuity contract.

Accumulated interest on an annuity contract you sell before its maturity date is taxable.

Usurious interest.

Usurious interest is interest charged at an illegal rate. This is taxable as interest unless state law automatically changes it to a payment on the principal.

Interest income on frozen deposits.

Exclude from your gross income interest on frozen deposits. A deposit is frozen if, at the end of the year, you cannot withdraw any part of the deposit because:

The amount of interest you must exclude is the interest that was credited on the frozen deposits minus the sum of:

The interest you exclude is treated as credited to your account in the following year. You must include it in income in the year you can withdraw it.

Bonds traded flat.

If you buy a bond at a discount when interest has been defaulted or when the interest has accrued but has not been paid, the transaction is described as trading a bond flat. The defaulted or unpaid interest is not income and is not taxable as interest if paid later. When you receive a payment of that interest, it is a return of capital that reduces the remaining cost basis of your bond. Interest that accrues after the date of purchase, however, is taxable interest income for the year received or accrued. See Bonds Sold Between Interest Dates, later in this chapter.

Loans subject to the rules.

The rules for below-market loans apply to:

Forgone interest.

For any period, forgone interest is:

Applicable federal rate.

Applicable federal rates are published by the IRS each month in the Internal Revenue Bulletin. The Internal Revenue Bulletin is available through IRS.gov/IRB. You also can find applicable federal rates in the Index of Applicable Federal Rates (AFR) Rulings at https://irs.gov/applicable-federal-rates.

See chapter 5, How To Get Tax Help, for other ways to get this information.

Rules for below-market loans.

The rules that apply to a below-market loan depend on whether the loan is a gift loan, demand loan, or term loan.

Gift and demand loans.

A gift loan is any below-market loan where the forgone interest is in the nature of a gift.

A demand loan is a loan payable in full at any time upon demand by the lender. A demand loan is a below-market loan if no interest is charged or if interest is charged at a rate below the applicable federal rate.

A demand loan or gift loan that is a below-market loan generally is treated as an arm's-length transaction in which the lender is treated as having made:

The lender's additional payment to the borrower is treated as a gift, dividend, contribution to capital, pay for services, or other payment, depending on the substance of the transaction. The borrower may have to report this payment as taxable income, depending on its classification.

Term loans.

A term loan is any loan that is not a demand loan. A term loan is a below-market loan if the amount of the loan is more than the present value of all payments due under the loan.

A lender who makes a below-market term loan other than a gift loan is treated as transferring an additional lump-sum cash payment to the borrower (as a dividend, contribution to capital, etc.) on the date the loan is made. The amount of this payment is the amount of the loan minus the present value, at the applicable federal rate, of all payments due under the loan. An equal amount is treated as original issue discount (OID). The lender must report the annual part of the OID as interest income. The borrower may be able to deduct the OID as interest expense. See Original Issue Discount (OID), later.

Exceptions to the below-market loan rules.

Exceptions to the below-market loan rules are discussed here.

Exception for loans of $10,000 or less.

The rules for below-market loans do not apply to any day on which the total outstanding amount of loans between the borrower and lender is $10,000 or less. This exception applies only to:

Exception for loans to continuing care facilities.

Loans to qualified continuing care facilities under continuing care contracts are not subject to the rules for below-market loans for the calendar year if the lender or the lender's spouse is age 65 or older at the end of the year. For the definitions of qualified continuing care facility and continuing care contract, see Internal Revenue Code 7872(g)(4) and (h).

Exception for loans without significant tax effect.

Loans are excluded from the below-market loan rules if their interest arrangements do not have a significant effect on the federal tax liability of the borrower or the lender. These loans include:

Limit on forgone interest for gift loans of $100,000 or less.

For gift loans between individuals, if the outstanding loans between the lender and borrower total $100,000 or less, the forgone interest to be included in income by the lender and deducted by the borrower is limited to the amount of the borrower's net investment income for the year. If the borrower's net investment income is $1,000 or less, it is treated as zero. This limit does not apply to a loan if the avoidance of federal tax is one of the main purposes of the interest arrangement.

Accrual method taxpayers.

If you use an accrual method of accounting, you must report interest on U.S. savings bonds each year as it accrues. You cannot postpone reporting interest until you receive it or until the bonds mature.

Cash method taxpayers.

If you use the cash method of accounting, as most individual taxpayers do, you generally report the interest on U.S. savings bonds when you receive it. But see Reporting options for cash method taxpayers, later.

Series H and HH bonds.

These bonds were issued at face value in exchange for other savings bonds.

Series HH bonds were issued between 1980 and 2004. They mature 20 years after issue. Series HH bonds that have not matured pay interest twice a year, usually by direct deposit to your bank account. If you are a cash method taxpayer, you must report this interest as income in the year you receive it.

Series H bonds were issued before 1980. All Series H bonds have matured and are no longer earning interest.

In addition to the twice-a-year interest payments, most H/HH bonds also have a deferred interest component.

Series EE and Series I bonds.

Interest on these bonds is payable when you redeem the bonds. The difference between the purchase price and the redemption value is taxable interest.

Series E and EE bonds.

Series E bonds were issued before 1980. All Series E bonds have matured and are no longer earning interest. Series EE bonds were first offered in January 1980 and have a maturity period of 30 years; they were offered in paper (definitive) form until 2012. Paper Series EE and Series E bonds were issued at a discount and increase in value as they earn interest. Electronic (book-entry) Series EE bonds were first offered in 2003; they are issued at face value and increase in value as they earn interest. For all Series E and Series EE bonds, the purchase price plus all accrued interest is payable to you at redemption.

Series I bonds.

Series I bonds were first offered in 1998. These are inflation-indexed bonds issued at face value with a maturity period of 30 years. Series I bonds increase in value as they earn interest. The face value plus all accrued interest is payable to you at redemption.

Reporting options for cash method taxpayers.

If you use the cash method of reporting income, you can report the interest on Series EE, Series E, and Series I bonds in either of the following ways.

Change from method 1.

If you want to change your method of reporting the interest from method 1 to method 2, you can do so without permission from the IRS. In the year of change, you must report all interest accrued to date and not previously reported for all your bonds.

Once you choose to report the interest each year, you must continue to do so for all Series EE, Series E, and Series I bonds you own and for any you get later, unless you request permission to change, as explained next.

Change from method 2.

To change from method 2 to method 1, you must request permission from the IRS. Permission for the change is automatically granted if you send the IRS a statement that meets all the following requirements.

You must attach this statement to your tax return for the year of change, which you must file by the due date (including extensions).

You can have an automatic extension of 6 months from the due date of your return for the year of change (excluding extensions) to file the statement with an amended return. On the statement, type or print “Filed pursuant to section 301.9100-2.” To get this extension, you must have filed your original return for the year of the change by the due date (including extensions). See also Revenue Procedure 2015-13, Section 6.03(4).

Instead of filing this statement, you can request permission to change from method 2 to method 1 by filing Form 3115. In that case, follow the form instructions for an automatic change. No user fee is required.

Co-owners.

If a U.S. savings bond is issued in the names of co-owners, such as you and your child or you and your spouse, interest on the bond generally is taxable to the co-owner who bought the bond.

One co-owner's funds used.

If you used your funds to buy the bond, you must pay the tax on the interest. This is true even if you let the other co-owner redeem the bond and keep all the proceeds. Under these circumstances, the co-owner who redeemed the bond will receive a Form 1099-INT at the time of redemption and must provide you with another Form 1099-INT showing the amount of interest from the bond taxable to you. The co-owner who redeemed the bond is a “nominee.” See Nominee distributions, later, for more information about how a person who is a nominee reports interest income belonging to another person.

Both co-owners' funds used.

If you and the other co-owner each contribute part of the bond's purchase price, the interest generally is taxable to each of you in proportion to the amount each of you paid.

Community property.

If you and your spouse live in a community property state and hold bonds as community property, one-half of the interest is considered received by each of you. If you file separate returns, each of you generally must report one-half of the bond interest. For more information about community property, see Pub. 555.

Table 1-2.

These rules are also shown in Table 1-2.

Child as only owner.

Interest on U.S. savings bonds bought for and registered only in the name of your child is income to your child, even if you paid for the bonds and are named as beneficiary. If the bonds are Series EE or Series I bonds, the interest on the bonds is income to your child in the earlier of the year the bonds are cashed or disposed of or the year the bonds mature, unless your child chooses to report the interest income each year.

Choice to report interest each year.

The choice to report the accrued interest each year can be made either by your child or by you for your child. This choice is made by filing an income tax return that shows all the interest earned to date, and by stating on the return that your child chooses to report the interest each year. Either you or your child should keep a copy of this return.

Unless your child is otherwise required to file a tax return for any year after making this choice, your child does not have to file a return only to report the annual accrual of U.S. savings bond interest under this choice. However, see Tax on unearned income of certain children, earlier, under General Information. Neither you nor your child can change the way you report the interest unless you request permission from the IRS, as discussed earlier under Change from method 2.

Ownership transferred.

If you bought Series EE or Series I bonds entirely with your own funds and had them reissued in your co-owner's name or beneficiary's name alone, you must include in your gross income for the year of reissue all interest that you earned on these bonds and have not previously reported. But, if the bonds were reissued in your name alone, you do not have to report the interest accrued at that time.

This same rule applies when bonds (other than bonds held as community property) are transferred between spouses or incident to divorce.

Purchased jointly.

If you and a co-owner each contributed funds to buy Series E, Series EE, or Series I bonds jointly and later have the bonds reissued in the co-owner's name alone, you must include in your gross income for the year of reissue your share of all the interest earned on the bonds that you have not previously reported. The former co-owner does not have to include in gross income at the time of reissue his or her share of the interest earned that was not reported before the transfer. This interest, however, as well as all interest earned after the reissue, is income to the former co-owner.

This income-reporting rule also applies when the bonds are reissued in the name of your former co-owner and a new co-owner. But the new co-owner will report only his or her share of the interest earned after the transfer.

If bonds that you and a co-owner bought jointly are reissued to each of you separately in the same proportion as your contribution to the purchase price, neither you nor your co-owner has to report at that time the interest earned before the bonds were reissued.

Transfer to a trust.

If you own Series E, Series EE, or Series I bonds and transfer them to a trust, giving up all rights of ownership, you must include in your income for that year the interest earned to the date of transfer if you have not already reported it. However, if you are considered the owner of the trust and if the increase in value both before and after the transfer continues to be taxable to you, you can continue to defer reporting the interest earned each year. You must include the total interest in your income in the year you cash or dispose of the bonds or the year the bonds finally mature, whichever is earlier.

The same rules apply to previously unreported interest on Series EE or Series E bonds if the transfer to a trust consisted of Series HH or Series H bonds you acquired in a trade for the Series EE or Series E bonds. See Savings bonds traded, later.

Decedents.

The manner of reporting interest income on Series E, Series EE, or Series I bonds, after the death of the owner (decedent), depends on the accounting and income-reporting methods previously used by the decedent.

Decedent who reported interest each year.

If the bonds transferred because of death were owned by a person who used an accrual method, or who used the cash method and had chosen to report the interest each year, the interest earned in the year of death up to the date of death must be reported on that person's final return. The person who acquires the bonds includes in income only interest earned after the date of death.

Decedent who postponed reporting interest.

If the transferred bonds were owned by a decedent who had used the cash method and had not chosen to report the interest each year, and who had bought the bonds entirely with his or her own funds, all interest earned before death must be reported in one of the following ways.

Savings bonds distributed from a retirement or profit-sharing plan.

If you acquire a U.S. savings bond in a taxable distribution from a retirement or profit-sharing plan, your income for the year of distribution includes the bond's redemption value (its cost plus the interest accrued before the distribution). When you redeem the bond (whether in the year of distribution or later), your interest income includes only the interest accrued after the bond was distributed. To figure the interest reported as a taxable distribution and your interest income when you redeem the bond, see Worksheet for savings bonds distributed from a retirement or profit-sharing plan, later.

Savings bonds traded.

Prior to September 2004, you could trade (exchange) Series E or EE bonds for Series H or HH bonds. At the time of the trade, you had the choice to postpone (defer) reporting the interest which had been earned on your Series E or EE bonds until the Series H or HH bonds received in the trade were redeemed or matured. Any cash you received in the transaction was income up to the amount of the interest that had accrued on the Series E or EE bonds. The amount of income that you chose to postpone reporting was recorded on the face of the Series H or HH bonds as "Deferred Interest"; this amount is also equal to the difference between the redemption value of the Series H or HH bonds and your cost. Your cost is the sum of the amount you paid for the exchanged Series E or EE bonds plus any amount you had to pay at the time of the transaction.

Choice to report interest in year of trade.

You could have chosen to treat all of the previously unreported accrued interest on Series EE bonds traded for Series HH bonds as income in the year of the trade. If you made this choice, it is treated as a change from method 1. See Change from method 1, earlier.

Form 1099-INT for U.S. savings bond interest.

You may receive a Form 1099-INT when you redeem a bond. Box 3 of your Form 1099-INT should show the interest as the difference between the amount you received and the amount paid for the bond. However, your Form 1099-INT may show more interest than you have to include on your income tax return. For example, this may happen if any of the following are true.

For more information on including the correct amount of interest on your return, see U.S. savings bond interest previously reported or Nominee distributions, later.

.Interest on U.S. savings bonds is exempt from state and local taxes. The Form 1099-INT you receive will indicate the amount that is for U.S. savings bonds interest in box 3. Do not include this income on your state or local income tax return..

Taxation of interest.

Interest income from Treasury bills, notes, and bonds is subject to federal income tax but is exempt from all state and local income taxes. You should receive Form 1099-INT showing the interest (in box 3) paid to you for the year.

Treasury bills.

These bills generally have a 4-week, 8-week, 13-week, 26-week, or 52-week maturity period. They generally are issued at a discount in the amount of $100 and multiples of $100. The difference between the discounted price you pay for the bills and the face value you receive at maturity is interest income. Generally, you report this interest income when the bill is paid at maturity. If you paid a premium for a bill (more than face value), you generally report the premium as a section 171 deduction when the bill is paid at maturity. See Discount on Short-Term Obligations, later.

If you reinvest your Treasury bill at its maturity in a new Treasury bill, note, or bond, you will receive payment for the difference between the proceeds of the maturing bill (par amount less any tax withheld) and the purchase price of the new Treasury security. However, you must report the full amount of the interest income on each of your Treasury bills at the time it reaches maturity.

Treasury notes and bonds.

Treasury notes have maturity periods of at least 1 year, ranging up to 10 years. Maturity periods for Treasury bonds are generally longer than 10 years. Both generally are issued in denominations of $100 to $1 million and both generally pay interest every 6 months. Generally, you report this interest for the year paid. When the notes or bonds mature, you can redeem these securities for face value or use the proceeds from the maturing note or bond to reinvest in another note or bond of the same type and term.

Treasury notes and bonds are sold by auction. Two types of bids are accepted: competitive bids and noncompetitive bids. If you make a competitive bid and a determination is made that the purchase price is less than the face value, you will receive a refund for the difference between the purchase price and the face value. This amount is considered original issue discount. However, the original issue discount rules (discussed later) do not apply if the discount is less than one-fourth of 1% (0.0025) of the face amount, multiplied by the number of full years from the date of original issue to maturity. See De minimis OID, later. If the purchase price is determined to be more than the face amount, the difference is a premium. (See Bond Premium Amortization in chapter 3.)

Treasury inflation-protected securities (TIPS).

These securities pay interest twice a year at a fixed rate, based on a principal amount adjusted to take into account inflation and deflation. For the tax treatment of these securities, see Inflation-Indexed Debt Instruments, later.

Retirement, sale, or redemption.

For information on the retirement, sale, or redemption of U.S. government obligations, see Capital or Ordinary Gain or Loss in chapter 4. Also, see Nontaxable Trades in chapter 4 for information about trading U.S. Treasury obligations for certain other designated issues.

Interest option on insurance.

If you leave life insurance proceeds on deposit with an insurance company under an agreement to pay interest only, the interest paid to you is taxable.

Annuity.

If you buy an annuity with life insurance proceeds, the annuity payments you receive are taxed as pension and annuity income from a nonqualified plan, not as interest income. See Pub. 939, General Rule for Pensions and Annuities, for information on taxation of pension and annuity income from nonqualified plans.

De minimis OID.

You can treat the discount as zero if it is less than one-fourth of 1% (0.0025) of the stated redemption price at maturity multiplied by the number of full years from the date of original issue to maturity. This small discount is known as “de minimis” OID. In the case of a debt instrument providing for more than one stated principal payment (an installment obligation), the “de minimis” formula described above is modified. See Regulations section 1.1273-1(d)(3).

Debt instrument bought after original issue.

If you buy a debt instrument with de minimis OID at a premium, the discount is not includible in income. If you buy a debt instrument with de minimis OID at a discount, the discount is reported under the market discount rules. See Market Discount Bonds, later in this chapter.

Exceptions to reporting OID as current income.

The OID rules discussed here do not apply to the following debt instruments.

Market discount.

Market discount is the amount of the stated redemption price of a bond at maturity that is more than your basis in the bond immediately after you acquire it. You treat market discount as zero if it is less than one-fourth of 1% (0.0025) of the stated redemption price of the bond multiplied by the number of full years to maturity (after you acquire the bond).

If a market discount bond also has OID, the market discount is the sum of the bond's issue price and the total OID includible in the gross income of all holders (for a tax-exempt bond, the total OID that accrued) before you acquired the bond, reduced by your basis in the bond immediately after you acquired it.

Bonds acquired at original issue.

Generally, a bond you acquired at original issue is not a market discount bond. If your adjusted basis in a bond is determined by reference to the adjusted basis of another person who acquired the bond at original issue, you also are considered to have acquired it at original issue.

Exceptions.

A bond you acquired at original issue can be a market discount bond if either of the following is true.

Accrued market discount.

The accrued market discount is figured in one of two ways.

Ratable accrual method.

Treat the market discount as accruing in equal daily installments during the period you hold the bond. Figure the daily installments by dividing the market discount by the number of days after the date you acquired the bond, up to and including its maturity date. Multiply the daily installments by the number of days you held the bond to figure your accrued market discount.

Constant yield method.

Instead of using the ratable accrual method, you can choose to figure the accrued discount using a constant interest rate (the constant yield method). Make this choice by attaching to your timely filed return a statement identifying the bond and stating that you are making a constant interest rate election. The choice takes effect on the date you acquired the bond. If you choose to use this method for any bond, you cannot change your choice for that bond.

For information about using the constant yield method, see Constant yield method under Debt Instruments Issued After 1984 in Pub. 1212. To use this method to figure market discount (instead of OID), treat the bond as having been issued on the date you acquired it. Treat the amount of your basis (immediately after you acquired the bond) as the issue price and apply the formula shown in Pub. 1212.

Choosing to include market discount in income currently.

You can make this choice if you have not revoked a prior choice to include market discount in income currently within the last 5 calendar years. Make the choice by attaching to your timely filed return a statement in which you:

Once you make this choice, it will apply to all market discount bonds you acquire during the tax year and in later tax years. You cannot revoke your choice without the consent of the IRS. See Rev. Proc. 2023-24 for information on how to revoke your election.

Also, see Election To Report All Interest as OID, later. If you make that election, you must use the constant yield method.

Effect on basis.

You increase the basis of your bonds by the amount of market discount you include in your income.

Partial principal payments.

If you receive a partial payment of principal on a market discount bond you acquired after October 22, 1986, and you did not choose to include the discount in income currently, you must treat the payment as ordinary interest income up to the amount of the bond's accrued market discount. Reduce the amount of accrued market discount reportable as interest at disposition by that amount.

There are three methods you can use to figure accrued market discount for this purpose.

Under method (2) above, figure accrued market discount for a period by multiplying the total remaining market discount by a fraction. The numerator (top part) of the fraction is the OID for the period, and the denominator (bottom part) is the total remaining OID at the beginning of the period.

Under method (3) above, figure accrued market discount for a period by multiplying the total remaining market discount by a fraction. The numerator is the stated interest paid in the accrual period, and the denominator is the total stated interest remaining to be paid at the beginning of the accrual period.

Short-term obligations for which no choice is available.

You must include any discount or interest in current income as it accrues for any short-term obligation (other than a tax-exempt obligation) that is:

Effect on basis.

Increase the basis of your obligation by the amount of discount you include in income currently.

Figuring the accrued discount.

Figure the accrued discount by using either the ratable accrual method or the constant yield method discussed in Accrued market discount, earlier.

Government obligations.

For an obligation described above that is a short-term government obligation, the amount you include in your income for the current year is the accrued acquisition discount, if any, plus any other accrued interest payable on the obligation. The acquisition discount is the stated redemption price at maturity minus your basis.

If you choose to use the constant yield method to figure accrued acquisition discount, treat the cost of acquiring the obligation as the issue price. If you choose to use this method, you cannot change your choice.

Nongovernment obligations.

For an obligation listed above that is not a government obligation, the amount you include in your income for the current year is the accrued OID, if any, plus any other accrued interest payable. If you choose the constant yield method to figure accrued OID, apply it by using the obligation's issue price.

Choosing to include accrued acquisition discount instead of OID.

You can choose to report accrued acquisition discount (defined earlier under Government obligations) rather than accrued OID on these short-term obligations. Your choice will apply to the year for which it is made and to all later years and cannot be changed without the consent of the IRS.

You must make your choice by the due date of your return, including extensions, for the first year for which you are making the choice. Attach a statement to your return or amended return indicating:

Choosing to include accrued discount and other interest in current income.

If you acquire short-term discount obligations that are not subject to the rules for current inclusion in income of the accrued discount or other interest, you can choose to have those rules apply. This choice applies to all short-term obligations you acquire during the year and in all later years. You cannot change this choice without the consent of the IRS.

The procedures to use in making this choice are the same as those described for choosing to include acquisition discount instead of OID on nongovernment obligations in current income. However, you should indicate that you are making the choice under section 1282(b)(2) of the Internal Revenue Code.

Also, see the following discussion. If you make the election to report all interest currently as OID, you must use the constant yield method.

Qualified Opportunity Fund (QOF).

Effective December 22, 2017, section 1400Z-2 provides a temporary deferral of inclusion in gross income for capital gains invested in QOFs, and permanent exclusion of capital gains from the sale or exchange of an investment in the QOF if the investment is held for at least 10 years. See the Form 8949 instructions on how to report your election to defer eligible gains invested in a QOF. For additional information, please see Opportunity Zones Frequently Asked Questions available at www.IRS.gov/Newsroom/Opportunity-Zones-Frequently-Asked-Questions.

Qualified Opportunity Investment.

If you held a qualified investment in a qualified opportunity fund (QOF) at any time during the year, you must file your return with Form 8997, Initial and Annual Statement of Qualified Opportunity Fund Investments, attached. See Form 8997 instructions.

Undistributed capital gains of mutual funds and REITs.

Some mutual funds and REITs keep their long-term capital gains and pay tax on them. You must treat your share of these gains as distributions, even though you did not actually receive them. However, they are not included on Form 1099-DIV. Instead, they are reported to you in box 1a of Form 2439.

Form 2439 also will show how much, if any, of the undistributed capital gains is:

The tax paid on these gains by the mutual fund or REIT is shown in box 2 of Form 2439.

Basis adjustment.

Increase your basis in your mutual fund, or your interest in a REIT, by the difference between the gain you report and the credit you claim for the tax paid.

Basis adjustment.

A nondividend distribution reduces the basis of your stock. It is not taxed until your basis in the stock is fully recovered. This nontaxable portion also is called a return of capital; it is a return of your investment in the stock of the company. If you buy stock in a corporation in different lots at different times, and you cannot definitely identify the shares subject to the nondividend distribution, reduce the basis of your earliest purchases first.

When the basis of your stock has been reduced to zero, report any additional nondividend distribution you receive as a capital gain. Whether you report it as a long-term or short-term capital gain depends on how long you have held the stock. See Holding Period in chapter 4.

.For more information on Form 8949 and Schedule D (Form 1040), see Reporting Capital Gains and Losses in chapter 4. Also, see the Instructions for Form 8949 and the Instructions for Schedule D (Form 1040)..

Stock acquired at different times.

If you acquired stock in the same corporation in more than one transaction, you own more than one block of stock in the corporation. If you receive distributions from the corporation in complete liquidation, you must divide the distribution among the blocks of stock you own in the following proportion: the number of shares in that block over the total number of shares you own. Divide distributions in partial liquidation among that part of the stock redeemed in the partial liquidation. After the basis of a block of stock is reduced to zero, you must report the part of any later distribution for that block as a capital gain.

Distributions less than basis.

If the total liquidating distributions you receive are less than the basis of your stock, you may have a capital loss. You can report a capital loss only after you have received the final distribution in liquidation that results in the redemption or cancellation of the stock. Whether you report the loss as a long-term or short-term capital loss depends on how long you held the stock. See Holding Period in chapter 4.

Taxable stock dividends and stock rights.

Distributions of stock dividends and stock rights are taxable to you if any of the following apply.

The term “stock” includes rights to acquire stock, and the term “shareholder” includes a holder of rights or convertible securities.

Constructive distributions.

You must treat certain transactions that increase your proportionate interest in the earnings and profits or assets of a corporation as if they were distributions of stock or stock rights. These constructive distributions are taxable if they have the same result as a distribution described in (2), (3), (4), or (5) of the above discussion.

This treatment applies to a change in your stock's conversion ratio or redemption price, a difference between your stock's redemption price and issue price, a redemption not treated as a sale or exchange of your stock, and any other transaction having a similar effect on your interest in the corporation.

Preferred stock redeemable at a premium.

If you receive preferred stock having a redemption price higher than its issue price, the difference (the redemption premium) generally is taxable as a constructive distribution of additional stock on the preferred stock.

Basis.

Your basis in stock or stock rights received in a taxable distribution is their fair market value when distributed. If you receive stock or stock rights that are not taxable to you, see Stocks and Bonds, later, for information on how to figure their basis.

Fractional shares.

You may not own enough stock in a corporation to receive a full share of stock if the corporation declares a stock dividend. However, with the approval of the shareholders, the corporation may set up a plan in which fractional shares are not issued but instead are sold, and the cash proceeds are given to the shareholders. Any cash you receive for fractional shares under such a plan is treated as an amount realized on the sale of the fractional shares. Report this transaction on Form 8949. Enter your gain or loss, the difference between the cash you receive and the basis of the fractional shares sold, in column (h) of Schedule D (Form 1040) in Part I or Part II, whichever is appropriate.

.Report these transactions on Form 8949 with the correct box checked..

For more information on Form 8949 and Schedule D (Form 1040), see Reporting Capital Gains and Losses in chapter 4. Also, see the Instructions for Form 8949 and the Instructions for Schedule D (Form 1040).

Scrip dividends.

A corporation that declares a stock dividend may issue you a scrip certificate that entitles you to a fractional share. The certificate generally is nontaxable when you receive it. If you choose to have the corporation sell the certificate for you and give you the proceeds, your gain or loss is the difference between the proceeds and the part of your basis in the corporation's stock allocated to the certificate.

However, if you receive a scrip certificate that you can choose to redeem for cash instead of stock, the certificate is taxable when you receive it. You must include its fair market value in income on the date you receive it.

Exempt-interest dividends.

Exempt-interest dividends you receive from a mutual fund or other regulated investment company are not included in your taxable income. (However, see Information reporting requirement, next.) Exempt-interest dividends should be shown in box 12 of Form 1099-DIV.

Information reporting requirement.

Although exempt-interest dividends are not taxable, you must show them on your tax return if you have to file a return. See Reporting tax-exempt interest, earlier.

Alternative minimum tax treatment.

Exempt-interest dividends paid from specified private activity bonds may be subject to the AMT. The exempt-interest dividends subject to the AMT should be shown in box 13 of Form 1099-DIV. See Form 6251 and its instructions for more information.

Dividends on insurance policies.

Insurance policy dividends the insurer keeps and uses to pay your premiums are not taxable. However, you must report as taxable interest income the interest that is paid or credited on dividends left with the insurance company.

If dividends on an insurance contract (other than a modified endowment contract) are distributed to you, they are a partial return of the premiums you paid. Do not include them in your gross income until they are more than the total of all net premiums you paid for the contract. (For information on the treatment of a distribution from a modified endowment contract, see Distribution Before Annuity Starting Date From a Nonqualified Plan under Taxation of Nonperiodic Payments in Pub. 575.) See instructions for the Form 1040 or Form 1040-SR for where to report.

Dividends on veterans' insurance.

Dividends you receive on veterans' insurance policies are not taxable. In addition, interest on dividends left with the Department of Veterans Affairs is not taxable.

Patronage dividends.

Generally, patronage dividends you receive in money from a cooperative organization are included in your income. You should receive Form 1099-PATR, Taxable Distributions Received from Cooperatives.

Do not include in your income patronage dividends you receive on:

These rules are the same whether the cooperative paying the dividend is a taxable or tax-exempt cooperative.

Alaska Permanent Fund dividends.

Do not report these amounts as dividends. Instead, include these amounts on Schedule 1 (Form 1040), line 8g.

Forms 1099-INT and 1099-OID.

You should receive a copy of Form 1099-INT or Form 1099-OID generally by January 31, 2024. See the General Instructions for Certain Information Returns for information on when you should receive your copy of Form 1099-INT or Form 1099-OID and a written statement providing additional information. The statement should contain enough information about the CDO to enable you to figure your accrual of market discount or amortizable bond premium.

Form 1099-INT shows the interest income paid to you for the period you held the CDO.

Form 1099-OID shows the OID accrued to you and the interest, if any, paid to you for the period you held the CDO. You should not need to make any adjustments to the amounts reported even if you held the CDO for only a part of the calendar year. However, if you bought the CDO at a premium or acquisition premium, see Refiguring OID shown on Form 1099-OID, earlier.

If you did not receive a Form 1099, see You may not get a Form 1099, earlier.

Clubs formed before 1997.

Before 1997, the rules for determining how an investment club is treated were different from those explained in the following discussions. An investment club that existed before 1997 is treated for later years the same way it was treated before 1997, unless it chooses to be treated a different way under the new rules. To make that choice, the club must file Form 8832, Entity Classification Election.

Disclosure of reportable transactions.

You must disclose information for each reportable transaction in which you participate. See Reportable Transaction Disclosure Statement, later.

Material advisors with respect to any reportable transaction must disclose information about the transaction on Form 8918, Material Advisor Disclosure Statement. To determine whether you are a material advisor to a transaction, see the Instructions for Form 8918.

Material advisors will receive a reportable transaction number for the disclosed reportable transaction. They must provide this number to all persons to whom they acted as a material advisor. They must provide the number at the time the transaction is entered into. If they do not have the number at that time, they must provide it within 60 days from the date the number is mailed to them. For information on penalties for failure to disclose and failure to maintain lists, see sections 6707, 6707A, and 6708.

Requirement to maintain list.

Material advisors must maintain a list of persons to whom they provide material aid, assistance, or advice on any reportable transaction. The list must be available for inspection by the IRS, and the information required to be included on the list must generally be kept for 7 years. See Regulations section 301.6112-1 for more information (including what information is required to be included on the list).

Confidentiality privilege.

The confidentiality privilege between you and a federally authorized tax practitioner does not apply to written communications made after October 21, 2004, regarding the promotion of your direct or indirect participation in any tax shelter.

Appraisal requirement for donated property.

If you claim a deduction of more than $5,000 for an item or group of similar items of donated property, you must generally get a qualified appraisal. See section 170 and Form 8283 for more information. If you claim a deduction of more than $500,000 for the donated property, you must generally attach the qualified appraisal to your return. If you file electronically, see Form 8453, U.S. Individual Income Tax Transmittal for an IRS e-file Return, and its instructions. See Pub. 561 for information about appraisals.

Passive activity loss and credit limits.

The passive activity loss and credit rules limit the amount of losses and credits that can be claimed from passive activities and limit the amount that can offset nonpassive income, such as certain portfolio income from investments. See Pub. 925 for information about income, losses, and credits from passive activities.

Interest on penalties.

If you are assessed an accuracy-related or civil fraud penalty (as discussed under Penalties, later), interest will be imposed on the amount of the penalty from the due date of the return (including any extensions) to the date you pay the penalty.

Accounting method restriction.

Tax shelters generally cannot use the cash method of accounting.

Uniform capitalization rules.

The uniform capitalization rules generally apply to producing property or acquiring it for resale. Under those rules, the direct cost and part of the indirect cost of the property must be capitalized or included in inventory. See Pub. 538 for uniform capitalization rules.

Denial of deduction for interest on an underpayment due to a reportable transaction.

You cannot deduct any interest you paid or accrued on any part of an underpayment of tax due to an understatement arising from a reportable transaction if the relevant facts affecting the tax treatment of the item are not adequately disclosed. See Reportable transaction, later. This rule applies to reportable transactions entered into in tax years beginning after October 22, 2004.

Accuracy-related penalties.

An accuracy-related penalty of 20% can be imposed for underpayments of tax due to:

If you are charged an accuracy-related penalty, interest will be imposed on the amount of the penalty from the due date of the return (including extensions) to the date you pay the penalty.

The 20% penalties do not apply to any underpayment attributable to a reportable transaction understatement subject to an accuracy-related penalty (discussed later).

Negligence or disregard of rules or regulations.

The penalty for negligence or disregard of rules or regulations is imposed only on the part of the underpayment due to negligence or disregard of rules or regulations. Generally, the penalty will not be charged if you can show you had reasonable cause for understating your tax and that you acted in good faith.

Negligence includes any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue Code. It also includes any failure to keep adequate books and records. A return position that has a reasonable basis is not negligence. See Regulations section 1.6662-3(b)(1).

Disregard includes any careless, reckless, or intentional disregard of rules or regulations.

The penalty for disregard of rules and regulations can be avoided if all the following are true.

Substantial understatement of tax.

An understatement is considered to be substantial if it is more than the greater of:

For items other than tax shelters, you can file Form 8275 or Form 8275-R to disclose items that could cause a substantial understatement of income tax. In that way, you can avoid the substantial understatement penalty if you have a reasonable basis for your position on the tax issue. Disclosure of the tax shelter item on a tax return does not reduce the amount of the understatement.

Also, the understatement penalty will not be imposed if you can show there was reasonable cause for the underpayment caused by the understatement and that you acted in good faith. An important factor in establishing reasonable cause and good faith will be the extent of your effort to determine your proper tax liability under the law.

Substantial valuation misstatement.

In general, you are liable for a 20% penalty for a substantial valuation misstatement if any the following are true.

You may be assessed a penalty of 40% for a gross valuation misstatement. If you misstate the value or the adjusted basis of property by 200% or more of the amount determined to be correct, you will be assessed a penalty of 40%, instead of 20%, of the amount you underpaid because of the gross valuation misstatement. The penalty rate is also 40% if the property's correct value or adjusted basis is zero.

Transaction lacking economic substance.

The economic substance doctrine only applies to an individual that entered into a transaction in connection with a trade or business or an activity engaged in for the production of income. A transaction has economic substance for you as an individual taxpayer only if:

For purposes of determining whether economic substance exists, a transaction's profit potential will only be taken into account if the present value of the reasonably expected pre-tax profit from the transaction is substantial compared to the present value of the expected net tax benefits that would be allowed if the transaction were respected.

If any part of your underpayment is due to any disallowance of claimed tax benefits by reason of a transaction lacking economic substance or failing to meet the requirements of any similar rule of law, that part of your underpayment will be subject to the 20% accuracy-related penalty even if you had a reasonable cause and acted in good faith concerning that part.

Additionally, the penalty increases to 40% if you do not adequately disclose, on your return or in a statement attached to your return, the relevant facts affecting the tax treatment of a transaction that lacks economic substance. Relevant facts include any facts affecting the tax treatment of the transaction.

.You may be subject to a 20% penalty based on the excessive amount of an erroneous claim for an income tax refund or credit. If that excessive amount results from a transaction found to be lacking economic substance, it will NOT be treated as due to reasonable cause. .

Undisclosed foreign financial asset understatement.

For tax years beginning after March 18, 2010, you may be liable for a 40% penalty for an understatement of your tax liability due to an undisclosed foreign financial asset. An undisclosed foreign financial asset is any asset for which an information return, required to be provided under sections 6038, 6038B, 6038D, 6046A, or 6048 for any tax year, is not provided. The penalty applies to any part of an underpayment related to the following undisclosed foreign financial assets.

.Instead of, or in addition to, Form 8275 or 8275-R, you may have to file Form 8938, Statement of Specified Foreign Financial Assets, with your tax return. See the Instructions for Form 8938 for details..

Penalty for incorrect appraisals.

The person who prepares an appraisal of the value of property may have to pay a penalty if:

Penalty for failure to disclose a reportable transaction.

If you fail to include any required information regarding a reportable transaction on a return or statement, you may have to pay a penalty of 75% of the decrease in tax shown on your return as a result of such transaction (or that would have resulted if the transaction were respected for federal tax purposes). See Reportable transaction, earlier. For an individual, the minimum penalty is $5,000 and the maximum is $10,000 (or $100,000 for a listed transaction). This penalty is in addition to any other penalty that may be imposed.

The IRS may rescind or abate the penalty for failing to disclose a reportable transaction under certain limited circumstances but cannot rescind the penalty for failing to disclose a listed transaction. See Revenue Procedure 2007-21, as updated by Treasury Decision 9686 and Announcement 2016-1, for information on rescission.

Accuracy-related penalty for a reportable transaction understatement.

If you have a reportable transaction understatement, you may have to pay a penalty equal to 20% of the amount of that understatement. This applies to any item due to a listed transaction or other reportable transaction with a significant purpose of avoiding or evading federal income tax. The penalty is 30% rather than 20% for the part of any reportable transaction understatement if the transaction was not properly disclosed.

This penalty does not apply to the part of an understatement on which the fraud penalty, gross valuation misstatement penalty, or penalty for nondisclosure of noneconomic substance transactions is imposed.

Civil fraud penalty.

If any underpayment of tax on your return is due to fraud, a penalty of 75% of the underpayment will be added to your tax.

Joint return.

The fraud penalty on a joint return applies to a spouse only if some part of the underpayment is due to the fraud of that spouse.

Failure to pay tax.

If a deficiency is assessed and is not paid within 10 days of the demand for payment, you may be penalized with up to a 25% addition to tax if the failure to pay continues.

Investment property.

Property held for investment includes property that produces interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business. It also includes property that produces gain or loss (not derived in the ordinary course of a trade or business) from the sale or trade of property producing these types of income or held for investment (other than an interest in a passive activity). Investment property also includes an interest in a trade or business activity in which you did not materially participate (other than a passive activity).

Partners, shareholders, and beneficiaries.

To determine your investment interest, combine your share of investment interest from a partnership, S corporation, estate, or trust with your other investment interest.

Constant yield method.

Figure the bond premium amortization for each accrual period as follows.

Step 1: Determine your yield.

Your yield is the discount rate that, when used in figuring the present value of all remaining payments to be made on the bond (including payments of qualified stated interest), produces an amount equal to your basis in the bond. Figure the yield as of the date you got the bond. It must be constant over the term of the bond and must be figured to at least two decimal places when expressed as a percentage.

If you do not know the yield, consult your broker or tax advisor. Databases available to them are likely to show the yield at the date of purchase.

Step 2: Determine the accrual periods.