John M. Hoffman & Associates CPAs

Frequently Asked Questions

Investment Income (Interest & Dividends)

 

What is accrued interest purchased and what is the tax implication?

Most bonds pay interest every six months. This is the coupon date. Let's say that you purchase a $10,000 bond paying 6% interest that will mature on September 30, 2015. Every March 31 and September 30 until (and including) September 30, 2015 the bond issuer pays interest at the stated rate of the bond (the coupon rate). In this case that amount is $300 (6% times $10,000 for one half a year).

If you buy that bond on September 15, you will be the one that gets that full coupon payment representing six months of interest on September 30. Sounds like a great deal. Not so fast. Not that it is a good deal or a bad deal but what occurs is a fair deal. When you buy that bond, you will pay the seller the interest from the previous coupon date through the purchase date. In this case essentially 5 and 1/2 months of interest.

This amount that you pay is the accrued interest purchased. In this case that amount would be approximately $250. In a perfectly simple world, you would pay $10,250 to acquire the bond, $250 of that being for the accrued interest.

On September 30, you receive a coupon payment for $300. This $300 payment is reported as interest income to you. At tax time we will want to report the $250 of accrued interest purchased as an offset to your $300 of interest income, essentially netting out to the $50 that you actually received.

In the subsequent year things will be very simple, two coupon payments of $300 each and the resulting $600 being the interest received and taxable for that year.