IRS Pub. 17, Your Federal Income Tax
When you report your interest income depends on whether you use the
cash method or an accrual method to report income.
Cash method.
If you use this method, you generally report your interest income
in the year in which you actually or constructively receive it. Most
individual taxpayers use this method. However, there are special rules
for reporting the discount on certain debt instruments. See U.S.
Savings Bonds, and Original Issue Discount, earlier.
Example.
On September 1, 1996, you loaned a friend $2,000 at 12%, compounded
annually. You are not in the business of lending money. The note
stated that principal and interest would be due on August 31, 1998. In
1998, you received $2,508.80 ($2,000 principal and $508.80 interest).
If you use the cash method, you must include in income on your 1998
return the $508.80 interest you received in that year.
Constructive receipt.
You constructively receive income when it is credited to your
account or made available to you. You do not need to have physical
possession of it. For example, you are considered to receive interest,
dividends, or other earnings on any deposit or account in a bank,
savings and loan, or similar financial institution, or interest on
life insurance policy dividends left to accumulate, when they are
credited to your account and subject to your withdrawal. This is true
even if they are not yet entered in your passbook.
You constructively receive income on the deposit or account even if
you must:
- Make withdrawals in multiples of even amounts,
- Give a notice to withdraw before making the
withdrawal,
- Withdraw all or part of the account to withdraw the
earnings, or
- Pay a penalty on early withdrawals, unless the interest you
are to receive on an early withdrawal or redemption is substantially
less than the interest payable at maturity.
Accrual method.
If you use an accrual method, you report your interest income when
you earn it, whether or not you have received it. Interest is earned
over the term of the debt instrument.
Example.
If, in the previous example, you use an accrual method, you must
include the interest in your income as you earn it. You would report
the interest as follows: 1996, $80; 1997, $249.60; and 1998, $179.20.
Coupon bonds.
Interest on coupon bonds is taxable in the year the coupon becomes
due and payable. It does not matter when you mail the coupon for
payment.
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