Page 59 - 2020 Publication 17

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The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.
reduce your basis for distributions that are ex- Interest subject to penalty for early with- U.S. obligations. Interest on U.S. obligations
empt-interest dividends. drawal. If you withdraw funds from a deferred issued by any agency or instrumentality of the
interest account before maturity, you may have United States, such as U.S. Treasury bills,
Information-reporting requirement. Al- to pay a penalty. You must report the total notes, and bonds, is taxable for federal income
though exempt-interest dividends aren't taxa- amount of interest paid or credited to your ac- tax purposes.
ble, you must show them on your tax return if count during the year, without subtracting the Interest on tax refunds. Interest you receive
you have to file. This is an information-reporting penalty. See Penalty on early withdrawal of sav-
requirement and doesn't change the exempt-in- ings in chapter 1 of Pub. 550 for more informa- on tax refunds is taxable income.
terest dividends into taxable income. tion on how to report the interest and deduct the Interest on condemnation award. If the con-
penalty. demning authority pays you interest to compen-
Note. Exempt-interest dividends paid from sate you for a delay in payment of an award, the
specified private activity bonds may be subject Money borrowed to invest in certificate interest is taxable.
to the alternative minimum tax. See Alternative of deposit. The interest expense you pay on
Minimum Tax (AMT) in chapter 13 for more in- money borrowed from a bank or savings institu- Installment sale payments. If a contract for
formation. Chapter 1 of Pub. 550 contains a dis- tion to meet the minimum deposit required for a the sale or exchange of property provides for
cussion on private activity bonds under State or certificate of deposit from the institution and the deferred payments, it also usually provides for
Local Government Obligations. interest you earn on the certificate are two sep- interest payable with the deferred payments.
Generally, that interest is taxable when you re-
Interest on VA dividends. Interest on insur- arate items. You must report the total interest ceive it. If little or no interest is provided for in a
income you earn on the certificate in your in-
ance dividends left on deposit with the Depart- come. If you itemize deductions, you can de- deferred payment contract, part of each pay-
ment of Veterans Affairs (VA) isn't taxable. This duct the interest you pay as investment interest, ment may be treated as interest. See Unstated
includes interest paid on dividends on conver- up to the amount of your net investment in- Interest and Original Issue Discount in Pub.
ted United States Government Life Insurance come. See Interest Expenses in chapter 3 of 537, Installment Sales.
and on National Service Life Insurance policies. Pub. 550. Interest on annuity contract. Accumulated
Individual retirement arrangements (IRAs). interest on an annuity contract you sell before
Interest on a Roth IRA generally isn't taxable. Example. You deposited $5,000 with a its maturity date is taxable.
Interest on a traditional IRA is tax deferred. You bank and borrowed $5,000 from the bank to
generally don't include interest earned in an IRA make up the $10,000 minimum deposit required Usurious interest. Usurious interest is interest
in your income until you make withdrawals from to buy a 6-month certificate of deposit. The cer- charged at an illegal rate. This is taxable as in-
the IRA. See chapter 9. tificate earned $575 at maturity in 2020, but you terest unless state law automatically changes it
received only $265, which represented the to a payment on the principal.
Taxable Interest $575 you earned minus $310 interest charged Interest income on frozen deposits. Ex-
on your $5,000 loan. The bank gives you a
Form 1099-INT for 2020 showing the $575 in- clude from your gross income interest on frozen
Taxable interest includes interest you receive terest you earned. The bank also gives you a deposits. A deposit is frozen if, at the end of the
from bank accounts, loans you make to others, statement showing that you paid $310 of inter- year, you can't withdraw any part of the deposit
and other sources. The following are some est for 2020. You must include the $575 in your because:
sources of taxable interest. income. If you itemize your deductions on • The financial institution is bankrupt or in-
Dividends that are actually interest. Certain Schedule A (Form 1040), you can deduct $310, solvent, or
distributions commonly called dividends are ac- subject to the net investment income limit. • The state where the institution is located
tually interest. You must report as interest Gift for opening account. If you receive non- has placed limits on withdrawals because
so-called dividends on deposits or on share ac- cash gifts or services for making deposits or for other financial institutions in the state are
counts in: opening an account in a savings institution, you bankrupt or insolvent.
• Cooperative banks, may have to report the value as interest. The amount of interest you must exclude is
For deposits of less than $5,000, gifts or
• Credit unions, services valued at more than $10 must be re- the interest that was credited on the frozen de-
posits minus the sum of:
• Domestic building and loan associations, ported as interest. For deposits of $5,000 or • The net amount you withdrew from these
• Domestic savings and loan associations, more, gifts or services valued at more than $20 deposits during the year, and
• Federal savings and loan associations, must be reported as interest. The value is deter- • The amount you could have withdrawn as
mined by the cost to the financial institution.
and of the end of the year (not reduced by any
• Mutual savings banks. Example. You open a savings account at penalty for premature withdrawals of a time
The “dividends” will be shown as interest in- your local bank and deposit $800. The account deposit).
earns $20 interest. You also receive a $15 cal-
come on Form 1099-INT. culator. If no other interest is credited to your If you receive a Form 1099-INT for interest in-
come on deposits that were frozen at the end of
Money market funds. Money market funds account during the year, the Form 1099-INT 2020, see Frozen deposits under How To Re-
pay dividends and are offered by nonbank fi- you receive will show $35 interest for the year. port Interest Income in chapter 1 of Pub. 550 for
nancial institutions, such as mutual funds and You must report $35 interest income on your tax information about reporting this interest income
stock brokerage houses. Generally, amounts return. exclusion on your tax return.
you receive from money market funds should Interest on insurance dividends. Interest on The interest you exclude is treated as credi-
be reported as dividends, not as interest. insurance dividends left on deposit with an in- ted to your account in the following year. You
Certificates of deposit and other deferred surance company that can be withdrawn annu- must include it in income in the year you can
interest accounts. If you open any of these ally is taxable to you in the year it is credited to withdraw it.
accounts, interest may be paid at fixed intervals your account. However, if you can withdraw it
of 1 year or less during the term of the account. only on the anniversary date of the policy (or Example. $100 of interest was credited on
You must generally include this interest in your other specified date), the interest is taxable in your frozen deposit during the year. You with-
income when you actually receive it or are enti- the year that date occurs. drew $80 but couldn't withdraw any more as of
tled to receive it without paying a substantial Prepaid insurance premiums. Any increase the end of the year. You must include $80 in
penalty. The same is true for accounts that ma- in the value of prepaid insurance premiums, ad- your income and exclude $20 from your income
ture in 1 year or less and pay interest in a single vance premiums, or premium deposit funds is for the year. You must include the $20 in your
payment at maturity. If interest is deferred for interest if it is applied to the payment of premi- income for the year you can withdraw it.
more than 1 year, see Original Issue Discount ums due on insurance policies or made availa- Bonds traded flat. If you buy a bond at a dis-
(OID), later. ble for you to withdraw. count when interest has been defaulted or

Chapter 6 Interest Income Page 55