Paying Taxes on Bonds and Interest Income

Conservative savers oftentimes gravitate towards the bond market for fixed income and the relative safety of principal. As with all investments, taxes and inflation must both be taken into consideration when calculating total bond returns. In recent years, the real returns on bonds have stubbornly remained deeply negative.

Prepare Tax Paperwork

Your brokerage will compile and submit 1099 forms to both the IRS and your address on record at tax time. The 1099 will categorize bond market activity according to interest income and realized capital gains. This information will be transferred directly onto Schedule B, Schedule D, and Form 1040 IRS tax filings.

Interest Income

Bond interest income is typically taxable at ordinary income tax rates. For 2021, ordinary income is taxed at 10, 12, 22, 24, 32, 35, and 37-percent rates. The U.S. tax code is progressive, which means that higher earners are taxed at higher brackets.

For a single filer, his marginal bond interest will be taxed at 35%, if he reports taxable income above $209,426. Tax rates have increased with this latest change in Administration.

Realized Capital Gains and Losses

You will owe taxes on realized capital gains when you sell bonds at a profit. Here, realized capital gains are classified as either short or long-term capital gains. For this timeline, a one-year holding period is the breakpoint. Short-term capital gains are taxed as ordinary income, while long-term capital gains are taxed at 0, 15, and 20-percent rates.

Be further advised that you may write off up to $3,000 worth of realized capital losses from your taxable income if your bond market investments fail to perform. Losses above the $3,000 threshold can be carried forward and written off in subsequent years. These deductions are not applicable to wash sales – or rapid-fire trading.

Investment Strategy

A proper balance of risks versus rewards does not always translate into a minimal tax bill. Do not purposefully hold onto a losing bond investment for the sole purpose of taking a tax write off. Bonds are highly susceptible to inflationary risks, which devastate purchasing power. Stock market investments are the best counters against inflation.