[Code of Federal Regulations]
[Title 26, Volume 2]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.61-7]

[Page 42-43]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.61-7  Interest.

    (a) In general. As a general rule, interest received by or credited 
to the taxpayer constitutes gross income and is fully taxable. Interest 
income includes interest on savings or other bank deposits; interest on 
coupon bonds; interest on an open account, a promissory note, a 
mortgage, or a corporate bond or debenture; the interest portion of a 
condemnation award; usurious interest (unless by State law it is 
automatically converted to a payment on the principal); interest on 
legacies; interest on life insurance proceeds held under an agreement to 
pay interest thereon; and interest on refunds of Federal taxes. For 
rules determining the taxable year in which interest, including interest 
accrued or constructively received, is included in gross income, see 
section 451 and the regulations thereunder. For the inclusion of

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interest in income for the purpose of the retirement income credit, see 
section 37 and the regulations thereunder. For credit of tax withheld at 
source on interest on tax-free covenant bonds, see section 32 and the 
regulations thereunder. For rules relating to interest on certain 
deferred payments, see section 483 and the regulations thereunder.
    (b) Interest on Government obligations--(1) Wholly tax-exempt 
interest. Interest upon the obligations of a State, Territory, or a 
possession of the United States, or any political subdivision of any of 
the foregoing, or of the District of Columbia, is wholly exempt from 
tax. Interest on certain United States obligations issued before March 
1, 1941, is exempt from tax to the extent provided in the acts of 
Congress authorizing the various issues. See section 103 and the 
regulations thereunder.
    (2) Partially tax-exempt interest. Interest earned on certain United 
States obligations is partly tax exempt and partly taxable. For example, 
the interest on United States Treasury bonds issued before March 1, 
1941, to the extent that the principal of such bonds exceeds $5,000, is 
exempt from normal tax but is subject to surtax. See sections 35 and 
103, and the regulations thereunder.
    (3) Fully taxable interest. In general, interest on United States 
obligations issued on or after March 1, 1941, and obligations issued by 
any agency or instrumentality of the United States after that date, is 
fully taxable; but see section 103 and the regulations thereunder. A 
taxpayer using the cash receipts and disbursements method of accounting 
who owns United States savings bonds issued at a discount has an 
election as to when he will report the interest; see section 454 and the 
regulations thereunder.
    (c) Obligations bought at a discount; bonds bought when interest 
defaulted or accrued. When notes, bonds, or other certificates of 
indebtedness are issued by a corporation or the Government at a discount 
and are later redeemed by the debtor at the face amount, the original 
discount is interest, except as otherwise provided by law. See also 
paragraph (b) of this section for the rules relating to Government 
bonds. If a taxpayer purchases bonds when interest has been defaulted or 
when the interest has accrued but has not been paid, any interest which 
is in arrears but has accrued at the time of purchase is not income and 
is not taxable as interest if subsequently paid. Such payments are 
returns of capital which reduce the remaining cost basis. Interest which 
accrues after the date of purchase, however, is taxable interest income 
for the year in which received or accrued (depending on the method of 
accounting used by the taxpayer).
    (d) Bonds sold between interest dates; amounts received in excess of 
original issue discount; interest on life insurance. When bonds are sold 
between interest dates, part of the sales price represents interest 
accrued to the date of the sale and must be reported as interest income. 
Amounts received in excess of the original issue discount upon the 
retirement or sale of a bond or other evidence of indebtedness may under 
some circumstances constitute capital gain instead of ordinary income. 
See section 1232 and the regulations thereunder. Interest payments on 
amounts payable as employees' death benefits (whether or not section 
101(b) applies thereto) and on the proceeds of life insurance policies 
payable by reason of the insured's death constitute gross income under 
some circumstances. See section 101 and the regulations thereunder for 
details. Where accrued interest on unwithdrawn insurance policy 
dividends is credited annually and is subject to withdrawal annually by 
the taxpayer, such interest credits constitute gross income to such 
taxpayer as of the year of credit. However, if under the terms of the 
insurance policy the interest on unwithdrawn policy dividends is subject 
to withdrawal only on the anniversary date of the policy (or some other 
date specified therein), then such interest shall constitute gross 
income to the taxpayer for the taxable year in which such anniversary 
date (or other specified date) falls.

[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6723, 29 FR 
5342, Apr. 21, 1964; T.D. 6873, 31 FR 941, Jan. 25, 1966]

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