Table of Contents
- Reminder
- Introduction
- Useful Items - You may want to see:
- General Information
- Taxable Interest
- Interest subject to penalty for early withdrawal.
- Money borrowed to invest in certificate of deposit.
- U.S. Savings Bonds
- Education Savings Bond Program
- U.S. Treasury Bills, Notes, and Bonds
- Bonds Sold Between Interest Dates
- Insurance
- State or Local Government Obligations
- Original Issue Discount (OID)
- When To Report Interest Income
- How To Report Interest Income
Foreign-source income. If you are a U.S. citizen with interest income from sources outside the United States (foreign income), you must report that income on your tax return unless it is exempt by U.S. law. This is true whether you reside inside or outside the United States and whether or not you receive a Form 1099 from the foreign payer.
This chapter discusses the following topics.
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Different types of interest income.
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What interest is taxable and what interest is nontaxable.
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When to report interest income.
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How to report interest income on your tax return.
In general, any interest you receive or that is credited to your account and can be withdrawn is taxable income. Exceptions to this rule are discussed later in this chapter.
You may be able to deduct expenses you have in earning this income on Schedule A (Form 1040) if you itemize your deductions. See chapter 28.
Publication
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537 Installment Sales
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550 Investment Income and Expenses
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1212 Guide to Original Issue Discount (OID) Instruments
Form (and Instructions)
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Schedule B (Form 1040) Interest and Ordinary Dividends
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Schedule 1 (Form 1040A) Interest and Ordinary Dividends for Form 1040A Filers
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3115 Application for Change in Accounting Method
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8815 Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989
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8818 Optional Form To Record Redemption of Series EE and I U.S. Savings Bonds Issued After 1989
A few items of general interest are covered here.
Recordkeeping. You should keep a list showing sources and amounts of interest received during the year. Also, keep the forms you receive that show your interest income (Forms 1099-INT, for example) as an important part of your records.
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The child was under age 18 at the end of 2007. A child born on January 1, 1990, is considered to be age 18 at the end of 2007.
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The child had more than $1,700 of investment income (such as taxable interest and dividends) and has to file a tax return.
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Either parent was alive at the end of 2007.
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The savings account legally belongs to the child.
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The parents are not legally permitted to use any of the funds to support the child.
Note.
Exempt-interest dividends paid from specified private activity bonds may be subject to the alternative minimum tax. See Alternative Minimum Tax in chapter 30 for more information. Chapter 1 of Publication 550 contains a discussion on private activity bonds under State or Local Government Obligations.
Taxable interest includes interest you receive from bank accounts, loans you make to others, and other sources. The following are some other sources of taxable interest.
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Cooperative banks,
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Credit unions,
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Domestic building and loan associations,
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Domestic savings and loan associations,
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Federal savings and loan associations, and
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Mutual savings banks.
Example.
You deposited $5,000 with a bank and borrowed $5,000 from the bank to make up the $10,000 minimum deposit required to buy a 6-month certificate of deposit. The certificate earned $575 at maturity in 2007, but you received only $265, which represented the $575 you earned minus $310 interest charged on your $5,000 loan. The bank gives you a Form 1099-INT for 2007 showing the $575 interest you earned. The bank also gives you a statement showing that you paid $310 interest for 2007. You must include the $575 in your income. If you itemize your deductions on Schedule A (Form 1040), you can deduct $310, subject to the net investment income limit.
Example.
You open a savings account at your local bank and deposit $800. The account earns $20 interest. You also receive a $15 calculator. If no other interest is credited to your account during the year, the Form 1099-INT you receive will show $35 interest for the year. You must report $35 interest income on your tax return.
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The financial institution is bankrupt or insolvent, or
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The state where the institution is located has placed limits on withdrawals because other financial institutions in the state are bankrupt or insolvent.
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The net amount you withdrew from these deposits during the year, and
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The amount you could have withdrawn as of the end of the year (not reduced by any penalty for premature withdrawals of a time deposit).
Example.
$100 of interest was credited on your frozen deposit during the year. You withdrew $80 but could not withdraw any more as of the end of the year. You must include $80 in your income and exclude $20 from your income for the year. You must include the $20 in your income for the year you can withdraw it.
This section provides tax information on U.S. savings bonds. It explains how to report the interest income on these bonds and how to treat transfers of these bonds.
For other information on U.S. savings bonds, write to:
For series EE and I:
Bureau of the Public Debt
Division of Customer Assistance
P.O. Box 7012
Parkersburg, WV 26106-7012
For series HH/H:
Bureau of the Public Debt
Division of Customer Assistance
P.O. Box 2186
Parkersburg, WV 26106-2186
Or, on the Internet, visit:
www.treasurydirect.gov/indiv/products/products.htm.
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Method 1. Postpone reporting the interest until the earlier of the year you cash or dispose of the bonds or the year they mature. (However, see Savings bonds traded , later.)
Note. Series E bonds issued in 1977 matured in 2007. If you have used method 1, you generally must report the interest on these bonds on your 2007 return. -
Method 2. Choose to report the increase in redemption value as interest each year.
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You have typed or printed at the top: “Change in Method of Accounting Under Section 6.01 of the Appendix of Rev. Proc. 2002-9 (or later update).”
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It includes your name and social security number under the label in (1).
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It identifies the savings bonds for which you are requesting this change.
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It includes your agreement to
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Report all interest on any bonds acquired during or after the year of change when the interest is realized upon disposition, redemption, or final maturity, whichever is earliest, and
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Report all interest on the bonds acquired before the year of change when the interest is realized upon disposition, redemption, or final maturity, whichever is earliest, with the exception of the interest reported in prior tax years.
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It includes your signature.
Internal Revenue Service
Attention: CC:IT&A (Automatic Rulings Branch)
P.O. Box 7604
Benjamin Franklin Station
Washington, DC 20044
Internal Revenue Service
Attention: CC:IT&A (Automatic Rulings Branch)
1111 Constitution Avenue, NW
Washington, DC 20224
IF ... | THEN the interest must be reported by ... |
you buy a bond in your name and the name of another person as co-owners, using only your own funds | you. |
you buy a bond in the name of another person, who is the sole owner of the bond | the person for whom you bought the bond. |
you and another person buy a bond as co-owners, each contributing part of the purchase price | both you and the other co-owner, in proportion to the amount each paid for the bond. |
you and your spouse, who live in a community property state, buy a bond that is community property | you and your spouse. If you file separate returns, both you and your spouse generally report one-half of the interest. |
Example 1.
You and your spouse each spent an equal amount to buy a $1,000 series EE savings bond. The bond was issued to you and your spouse as co-owners. You both postpone reporting interest on the bond. You later have the bond reissued as two $500 bonds, one in your name and one in your spouse's name. At that time neither you nor your spouse has to report the interest earned to the date of reissue.
Example 2.
You bought a $1,000 series EE savings bond entirely with your own funds. The bond was issued to you and your spouse as co-owners. You both postpone reporting interest on the bond. You later have the bond reissued as two $500 bonds, one in your name and one in your spouse's name. You must report half the interest earned to the date of reissue.
Example.
In 2004, you traded series EE bonds (on which you postponed reporting the interest) for $2,500 in series HH bonds and $223 in cash. You reported the $223 as taxable income in 2004, the year of the trade. At the time of the trade, the series EE bonds had accrued interest of $523 and a redemption value of $2,723. You hold the series HH bonds until maturity, when you receive $2,500. You must report $300 as interest income in the year of maturity. This is the difference between their redemption value, $2,500, and your cost, $2,200 (the amount you paid for the series EE bonds). (It is also the difference between the accrued interest of $523 on the series EE bonds and the $223 cash received on the trade.)
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You chose to report the increase in the redemption value of the bond each year. The interest shown on your Form 1099-INT will not be reduced by amounts previously included in income.
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You received the bond from a decedent. The interest shown on your Form 1099-INT will not be reduced by any interest reported by the decedent before death, or on the decedent's final return, or by the estate on the estate's income tax return.
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Ownership of the bond was transferred. The interest shown on your Form 1099-INT will not be reduced by interest that accrued before the transfer.
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You were named as a co-owner and the other co-owner contributed funds to buy the bond. The interest shown on your Form 1099-INT will not be reduced by the amount you received as nominee for the other co-owner. (See Co-owners , earlier in this chapter, for more information about the reporting requirements.)
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You received the bond in a taxable distribution from a retirement or profit-sharing plan. The interest shown on your Form 1099-INT will not be reduced by the interest portion of the amount taxable as a distribution from the plan and not taxable as interest. (This amount is generally shown on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., for the year of distribution.)
You may be able to exclude from income all or part of the interest you receive on the redemption of qualified U.S. savings bonds during the year if you pay qualified higher educational expenses during the same year. This exclusion is known as the Education Savings Bond Program.
You do not qualify for this exclusion if your filing status is married filing separately.
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Tax-free part of scholarships and fellowships (see Scholarships and fellowships in chapter 12).
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Expenses used to figure the tax-free portion of distributions from a Coverdell ESA.
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Expenses used to figure the tax-free portion of distributions from a qualified tuition program.
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Any tax-free payments (other than gifts or inheritances) received for educational expenses, such as
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Veterans' educational assistance benefits,
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Qualified tuition reductions, or
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Employer-provided educational assistance.
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Any expense used in figuring the Hope and lifetime learning credits.
Example.
In February 2007, Mark and Joan, a married couple, cashed a qualified series EE U.S. savings bond they bought in April 1996. They received proceeds of $7,512 representing principal of $5,000 and interest of $2,512. In 2007, they paid $4,000 of their daughter's college tuition. They are not claiming an education credit for that amount, and their daughter does not have any tax-free educational assistance. They can exclude $1,338 ($2,512 × ($4,000 ÷ $7,512)) of interest in 2007. They must pay tax on the remaining $1,174 ($2,512 − $1,338) interest.
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$65,600 to $80,600 for taxpayers filing single or head of household, and
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$98,400 to $128,400 for married taxpayers filing jointly or for a qualifying widow(er) with dependent child.
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Foreign earned income exclusion,
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Foreign housing exclusion and deduction,
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Exclusion of income for bona fide residents of American Samoa,
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Exclusion for income from Puerto Rico,
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Exclusion for adoption benefits received under an employer's adoption assistance program,
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Deduction for tuition and fees,
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Deduction for student loan interest, and
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Deduction for domestic production activities.
Recordkeeping. If you claim the interest exclusion, you must keep a written record of the qualified U.S. savings bonds you redeem. Your record must include the serial number, issue date, face value, and total redemption proceeds (principal and interest) of each bond. You can use Form 8818, Optional Form To Record Redemption of Series EE and I U.S. Savings Bonds Issued After 1989, to record this information. You should also keep bills, receipts, canceled checks, or other documentation that shows you paid qualified higher educational expenses during the year.
Treasury bills, notes, and bonds are direct debts (obligations) of the U.S. Government.
For other information on Treasury notes or bonds, write to:
Bureau of The Public Debt
P.O. Box 7015
Parkersburg, WV 26106–7015
Or, on the Internet, visit: www.treasurydirect.gov/indiv/indiv.htm
For information on series EE, series I, and series HH savings bonds, see U.S. Savings Bonds , earlier.
If you sell a bond between interest payment dates, part of the sales price represents interest accrued to the date of sale. You must report that part of the sales price as interest income for the year of sale.
If you buy a bond between interest payment dates, part of the purchase price represents interest accrued before the date of purchase. When that interest is paid to you, treat it as a return of your capital investment, rather than interest income, by reducing your basis in the bond. See Accrued interest on bonds under How To Report Interest Income in chapter 1 of Publication 550 for information on reporting the payment.
Life insurance proceeds paid to you as beneficiary of the insured person are usually not taxable. But if you receive the proceeds in installments, you must usually report a part of each installment payment as interest income.
For more information about insurance proceeds received in installments, see Publication 525, Taxable and Nontaxable Income.
Interest on a bond used to finance government operations generally is not taxable if the bond is issued by a state, the District of Columbia, a possession of the United States, or any of their political subdivisions.
Bonds issued after 1982 by an Indian tribal government are treated as issued by a state. Interest on these bonds is generally tax exempt if the bonds are part of an issue of which substantially all of the proceeds are to be used in the exercise of any essential government function.
Interest on arbitrage bonds issued by state or local governments after October 9, 1969, is taxable.
Interest on a private activity bond that is not a qualified bond is taxable. For more information on whether such interest is taxable or tax exempt, see State or Local Government Obligations in chapter 1 of Publication 550.
Original issue discount (OID) is a form of interest. You generally include OID in your income as it accrues over the term of the debt instrument, whether or not you receive any payments from the issuer.
A debt instrument generally has OID when the instrument is issued for a price that is less than its stated redemption price at maturity. OID is the difference between the stated redemption price at maturity and the issue price.
All debt instruments that pay no interest before maturity are presumed to be issued at a discount. Zero coupon bonds are one example of these instruments.
The OID accrual rules generally do not apply to short-term obligations (those with a fixed maturity date of 1 year or less from date of issue). See Discount on Short-Term Obligations in chapter 1 of Publication 550.
Example 1.
You bought a 10-year bond with a stated redemption price at maturity of $1,000, issued at $980 with OID of $20. One-fourth of 1% of $1,000 (stated redemption price) times 10 (the number of full years from the date of original issue to maturity) equals $25. Because the $20 discount is less than $25, the OID is treated as zero. (If you hold the bond at maturity, you will recognize $20 ($1,000 − $980) of capital gain.)
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Tax-exempt obligations. (However, see Stripped tax-exempt obligations under Stripped Bonds and Coupons in chapter 1 of Publication 550).
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U.S. savings bonds.
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Short-term debt instruments (those with a fixed maturity date of not more than 1 year from the date of issue).
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Obligations issued by an individual before March 2, 1984.
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Loans between individuals, if all the following are true.
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The lender is not in the business of lending money.
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The amount of the loan, plus the amount of any outstanding prior loans between the same individuals, is $10,000 or less.
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Avoiding any federal tax is not one of the principal purposes of the loan.
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You bought the debt instrument after its original issue and paid a premium or an acquisition premium.
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The debt instrument is a stripped bond or a stripped coupon (including certain zero coupon instruments).
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Time deposits,
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Bonus plans,
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Savings certificates,
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Deferred income certificates,
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Bonus savings certificates, and
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Growth savings certificates.
When to report your interest income depends on whether you use the cash method or an accrual method to report income.
Example.
On September 1, 2005, you loaned another individual $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, 2007. In 2007, 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 2007 return the $508.80 interest you received in that year.
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Make withdrawals in multiples of even amounts,
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Give a notice to withdraw before making the withdrawal,
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Withdraw all or part of the account to withdraw the earnings, or
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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.
Generally, you report all of your taxable interest income on Form 1040, line 8a; Form 1040A, line 8a; or Form 1040EZ, line 2.
You cannot use Form 1040EZ if your interest income is more than $1,500. Instead, you must use Form 1040A or Form 1040.
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Your taxable interest income is more than $1,500.
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You are claiming the interest exclusion under the Education Savings Bond Program (discussed earlier).
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You received interest from a seller-financed mortgage, and the buyer used the property as a home.
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You received a Form 1099-INT for U.S. savings bond interest that includes amounts you reported before 2007.
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You received, as a nominee, interest that actually belongs to someone else.
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You received a Form 1099-INT for interest on frozen deposits.
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You forfeited interest income because of the early withdrawal of a time deposit,
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You received or paid accrued interest on securities transferred between interest payment dates,
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You had a financial account in a foreign country, unless the combined value of all foreign accounts was $10,000 or less during all of 2007 or the accounts were with certain U.S. military banking facilities,
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You acquired taxable bonds after 1987 and choose to reduce interest income from the bonds by any amortizable bond premium (see Bond Premium Amortization in chapter 3 of Publication 550),
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You are reporting OID in an amount more or less than the amount shown on Form 1099-OID, or
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You received tax-exempt interest from private activity bonds issued after August 7, 1986.
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Your taxable interest income is more than $1,500.
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You are claiming the interest exclusion under the Education Savings Bond Program (discussed earlier).
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You had a foreign account or you received a distribution from, or were a grantor of, or transferor to, a foreign trust.
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You received interest from a seller-financed mortgage, and the buyer used the property as a home.
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You received a Form 1099-INT for U.S. savings bond interest that includes amounts you reported before 2007.
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You received, as a nominee, interest that actually belongs to someone else.
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You received a Form 1099-INT for interest on frozen deposits.
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You received a Form 1099-INT for interest on a bond that you bought between interest payment dates.
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Statement (4) or (5) in the preceding list is true.
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Several lines above line 2, enter a subtotal of all interest listed on line 1.
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Below the subtotal enter “U.S. Savings Bond Interest Previously Reported” and enter amounts previously reported or interest accrued before you received the bond.
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Subtract these amounts from the subtotal and enter the result on line 2.
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