Investment Income & Expenses (2025)

Interest Income

All interest is taxable unless specifically exempt. Report on 1040 Line 2b. File Schedule B if total >$1,500.

Taxable interest: bank accounts, CDs, money market accounts, corporate bonds, personal loans, tax refund interest, insurance proceeds held with interest. Cooperative bank/credit union "dividends" on deposit accounts are reported as interest.

Tax-exempt interest: state/local municipal bonds (federal tax only — may be taxable at state level). Reported on 1040 Line 2a but not taxed. Cannot deduct investment interest expense allocable to tax-exempt income (e.g., interest on debt to buy municipal bonds).

1099-INT: Issued if interest ≥$10. Even without it, must report all interest.

Bank account gifts: If deposit <$5,000, report gift value >$10 as interest. If deposit ≥$5,000, report value >$20 (value = institution's cost).

Credit card/customer loyalty rewards: Generally NOT taxable (IRS treats as rebates/price adjustments). Sign-up bonuses for opening checking/credit accounts = taxable interest.

US Treasury Securities

Treasury bills, notes, bonds (and US agency bonds): Interest is federal taxable but state/local EXEMPT. EE bonds (paper = discount; electronic = face value) — difference between purchase price and redemption = interest. Series I bonds: issued at face value, 30-year term, face value + accrued interest paid at maturity. Taxpayer may elect to report EE/I bond interest annually (accrual) or at maturity/redemption — but must use same method for ALL EE/I bonds owned. Form 1099-INT issued at redemption.

Education Savings Bond Program (Form 8815)

EE/I bonds issued after 1989 may have interest excluded if redeemed in the same year proceeds pay qualified higher-education expenses for taxpayer/spouse/dependent. Requirements:

• Bond titled in taxpayer's or spouse's name (not a child under 24)
• Owner ≥24 years old at issue date
• Qualified expenses = tuition & required fees at eligible institution
• Married — must file MFJ (MFS cannot exclude)
• If redemption exceeds qualified expenses, excludable interest is prorated

2025 MAGI phaseout: Single/HoH $99,500-$114,500; MFJ $149,250-$179,250 (fully eliminated at top). Form 8815 attached to return.

Dividend Income

Ordinary dividends (Line 3b): Most common — taxed at ordinary rates. Reported on 1099-DIV.

Qualified dividends (Line 3a): Taxed at capital gain rates (0%, 15%, 20%). Must meet holding period: >60 days during 121-day window beginning 60 days before ex-dividend date. Preferred stock may require longer period. Holding period starts day AFTER acquisition, includes sale date. Must be from US corporation or qualified foreign corporation.

Return of capital (non-dividend distribution): Not taxable — reduces basis. When basis reaches $0, further distributions = capital gain. Reported on 1099-DIV Box 3.

Schedule B: Required if total dividends >$1,500.

Stock Dividends & Stock Splits

• Pro-rata stock dividends (no cash option): Generally NOT taxable. Total basis unchanged; per-share basis decreases. Holding period of new shares = same as old shares.
• Stock dividends with cash option: If shareholder may elect cash instead, the stock dividend is taxable at FMV (whether cash or stock taken). FMV of stock received = basis in new shares.
• Stock splits: Not taxable; per-share basis adjusted (total basis unchanged).
• DRIP (dividend reinvestment): Dividends are taxable income even when reinvested. If shares purchased at a discount below FMV, report FMV at dividend date as dividend income (FMV − amount paid = additional dividend).

Mutual Fund Distributions

• Reported on 1099-DIV by type: ordinary dividends, qualified dividends, capital gain distributions, tax-exempt interest dividends, non-dividend distributions
• Capital gain distributions are ALWAYS long-term regardless of how long taxpayer held the fund shares
• Fund investing in tax-exempt securities → tax-exempt interest dividends (still report, but not taxed)
• If fund/REIT declares dividend in Oct/Nov/Dec but pays in January, shareholder treated as receiving it Dec 31 of declaration year

Capital Gain Distributions

From mutual funds/REITs. Reported on 1099-DIV. Goes directly to Schedule D or Form 1040 Line 7 if no other capital transactions. Taxed at capital gain rates (always long-term).

Constructive / Constructive Distributions

Certain company-shareholder transactions may be reclassified as constructive dividends (taxable to shareholder, not deductible by corporation):

• Company paying shareholder's personal expenses
• Excessive compensation to employee-shareholder (above reasonable → dividend)
• Renting property to/from shareholder at non-arm's-length rates (the bargain element)
• Canceling a shareholder's debt
• Selling property to shareholder below FMV (the excess)
• Below-market or interest-free loans to shareholder (foregone interest)

Investment Interest Expense

Deductible ONLY up to net investment income on Schedule A (Form 4952). Net investment income = investment income − investment expenses (excluding interest). Unused amounts carry forward indefinitely.

TCJA suspended miscellaneous deductions (investment advisory fees, safe deposit box) through 2025. Investment interest expense is NOT suspended.

Key Tax Forms