Is bond premium on tax-exempt bonds taxable?
PREMIUM – TAX-EXEMPT BONDS
Actually, there is not a deduction for the premium you paid for your tax-exempt bonds on your federal return. You are required to amortize the premium each year and this will reduce your basis (what you paid). So when the bond matures, your basis will be the face value of the bond. Generally, there will not be a loss.
- Select Federal Taxes.
- Under Wages & Income select Interest on 1099-INT.
- Enter your 1099-INT information, select Continue.
- Select I need to adjust the taxable amount, select Continue.
Box 13.
For a tax-exempt covered security acquired at a premium, enter the amount of bond premium amortization allocable to the interest paid during the tax year. If you reported a net amount of interest in box 8 or 9, whichever is applicable, leave this box blank.
AMORTIZATION OF BOND PREMIUM
[19] Under section 171, the holder of a taxable bond acquired at a premium may elect to amortize bond premium. The holder of a tax- exempt bond acquired at a premium must amortize the premium.
Capital gains on municipal bond investments are taxable as short- or long-term capital gains, depending on how long you have held the investment.
Taxable Bonds may be issued to advance refund prior Tax-Exempt Bonds, and Tax-Exempt Bonds may be issued to advance refund outstanding Taxable Bonds in certain situations, under guidance provided by the IRS Office of Chief Counsel (Chief Counsel Advice Memorandum 201843009).
Enter the total on line 2a. However, if you acquired a tax-exempt bond at a premium, only report the net amount of tax-exempt interest on line 2a (that is, the excess of the tax-exempt interest received during the year over the amortized bond premium for the year).
Tax-exempt interest.
In general, your tax-exempt stated interest should be shown in box 8 of Form 1099-INT or, for a tax-exempt OID bond, in box 2 of Form 1099-OID, and your tax-exempt OID should be shown in box 11 of Form 1099-OID. Enter the total on line 2a of your Form 1040 or 1040-SR.
Premium bonds are free of capital gains tax, stamp duty and income tax and do not count towards your personal savings allowance.
How do I know if my bond is taxable?
The interest you earn on corporate bonds is generally always taxable. Most all interest income earned on municipal bonds is exempt from federal income taxes. When you buy muni bonds issued by the state where you file state taxes, the interest you earn is usually also exempt from state income taxes.
If you have an amount listed in Box 13, please disregard unless you are subject to Alternative Minimum Tax (AMT). If you are subject to the AMT and must enter the amount listed in box 13, go to: Federal Section. Other Taxes.

Box 3 reports interest earned on U.S. savings bonds or Treasury notes, bills or bonds. Some of this may be tax-exempt. Box 4 reports any federal tax withheld on your interest income by the payer.
PREMIUM – TAX-EXEMPT BONDS
Even though there is no tax benefit for amortizing this premium, the investor must still reduce their cost basis in the bond for the amortized amount. If the tax-exempt bond is held to maturity, there is no deductible capital loss.
Tax on gross premiums – All insurance companies are subject to tax on gross premiums.
Amortizing the Bond
A method of amortizing a bond premium is with the constant yield method. The constant yield method amortizes the bond premium by multiplying the purchase price by the yield to maturity at issuance and then subtracting the coupon interest.
Tax-exempt bonds are the primary mechanism through which state and local governments raise capital to finance a wide range of essential public projects.
Income from bonds issued by state, city, and local governments (municipal bonds, or munis) is generally free from federal taxes.
Understanding Tax-Free Municipal Bonds
It's a go-to method for many municipalities to finance public projects, directly contributing to the socio-economic development of the area. Municipal bonds – or “munis” – are generally considered a lower-risk investment compared to stocks and corporate bonds.
As a result, you likely won't incur any capital gains tax. If, however, you purchase a municipal bond in the secondary market at a discount to the revised issue price, you can be taxed as either a capital gain or ordinary income, depending on the size of the discount and the years to maturity of the bond.
Do tax-exempt bonds have lower interest rates?
Given the tax benefits, the interest rate for tax-exempt municipal bonds is typically lower than that on taxable fixed-income securities, such as corporate bonds and even Treasury bonds.
The de minimis rule states that if a discount is less than 0.25% of the face value for each full year from the date of purchase to maturity, then it is too small (that is, de minimis) to be considered a market discount for tax purposes. Instead, the accretion should be treated as a capital gain.
Bond premium refers to purchasing a bond above par (face) value. For taxable bonds, bond premium can potentially represent a reduction to yearly income. Acquisition premium generally applies to zero coupon bonds, but can also apply to coupon paying bonds issued at a discount.
Section 265(a) provides in part that “no deduction shall be allowed for interest on indebtedness incurred or continued to purchase or carry obligations the interest on which is wholly exempt from tax.” The general rule under § 265(a)(2) is that 100 percent of a financial institution's interest expense allocable to tax ...
You can skip paying taxes on interest earned with Series EE and Series I savings bonds if you're using the money to pay for qualified higher education costs. That includes expenses you pay for yourself, your spouse or a qualified dependent.