How bond returns are taxed
A bond can hand you three different kinds of income, and they are not taxed the same way. Coupon interest is ordinary income unless the issuer is a municipality. If you bought the bond below its redemption price, the market discount that accrues while you hold it is treated as ordinary interest income under 26 U.S.C. 1276 when you sell or redeem. Whatever is left of the gain is a capital gain, taxed at long-term rates if you held the bond more than a year.
This calculator separates those three layers. Treasury interest is exempt from state and local income tax, municipal interest is generally exempt from federal tax, and market discount and capital gain remain taxable in both cases. Market discount is accrued on a straight-line basis over the original term, which is the default method allowed under the ratable accrual rules.
Figures are on a 2026 basis and are an estimate, not a tax return. Not covered here: original issue discount reported on Form 1099-OID, bond premium amortization, the 3.8% net investment income tax, the alternative minimum tax on private activity bonds, accrued interest paid at purchase, and wash sale or de minimis discount rules. Rates and thresholds change, so confirm the current figures with IRS Publication 550 and a tax professional before relying on any number here.
Frequently asked questions
Interest on most municipal bonds is exempt from federal income tax, and often from state tax in your home state. It is not exempt from everything: private activity bond interest can be an alternative minimum tax preference item, and any capital gain or accrued market discount on a municipal bond is still taxable.
If you bought a bond for less than its redemption price, the difference is market discount. Under 26 U.S.C. 1276 the discount that accrued while you held the bond is treated as ordinary interest income when you sell or redeem it, and only the remainder is capital gain.
No. Bonds issued below face value carry OID that is accrued and reported as interest each year under 26 U.S.C. 1272, separately from the coupon. Use the interest figure on your Form 1099-OID rather than this estimate for those bonds.