Question

A customer buys a municipal bond in the secondary market at a discount. Which of the following statements are TRUE regarding the discount and the tax consequence?
I. The discount must be accretedII. The discount may be accreted at the option of the bondholderIII. The discount is subject to taxIV. The discount is not subject to tax

Answer 1

Answer:

II. The discount may be accreted at the option of the bondholder

III. The discount is subject to tax

Explanation:

The discount is treated as taxable interest income earned. Regular interest earned (coupon) is not taxed by the federal government. The investor can accrete the discount annually as taxable interest income earned or can wait until he/she sells the bond or it matures to calculate accumulated "earned" discount (and pay taxes).