Interest on a corporate bond accrues daily, and for most U.S. corporate bonds it accrues on a 30/360 basis: every month is treated as 30 days and every year as 360 days. That convention determines how much a buyer owes the seller when a bond changes hands between coupon dates, and it feeds into several tax rules that decide what part of your return is ordinary income and what part is capital gain.
The 30/360 Convention
Under 30/360, February counts as 30 days, a six-month coupon period is always 180 days, and the fraction of a year that has passed between two dates is the number of 30/360 days divided by 360.1Corporate Finance Institute. Day-Count Convention The method was built to work with printed tables, and it stayed. You don’t have to worry about leap years or uneven months when pricing a corporate trade.2WWWFinance. Day Counting for Bonds
Not every fixed-income instrument works this way. U.S. Treasuries use Actual/Actual, counting real calendar days in both the coupon period and the year.3U.S. Department of the Treasury. Interest Rates – Frequently Asked Questions Money market instruments and commercial paper generally use Actual/360.4Nasdaq. Actual/360 The day count for a specific bond is fixed at issuance and written into the indenture.
Calculating What Has Accrued
Accrued interest is what the current holder has earned since the last coupon was paid. The formula:
Accrued Interest = Face Value × Coupon Rate × (Days Since Last Coupon ÷ 360)
Take a $1,000 face-value bond paying a 5% annual coupon in two installments. Each coupon is $25. Sixty days into the current coupon period under 30/360, accrued interest equals $1,000 × 0.05 × (60 ÷ 360), or $8.33.
Clean Price, Dirty Price
Corporate bonds are quoted without accrued interest in the number. That quoted figure is the clean price. The amount the buyer actually pays at settlement is the dirty price, which is the clean price plus accrued interest. Keeping the two separate stops market quotes from drifting upward each day just because interest is piling up.
Why the Buyer Reimburses the Seller
The issuer sends the full coupon to whoever holds the bond on the payment date. A buyer who purchases mid-period will collect the entire next coupon, including the piece earned while the seller still owned the bond. To square that, the buyer pays the seller at settlement for the days the seller held the bond during the current period. When the coupon arrives, the buyer effectively gets that money back.
Settlement Date Is What Counts
Accrued interest runs through the settlement date, not the trade date. Corporate bonds now settle on a T+1 basis, one business day after the trade. The SEC shortened the standard cycle from T+2 to T+1 effective May 28, 2024, for most securities transactions.5U.S. Securities and Exchange Commission. SEC Finalizes Rules to Reduce Risks in Clearance and Settlement Under amended Rule 15c6-1(a), broker-dealers cannot contract for payment and delivery later than the first business day after the trade unless both sides expressly agree otherwise.6U.S. Securities and Exchange Commission. Shortening the Securities Transaction Settlement Cycle Because settlement now falls one day sooner, the accrued interest owed on a given trade is slightly lower than it was under T+2.
How Coupon Interest Is Taxed
Corporate bond interest is ordinary income at your marginal federal rate. There is no federal exemption of the sort municipal bonds carry. Most individual investors report on a cash basis, so the interest lands on your return in the year the coupon actually pays.7Internal Revenue Service. Topic No. 403, Interest Received Your broker reports coupons to you and to the IRS on Form 1099-INT.
Backing Out Accrued Interest You Paid
Buying between coupon dates creates a reporting mismatch. The accrued interest you paid at settlement is taxable income to the seller, not to you. But your 1099-INT will typically show the full next coupon you receive, which includes that same amount.
The fix goes on Schedule B. Report the full 1099-INT figure, subtotal your interest, then subtract the accrued interest you paid at purchase, labeling the line “Accrued Interest.”8Internal Revenue Service. Instructions for Schedule B (Form 1040) Pay $10 in accrued interest at purchase, receive a $25 coupon later, and only $15 is taxable to you. IRS Publication 550 treats the accrued interest paid at purchase as a return of capital rather than interest income.9Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses
Bonds Bought Below Face Value
Discounts get two very different tax treatments depending on where the discount came from.
Original Issue Discount
A bond issued below face carries an original issue discount, and that discount is built-in interest. Under Section 1272 of the Internal Revenue Code, you include a portion of the OID in gross income every year you hold the bond, whether or not any cash was paid to you that year.10Office of the Law Revision Counsel. 26 USC 1272 – Current Inclusion in Income of Original Issue Discount The annual amount uses the constant yield method, which back-loads accrual because each year’s figure is based on the bond’s growing adjusted issue price times its yield to maturity. The issuer or broker reports the yearly figure on Form 1099-OID.11Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID
Zero-coupon corporate bonds are the extreme case. No cash coupon ever pays, but tax on accrued OID is due every year. That phantom income is why zeros are often held in IRAs or other tax-advantaged accounts.
Market Discount
Buying a bond on the secondary market below face (or below its adjusted issue price, if it already carries OID) creates market discount. You generally owe nothing on the discount until you sell or redeem, but at that point any gain is ordinary interest income up to the amount of accrued market discount, not a capital gain.12Office of the Law Revision Counsel. 26 USC 1278 – Definitions and Special Rules
A de minimis exception protects small discounts. If the discount is less than 0.25% of face value times the complete years remaining to maturity, the IRS treats it as zero and any gain is a capital gain.12Office of the Law Revision Counsel. 26 USC 1278 – Definitions and Special Rules On a $1,000 bond with 10 years left, the threshold is $25. Pay $980 and the $20 discount slips under.
Above the threshold, you track accrual. The default is a straight-line, ratable spread from acquisition to maturity. You can elect the constant yield method instead, but the election applies to all market discount bonds acquired in the year of election and cannot be revoked without IRS consent. A separate election lets you include market discount in income each year as it accrues rather than at sale, converting future ordinary income into current ordinary income and easing record-keeping for active traders.
Bonds Bought Above Face Value
Pay more than face and you have a bond premium. You can elect to amortize that premium over the remaining life of the bond, using the amortization each year to offset interest income and reduce the taxable portion of each coupon.13Office of the Law Revision Counsel. 26 USC 171 – Amortizable Bond Premium
For taxable corporate bonds the election is optional, but once made it applies to every taxable bond you hold and every one you acquire afterward. Selective amortization isn’t allowed. The amortization itself follows the constant yield method, so more premium is written off in earlier periods when the carrying value is highest.14eCFR. 26 CFR 1.171-1 – Bond Premium
Amortizing lowers taxable interest each year while also cutting your cost basis, which reduces any capital loss (or increases any capital gain) at sale. For investors in higher brackets planning to hold to maturity, the election usually pays off, because it trades a capital loss at maturity for annual reductions against ordinary income taxed at a higher rate.