 Hello and welcome to this session in which we will discuss interest income. Interest income is part of the gross income for the taxpayer. We have many sources of income. Interest income is one of them and today we're going to be discussing taxable interest income. So what is taxable interest income? Well, interest is earned through deposit account when you have money in the bank. You might invest in bonds. You could also make loans to others. All these three vehicles will give you, will generate interest income. For tax purposes, interest income is always included in gross income unless it's specifically executed by law. So every time you hear the word interest income, it's taxable unless there's a special rule that that specific interest, that specific source of interest is not taxable and would look at some of those. The following are the different sources of taxable income. The most common is savings and deposit in a bank account. CD certificate of deposit again in a bank account. Loans made to others. You could make loans to others. Gift more than $10 for opening financial accounts. For example, you want to open an account at a bank or at a financial institution and they'll give you a gift for $10. Well, guess what? That gift is considered interest income. They're not giving you the gift because they like you. They're giving you the gift because you are depositing money. It means when you deposit the money, you are lending the money to the bank. Therefore, it's interest in $20 if the account is more than $5,000. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses, broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead. Start your free trial today. No obligation. No credit card required. Interest received on tax refunds, including state, local, and federal. Now, we learned in the prior session about that concept that called the tax benefit rules. But generally speaking, interest received on any sorts of refund, the interest itself is taxable. So the interest is taxable. Now, whether the refund, the state or the local, is taxable or not, that will have to deal with the tax benefit rule we covered in the prior session. So make sure to understand that the interest component, you may receive a refund. Part of it is the refund itself. Part of it is interest because you have to wait three, six, one, or two years for that refund to come. The government will add interest. They compute the interest. That component is taxable. The refund itself may be taxable or not, depending on the tax benefit rule. U.S. Treasury bills, when you lend money to the U.S. government, notes and bonds, federal bonds, anything you lend to the federal government, the interest on those is taxable. Now, we're going to differentiate between the federal and the state and local government. Imputed interest on below market rate, market term loan. If you lend the money to someone and you charge them below market rate loans or you gave them zero, literally a zero percent loan, tell them, look, don't pay me interest. Just give me the money back. Well, guess what? You have to impute the interest. You have to compute the interest on that. U.S. savings bond, which includes series H, double H, IE, double E, it's worth noting that interest from series I or EE may be excluded from gross income if you have used for qualified business expense. And we'll talk a little bit more about what's executed. We have a whole chapter called executed income, but notice there are some exceptions for this. Now, also there are certain interest income that's non-taxable by law. And you need to know what these are. First, interest income on state and local government bonds. Remember, we have in the U.S. a federal government, a state government and a local government. Any interest you pay for the federal government, any interest you receive, not pay, any interest you receive from the federal government is taxable. You pay taxes on it, and I showed you this on the prior session. However, if you lend your money to the state government or if you lend your money to your local government, local government could be your local municipality or your local county, interest on those is not taxable. Now, I'm going to explain to you why you could memorize it, but if you understand why, then it's easy to remember. Here's the concept. The concept is this. The federal government is large enough. They have a lot of resources. Therefore, when you lend them money, they give you interest. That interest is taxable. However, state government, they're smaller. They cannot pay higher interest rate because they are not as big as the federal government, state or local. So what happened? The federal government says, look, we, since we are competing with you, because remember, the federal government wants to borrow money. The state government wants to borrow money and local government wants to borrow money. The federal government is the strongest of the three. So what they do, they would say something like this, because you are in a sense smaller, weaker in quote, weaker than us. If you issue bonds and you pay interest to the bondholders, the bondholders don't have to, don't have to pay taxes on the interest. So to do what? To encourage you, you and I to lend money to the state and local government. So it's a way to encourage people to invest in their state, to invest in their local government. How does that work specifically? Let's use some numbers. Let's assume you have $10,000. You have two options. You can lend this money to the federal government or you can lend this money to your state or local government. What would you do? How would you make that decision? You will say, the federal government is paying 10%, no way, but I'm just making the example that the federal government is paying 10%. Who knows, maybe if the inflation keep on going up, they might have to pay this. And the state and local government only paying 9%. You'd be like, oh, that's a no-brainer. I'm going to lend my money to the federal government. Why? Because it's paying 10%. So you will get, if you lend your money to the federal government, you'll get per year $1,000. If you lend your money to the state or local government, you will get per year $900. Now, the federal government want to encourage you to invest in the state and local government. So what would they do? They would say, look, you lend your money to the state or local government, you pay on this $900, 0%. So you will get in net $900. However, since you receive this money from the federal government and your tax rate is 30%, let me put the tax rate in a different color, you have to pay us 30%. You have to pay $300. Therefore, your investment netted only $700 for the federal government. So if you think about it, I'm better off giving my money to the state or local government. Why? Because I receive $900 and I will keep all the $900. If I give my money to the federal government, I receive $1,000 from them, then I have to pay taxes. So it's a way to encourage people to invest in their state and local government and this way state and local government, they pay a lower rate than the federal government. So they can raise money more easily. They're not as powerful as the federal government. The federal government wants to give them a break. Same concept apply to interest on obligation of US possessions like American Samoa, Guam, Puerto Rico, Yas Virgin Islands. Interest on series, EE savings bond if used for qualify educational expense. We'll talk about that later. We'll have a chapter, interest, income exclusion chapter, that's also executed. But on the CPA exam, what they focus on is interest on municipal bond, which is local government and state government. That's what they focus on now. Interest is tax free. However, if you buy a local bond or a state government bond and you sell them and you have a capital gain, the capital gain on the sale is taxable, just like any other capital gain. The interest component is tax free, not the capital gain. So the capital gain is always taxable. The interest is what's executed. Now what you need to know is the payer of interest in access of $10 is required to send you a 1099 INT. So if you have a bank account and you earn more than $10 in interest, the bank, the payer, which is the bank, is required to send you a notice for that $10. If it's less than $10, they don't have to send it to you. They'll tell you you're safe $10 in interest. And when I used to complete income tax return for individuals, I remember one of the individuals, he would always be nervous and I'll tell him, look, you did not receive less than $10, you don't have to report it. He would say, add $10 of interest income. So every year he would add $10 on his interest income just to make sure he covered his basis, although he never received $10 in interest. Now, then you have to complete what's called Schedule B, which I'll show you later to be attached to form 1041, the total dividend and or interest income received exceed 1500. So if you received more than 1500 in either dividend and or interest, you have to prepare Schedule B, which we'll talk about this, and attach Schedule B to your tax return. Actually, let's take a look at the 1099 interest. So the first thing is this is the form right here. Let me just, this is the form 1099 interest, and you would receive this from your bank. And in this box here, which is maybe you cannot see, but you can Google 1099. For example, they might say you earned $50. So first, they will give you this form that this is from the bank. Okay. Now, then you will take this money and you'll put, you know, Wells Fargo Bank, $50. This is Schedule B, and you'll have to complete your Schedule B. And if it's more than 1500, you have to attach. So you have to complete Schedule B, list all the interest income. Then you have a total of interest. Then after Schedule B, your interest will go on your form 1040. Again, I'm blocking out the years because the form could change down the road, but the concept is the same. You have Schedule B, where you would report your interest. And from Schedule B, you will transfer the money to your 1040. Now notice, some of the interest is tax exempt. Although it's tax exempt, you would include this information here. Although it's not taxable, but you have to report it, then the taxable amount will go here. So again, someone will send you a 1099, you will take the 1099 information, put it on your Schedule B, you total it, then from Schedule B, it goes on your 1040. Now, let's talk about the imputed interest and on below interest rate loans. You cannot give a loan and say, you know, it's interest free. There's always interest involved. If the interest is not used, then you have to use the applicable federal rate to compute the amount of interest you received. If your employer is giving you this loan, so if this transaction is between employee and employer, we don't call it interest. What's going to happen? You compute the interest and you add it as a form of compensation. It's a form of compensation because there's no relationship between employer and employer other than employee-employer relationship. And it's a form of compensation. If the transaction between shareholder and company, so if you're an owner in the company and the company gave you the loan, they gave you the loan and they did not charge you interest, you compute the interest and you will consider that as what? As dividend income. Exceptions apply here and it's covered in a separate recording and much more in details, but you need to know if the loan is less than 10,000. We ignore this imputed interest. If the loan is less than 100,000, then in this loan is used for, for example, investment, then the interest is limited to the investment income on the loan proceeds. So simply put, if you borrowed $100,000 and you use this money to invest it in a bond, and you earned from the bond, let's assume $1,500 from the bond, which is 1.5 percent. If that's what you earned on the bond, it doesn't matter what the federal rate is, then your interest expense is limited to that. Now, if the interest overall is less than 1,000, then there is no interest. We just say forget it, it's, you know, you don't have to worry about this. You will back to the loan less than 10,000. Again, those topics are covered in a separate recording later on in a separate recording that's relevant to that topic. What should you do now? Go to Farhat Lectures and look at additional MCQs through false additional resources that's going to help you understand this important topic. Interest expense, we're going to see later, some of it is executed. Okay, tax exempt interest, that's executed, tax exempt, which means it's not taxable. We're going to look later at tax interest expense. Now, when you are not receiving the interest, you are paying the interest and it gets a little bit more complicated with tax interest expense, depending whether it's business, not business, investment related, not investment related. Is it part of your real estate business? Is it part of your regular business? Does it go on your itemized Schedule A? This is just planting the seat for interest expense. For now, focus on one topic at a time. We're dealing with revenues, sources of income that's taxable. Focus on that. Stay safe and good luck.