A bond premium occurs when a taxpayer pays more than a bond's face value (or par value) when purchasing it. This usually happens when the bond offers a higher interest rate than current market rates, making it more valuable.
Bond premium is not a deductible investment loss or a brokerage fee.
📈 Why It Matters for Taxes
The premium paid affects the amount of interest income that is taxable. Taxpayers may be able to amortize (spread out) the premium over the life of the bond, reducing the amount of interest income they report each year.
🧾 Tax Treatment Depends on the Type of Bond
- Taxable Bonds (e.g., corporate bonds):
- You can elect to amortize the premium.
- The amortized amount reduces taxable interest income.
- Tax-Exempt Bonds (e.g., municipal bonds):
- You must amortize the premium.
- The amortized amount does not reduce taxable income but reduces the bond’s basis, affecting gain/loss when sold.
🛠️ Example:
You buy a bond for $1,050 with a face value of $1,000.
- The $50 is the bond premium.
- If you amortize it over 5 years, you reduce your annual taxable interest by $10 per year (for taxable bonds).