For zero-coupon bonds, the tax liability is determined by which of the following?

For zero-coupon bonds, the tax liability is determined by which of the following?

• A. Report the full amount of the discount at maturity
• B. Report semi-annual interest
• C. Report the annual accrual each year
• D. Elect to defer income recognition until bonds mature

Answer: (C)

Zero-coupon bonds don’t pay periodic interest. As the bond accretes toward its maturity value, the increase in value is treated as interest income each year. You report that annual accrual as ordinary income and pay tax on it, even though you haven’t received any cash. This continues annually until maturity, when you redeem for the face value. The yearly recognition matches the economic benefit you’re receiving from the bond’s growth, not a cash interest payment. The other options would imply cash interest or deferral, which don’t apply to zero-coupon bonds since there are no periodic payments to report or defer.

Zero-coupon bonds don’t pay periodic interest. As the bond accretes toward its maturity value, the increase in value is treated as interest income each year. You report that annual accrual as ordinary income and pay tax on it, even though you haven’t received any cash. This continues annually until maturity, when you redeem for the face value. The yearly recognition matches the economic benefit you’re receiving from the bond’s growth, not a cash interest payment. The other options would imply cash interest or deferral, which don’t apply to zero-coupon bonds since there are no periodic payments to report or defer.