The IRS taxes zero-coupon bonds as if interest were paid annually, even though no cash flow is received until maturity.

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The Internal Revenue Service taxes zero-coupon bonds, such as Treasury strips, as if interest were paid annually, even though no cash flow is received until maturity. The tax is based on amortizing the built-in gain over the life of the instrument. For tax reasons, zero coupons are usually only appropriate for tax-deferred accounts such as individual retirement accounts, 401(k) plans, or other nontaxable pension funds.

The IRS Taxes Zero-Coupon Bonds as If Interest Were Paid