On January 5, 2018, Tim purchased a bond paying interest at 6% for $30,000. On March 31, 2018, he gave the bond to Jane. The bond pays $1,800 interest on December 31. Tim and Jane are cash basis taxpayers. When Jane collects the interest in December 2018:
A) Tim must include all of the interest in his gross income.
B) Jane must report $1,800 gross income for 2018.
C) Jane reports $1,350 of interest income in 2018, and Tim reports $450 of interest income in 2018.
D) Jane reports $450 of interest income in 2018, and Tim reports $1,350 of interest income in 2018.
E) None of these is correct.

Question

Quizplus · Accepted Answer

Since Tim and Jane are both cash basis taxpayers, the interest income is taxable to the person who is holding the bond at the time the interest is paid.

Tim held the bond for the entire year of 2018, so he is deemed to have received the interest income for the year. However, he gave the bond to Jane on March 31, so he must give her a pro-rata portion of the interest income that accrued while he owned the bond (Jan 1 - Mar 31).

The bond pays $1,800 interest on December 31, so the interest accrued from Jan 1 - Mar 31 is (3/12) x $1,800 = $450.

Therefore, Jane reports $1,350 of interest income in 2018 (the remaining 9/12 of the interest), and Tim reports $450 of interest income in 2018 (the portion of the interest that accrued while he owned the bond).

On January 5, 2018, Tim Purchased a Bond Paying Interest