[FN**]
(1) In
General. As a general rule, interest received by or credited to the taxpayer
constitutes gross income and is fully taxable. Interest income includes
interest on savings or other bank deposits; interest on coupon bonds; interest
on an open account, a promissory note, a mortgage, or a corporate bond or
debenture; the interest portion of a condemnation award; usurious interest
(unless by State law it is automatically converted to a payment on the
principal); interest on legacies; interest on life insurance proceeds held
under an agreement to pay interest thereon; and interest on refunds of State or
Federal taxes. For rules determining the income year in which interest,
including interest accrued or constructively received, is included in gross
income, see Section 24661 and the regulations thereunder.
(2)
(A)
Interest on Governmental Obligations--Chapter 2. Interest received from
federal, state, municipal or other bonds is includible in the gross income of
taxpayers taxable under Chapter 2. Since the tax imposed under Chapter 2 is a
privilege tax for the right to exercise the corporate franchise, it is not a
tax upon such income, but merely uses such income of the preceding year as a
measure of the tax for the privilege of exercising the corporate franchise
during the taxable year. See Section
24272.
(B) Interest on Government
Obligations--Chapter 3. Interest on bonds and other obligations of the United
States, the District of Columbia, and territories of the United States is
exempt from state taxation under the Constitution and the laws of the United
States. Interest upon bonds of this State or its political subdivisions issued
after November 4, 1902 is exempt from state taxation under the State
Constitution.
Interest received or accrued on warrants, judgments,
claims for refund, etc., and similar obligations of California, its
subdivisions, or the United States and its territories is not exempt from tax.
Interest on all bonds and obligations of other states and foreign countries,
including those of the Philippines, the commonwealth of the Philippines or the
political subdivisions thereof issued on or after March 24, 1934, is also
subject to tax.
Although interest on bonds and obligations of the United
States is exempt from taxation, gains and profits from the sale or other
disposition of such bonds and obligations are taxable to the same extent as
gains and profits from the sale or exchange of other
property.
(3)
Obligations Bought at a Discount; Bonds Bought When Interest Defaulted or
Accrued. When notes, bonds, or other certificates of indebtedness are issued by
a corporation at a discount and are later redeemed by the debtor at the face
amount, the original discount is interest, except as otherwise provided by law.
If a taxpayer purchases bonds when interest has been defaulted or when the
interest has accrued but has not been paid, any interest which is in arrears
but has accrued at the time of purchase is not income and is not taxable as
interest if subsequently paid. Such payments are returns of capital which
reduce the remaining cost basis. Interest which accrues after the date of
purchase, however, is taxable interest income for the year in which received or
accrued (depending on the method of accounting used by the taxpayer).
(4) Bonds Sold Between Interest Dates;
Amounts Received in Excess of Original Issue Discount; Interest on Life
Insurance. When bonds are sold between interest dates, part of the sales price
represents interest accrued to the date of the sale and must be reported as
interest income.
[FN**]
Except for paragraph (2) and the provisions in paragraph
(4) relating to individuals, this regulation is substantially the same as
Section 26 CFR
1.61-7.
