Investors often choose to purchase bonds when companies first issue them. These investors receive interest payments based on the rate stated in the bond documents. They can pay the face value or a different amount to purchase the bond. The bondholder earns income from the bond, which needs he needs to record on his income tax return. He also needs to document his method for calculating the income he earned. This documentation should remain with his income tax return records and provide backup information if he ever undergoes an audit.
1. Read the original bond purchase documentation, and find the face value of the bond. This represents the amount the company will pay when the bond matures.
2. Locate the price you paid for the bond, as well as the brokerage fees you paid. Add these costs together to calculate the total cost.
3. Subtract the total cost from the bond’s face value. If the answer equals a positive number, you have experienced a gain.
4. Look up the present value factor on the present value of a dollar table. Use the number of periods from the date of purchase until the maturity date of the bond and the market interest rate to locate the factor. Multiply the present value factor by the total amount of the gain to calculate the value of the gain.
5. Multiply the stated interest rate by the face value of the bond and the percent of the year that each interest payment applies to. Multiply this amount by the total number of interest payments you received. This equals the total interest received over the life of the bond.
6. Look up the present value factor on the present value of an annuity table. Use the number of periods from the date of purchase until the maturity date of the bond and the market interest rate to locate the factor. Multiply the present value factor by the individual interest payment. This calculates the value of the interest payments.
7. Add the present value of the interest payments and the present value of the gain. This equals the total yield in dollars.
8. Divide the total yield in dollars by the amount you paid. This equals the yield percentage.
9. Write the calculations down on a sheet of paper, and gather the present value tables. Add these papers to your income tax file.