In California, accrued market discount on Treasury bonds is ordinary income and taxable. I recently made the following inquiry to the Franchise Tax Board and there response follows:
Is "accrued market discount" for treasury bonds taxable as interest for California income tax. Please sight the code that establishes how it's treated. Thank you
Our response:
California generally conforms to Internal Revenue Code (IRC) sections 1276 and 1278 via Revenue and Taxation Code (RTC) section 18151. IRC section 1278 provides the definition of a market discount bond, which does not exclude US Treasury bonds. Under IRC section 1276, the portion of the gain on the disposition of a bond that represents accrued market discount is ordinary income that is recognized and is treated as interest except in certain specified circumstances. US Treasury bonds are not one of the enumerated exceptions. Therefore, the accrued market discount portion of the gain would be ordinary income that must be reported as taxable interest income even if the underlying bond is a US Treasury bond. The accrued market discount portion of the gain does not represent tax-exempt interest earned on a federal obligation.
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