Someone needs to pay the tax on the interest earned.
Since the landlord is holding the security deposit account in their custody, they will very likely be the one to pay the tax on that interest reported on a 1099-INT.
With that said:
1. Is it reasonable for the landlord to deduct the cost of taxes from the balance in the security deposit account? (e.g. $1,000 security deposit, earns $10 in Interest = account balance of $1,010. $4 in taxes due, seems reasonable the landlord pays these taxes out of the $1,010 due to the tenant? The interest is due to the tenant ultimately but so should the tax on that interest?)
2. How does one actually calculate how much tax was paid on the interest? It will be subject to the landlord, not the tenant's marginal tax rates and the impact of that 1099-INT gets mixes in with everything else the landlord is paying tax on and thus it's not very intuitive to know how much tax the landlord paid against that 1099-INT specifically. The only way I can think of doing is for the landlord to finalize their entire federal and state tax returns and run the SW both with and without this interest to see what the difference is in tax liability. Any other thoughts?
