Understanding Imputed Interest: Definition & Calculation

Imputed interest is a type of interest that is interest that is accrued on an investment, but is not actually distributed to the investor at the time that it is earned. The interest is generally paid to the investor at a date in the future. This type of interest is also sometimes referred to as "phantom interest." 

How Imputed Interest Works

Imputed interest is often found with zero coupon bonds and other types of discount bonds. With this type of investment, you invest in a bond for less than the face value. Instead of receiving regular coupon payments from the bond, the issuer keeps the payments and it increases the value of the bond. Then at the end of the term, the investor can redeem the bonds for the full face value. All of the return is realized at the end of the investment. This type of interest also comes up with Treasury bonds that are issued by the United States Treasury.

Tax Issues

According to the IRS, investors have to account for this interest when they file their taxes on an annual basis. Even though they are not necessarily receiving the interest every year, they have to pay taxes on it as it is accrued. This means that you have to come up with the money to pay for the taxes on the interest from some other source.