Final answer:
Interest from corporate and U.S. Treasury bonds is taxed on an accrual basis, with corporate bonds typically offering higher interest rates to offset their higher default risk. Treasury bond interest is federally taxable but may be exempt at state and local levels, whereas corporate bond interest is generally taxable at both federal and state levels.
Step-by-step explanation:
When it comes to the timing and amount of interest income for corporate and U.S. Treasury bonds, tax rules are centered on the principle of accrual. Generally, interest is recognized as income when it is earned, not necessarily when it is received. For both corporate bonds and Treasury bonds, this typically means that interest income is reported annually. Corporate bonds usually pay a higher interest rate than Treasury bonds due to the greater risk of default. Nonetheless, both types of bonds adjust their interest rates based on the financial market conditions, affecting lenders and borrowers.
For U.S. Treasury bonds, which are also known as notes, the interest is treated as taxable income for federal income tax purposes but is often exempt from state and local taxes. Corporate bondholders must declare the interest as income on both federal and state tax returns, unless the bonds are municipal securities, which are generally tax-exempt at the federal level and may be exempt at the state level if the bondholder resides in the issuing state.