Molly Matters Inc issues a splitcoupon 1000 bond that mature

Molly Matters Inc. issues a split-coupon $1,000 bond that matures in seven years. Interest payments are $80 a year (8 percent) and start after three years have lapsed. The bond initially sells for a discounted price of $794. a) You are in the 30 percent income tax bracket and purchase the bond. What are the annual taxes owed on the interest? b) You are in the 30 percent income tax bracket and purchase the bond in your IRA. What are the annual taxes owed on the interest?

Solution

a) Coupon Income after three years=$80

   Capital gain after 7 years =$1000-$794=$206

   Annual Tax for (7-3-1) =3years will be equal to tax on coupon i.e. 30%*$80=$24

For last year annual tax will be equal to tax on (coupon+ Capital Gain) = 30 %*( 80+1000-794) = $30%*286=$85.80

b) Investors do not have to pay taxes on the interest and capital gains they earn within the IRA.