Identification

• Corporate bonds are debt securities issued by companies to borrow money. When you invest in a corporate bond, the interest it earns usually is paid twice yearly. If you invest in a bond fund that holds corporate bonds, your share in the interest earned by the bonds in the fund's portfolio is paid in the form of dividends, usually on a monthly basis. Either way, corporate bond interest is fully taxable and you must pay federal income taxes on the interest accordingly. You are also liable for state and local income taxes, if any.
  
  

Taxation

• Taxes due on corporate bond interest are calculated for the tax year in which the interest is paid. Your tax rate on corporate bond interest is your marginal tax rate. The marginal tax rate is the maximum percentage you pay in income tax on other income. For example, if your income puts you in the 25 percent tax bracket on your federal tax return, your marginal tax rate is 25 percent. That's the rate at which interest earned from investments in corporate bonds will be taxed.
  
  

Tax Shelters

• In some cases, you may be able to minimize or even eliminate taxation of corporate bond interest. If the bonds are held in a tax-deferred account, such as a Traditional IRA, the interest earned isn't taxed until withdrawn after retirement. If you expect your marginal tax rate to be lower when you retire, you'll pay less tax on the bond interest. If the bonds are held in a Roth IRA, you can eliminate taxation of corporate bond interest entirely. That's because earnings in a Roth IRA are exempt from income taxes when withdrawn after retirement.
  
  

Capital Gains

• Don't confuse interest paid on corporate bonds with capital gains tax. If you sell a corporate bond for more than the price you paid for it, you make a profit. Profits from buying and selling a bond are considered capital gains by the IRS (or a capital loss if you sold the bond for less than you paid). If you've held the bond for more than one year, any capital gains are taxed at 15 percent or less (as of 2011).