🏦LTB
← Series 7: Investment Information & Recommendations
Series 7 practice questionhardDebt Securities — US Government — STRIPS Taxation

How is the annual increase in value of a STRIPS (zero-coupon Treasury) treated for tax purposes?

  1. AIt is tax-free since it is a government obligation
  2. BIt is taxed only at the state and local level
  3. CIt is taxed annually as ordinary income (phantom income) at the federal level✓ Correct answer
  4. DIt is taxed as a capital gain only at maturity
Explanation

Why C — It is taxed annually as ordinary income (phantom income) at the federal level

STRIPS, like all zero-coupon bonds, create phantom income that must be reported as ordinary interest income annually for federal tax purposes, even though no cash is received until maturity. The annual accretion of the discount is calculated using the constant yield method. However, like all Treasury obligations, STRIPS interest is exempt from state and local income taxes. This phantom income taxation makes STRIPS particularly suitable for tax-deferred accounts like IRAs.

Turn it into reps

Reading one answer is not the same as being ready

Lucky the Banker is a free practice app with 755+ Series 7 questions, weak-area tracking, and timed mock exams. No credit card, no paywall.

Practice Series 7 freeSeries 7 exam guide
Related Investment Information & Recommendations questions