What does the amortization of a bond premium generally offset?

The amortization of a bond premium generally offsets interest income on the bond. When an investor purchases a bond at a premium (above its face value), the bond will pay interest based on its face value, but the investor will receive lower effective interest income due to the premium paid.

As the premium is amortized, it reduces the interest income reported on the investor’s tax return. This is because the bondholder must recognize a smaller amount of taxable interest income each year due to the premium amortization. In practical terms, this means that for tax purposes, the investor acknowledges the amortization as a way to account for the difference between the coupon payments received and the economic reality of the bond investment.

This reduction in reported interest income aligns with the tax treatment regarding the premium amortization and prevents the bondholder from being taxed on the entire coupon payment received while also having paid more than the face value for the bond.