J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

4.13 Interest on Frozen Accounts Not Taxed

If you have funds in a bankrupt or insolvent financial institution that freezes your account by limiting withdrawals, you do not pay tax on interest allocable to the frozen deposits. The interest is taxable when withdrawals are permitted. Officers and owners of at least a 1% interest in the financial institution, or their relatives, may not take advantage of this rule and must still report interest on frozen deposits.

On Part I of Schedule B (Form 1040 or Form 1040A), report the full amount shown on Form 1099-INT, even if the interest is on a “frozen” deposit. Then, on a separate line, subtract the amount allocable to the frozen deposit from the total interest shown on the Schedule; label the subtraction “frozen deposits.” Thus, the interest on the frozen deposit is not included on the line of your return showing taxable interest.

Refund opportunity.

If you reported interest on a frozen deposit on a tax return for a prior year, you generally have three years to file a refund claim for the tax paid on the interest (47.2).