Interest earned on all U.S. Treasury securities, including treasury bills, is exempt from taxation at the state and local level but is fully taxable at the federal level. At the end of each year, owners of treasury bills should be sent a 1099-INT form by the Treasury. This form details how much interest was earned on government securities.

Understanding Treasury Bills (T-bills)

Treasury bills – often referred to as T-bills – are short-term debt obligations that are fully backed by the faith and credit of the U.S. government. They are sold in denominations that range between $1,000 and $5 million. T-bill maturity durations are all less than one calendar year. Common maturity durations are one month, three months (13 weeks) or six months (26 weeks).

Like all Treasury securities, T-bills are considered to be risk-free investments. The likelihood of the federal government defaulting on debt obligations is incredibly low, since the government has the ability to tax and print money.

For instance, during the 2007-08 financial crisis, investors flocked to Treasury securities to safeguard assets as losses in stocks and other areas of their portfolios mounted, while those that had already placed assets in Treasury securities prior to the crisis were largely spared.

Taxation of Treasury Bills

Even if states require that earned interest on government securities is reported as income, that income is never taxable at anything below the federal level. The federal tax burden can be eased through tax withholding.

Those who hold Treasury bills can withhold up to 50% of their interest earnings. Any percentage below 50% is acceptable, and it can be specified through any retail securities site. The Treasury automatically transfers the withholdings to the U.S. Internal Revenue Service (IRS) and reports the amount that is withheld on the 1099-INT form.