According to Treasury Direct, interest from EE U.S. savings bonds is taxed at the federal level but not at the state or local levels for income. This interest is also taxed through federal and state estate, gift and excise taxes. The interest is the amount that a bond can be redeemed for above the face value of the bond, which is its original purchase price.
The ownership of the bond governs who is responsible for paying tax on the interest. If one person purchases the bond and is the sole owner for the life of the bond, that person owes the taxes on the interest. If a child is the sole owner, a parent may report the interest on the bond and pay the taxes on the parent's tax return.
If one person purchases the bond and adds another person to the bond as co-owner and that person remains as such for the life of the bond, however, the purchaser is responsible for the taxes. If one person purchases the bond and lists another person as the sole owner of the bond, the person listed as owner is responsible for the interest.
If two people split the purchase price of the bond, each person is responsible for the proportion of the taxes that represents the proportion of the ownership stake in the bond. For instance, if Jim and Bill purchase a $1,000 bond with Jim paying $400 and Bill paying $600, Jim is responsible for 40% of the taxes, and Bill is responsible for 60% of the taxes.
The Exception to the Proportional Rule
The exception to the proportional rule is for spouses who live in community property states and who are each responsible for half of the taxes if they file their taxes separately. Taxes may also be split if there is a succession of ownership. When a bond changes hands, the owners are each responsible only for the taxes on the portion of the interest that accrued during each period of ownership.
So, if Jill owned a bond from 2003 to 2007 before relinquishing it to Amy, who has owned it since, Jill must pay the taxes on the interest accrued between 2003 and 2007, and Amy must pay the taxes on interest earned after 2007.
Owners can wait to pay the taxes when they cash in the bond, when the bond matures or when they relinquish the bond to another owner. Alternatively, they may pay the taxes yearly as interest accrues. Most owners choose to defer the taxes until they redeem the bond. A bond that has reached maturity and stopped earning interest is automatically considered redeemed and the interest amount is reported to the Internal Revenue Service. The income is interest income and is reported on a 1099-INT, and the owner includes it on the yearly tax return.
If an owner decides to report the interest income yearly, the income from that bond and all other savings bonds for the same owner must continue to be reported yearly. The interest still accrues, in this case, and is not received. Once the bond reaches maturity, the owner must let the IRS know that the interest has been paid yearly.