How Are Savings Bonds Taxed?

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. Bonds typically earn interest, which is the amount that a bond can be redeemed for above its face value. The face value is the bond's original purchase price. The interest on savings bonds is also subject to federal gift, estate, and excise taxes. On the state level, the tax on the interest applies for estates or inheritances.

Key Takeaways

  • Interest from EE U.S. savings bonds is taxed at the federal level but not at the state or local levels for income.
  • The interest that savings bonds earn is the amount that a bond can be redeemed for above its face value or original purchase price.
  • Savings bonds' interest is also subject to federal gift, estate, and excise taxes while at the state level, the tax applies for estates or inheritances.

Understanding How Savings Bonds are Taxed

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.

However, there are ownership situations whereby the tax responsibility can vary. The taxes on interest for U.S. savings bonds are outlined under the section, tax considerations, on the Treasury Direct website.

Below are some of the ownership scenarios that can impact who pays the taxes on the interest for a savings bond. Please note that the tax rates can change depending on the policies of the U.S. Treasury and the Internal Revenue Service (IRS). Please consult a tax professional for your specific tax situation.

Another Owner Added by Purchaser

If one person purchases the bond and adds another person to the bond as co-owner whereby that person remains co-owner for the life of the bond, 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 the owner is responsible for the interest.

Proportional Ownership

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.

Exception to the Proportional Ownership 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.

Reporting the Interest for Taxes

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.