Megan Brooks
Savings bonds are a safe way to save money for the long term while earning interest. However, the interest earned is taxable. While the interest on savings bonds is subject to federal income tax, it is generally exempt from state and local income taxes. The interest income is reported on a 1099-INT form, and the owner includes it on their yearly tax return. If you choose to report the interest income yearly, you must continue to do so for all subsequent years. Additionally, if you receive payments of interest of $10 or more, you should receive a Form 1099-INT or Form 1099-OID reporting those payments. There are strategies to minimize or avoid taxes on savings bond interest, such as using the funds for qualified higher education expenses or rolling the savings into specific college savings accounts.
| Characteristics | Values |
|---|---|
| Interest on savings bonds is taxable | Yes, but there are some exceptions |
| Exceptions | Interest on savings bonds used to pay for higher education may be exempt from federal income tax |
| How to avoid paying taxes on savings bond interest | Roll the money into a college savings account, such as a 529 plan or a Coverdell Education Savings Account (ESA) |
| When is interest on savings bonds taxed? | When the bond matures or when it is redeemed, or annually if the owner chooses to report interest income yearly |
| Form for reporting interest on savings bonds | 1099-INT |
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What You'll Learn
Interest on savings bonds is taxable
Interest on savings bonds is generally taxable. This includes interest on bank accounts, money market accounts, certificates of deposit, corporate bonds, and deposited insurance dividends. The interest on savings bonds is considered income and must be reported on your federal income tax return. It is important to note that the interest on savings bonds is subject to federal gift, estate, and excise taxes, but it is typically exempt from state and local income taxes.
When it comes to reporting interest income, you have a few options. You can choose to report the interest in the year you earn it, or you can defer reporting the interest until the bond matures or is redeemed, whichever comes first. If you choose to report the interest annually, you must continue to do so for all subsequent years. Additionally, if you receive payments of interest of $10 or more, you should receive a Form 1099-INT or Form 1099-OID reporting those payments, which you can use to help with your tax filing.
It is worth mentioning that there are some exceptions to the taxability of savings bond interest. For example, if the savings bonds are used to finance qualified higher education expenses for yourself, your spouse, or your dependent, you may be able to exclude the interest from your gross income. This exclusion applies to Series EE and Series I savings bonds. Additionally, if the savings bonds are in a child's name, you may find it advantageous to report the interest annually, as the child may be subject to a lower tax rate than they will be when the bond matures.
Furthermore, there are strategies to minimize the taxes you pay on savings bond interest. One option is to roll the savings bonds into a college savings account, such as a 529 plan or a Coverdell Education Savings Account (ESA). By doing so, you can avoid taxes on the interest and continue saving for higher education expenses on a tax-advantaged basis. It is always recommended to consult with a financial advisor to determine the best approach for your specific situation.
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Report interest annually or when redeemed
Interest on savings bonds is generally taxable. However, you can choose to report the interest annually or when the bond is redeemed. If you choose to report the interest annually, you must continue to do so for all your savings bonds. This can help even out your income over the years, especially if your U.S. Savings Bond interest is substantial.
If you choose to report the interest when the bond is redeemed, you will receive a Form 1099-INT that shows the full amount of interest the bond earned. This form will only be provided when the bond is cashed or matures. The interest will be reported under the name and Social Security Number of the person who redeems the bond or owns it when it matures.
If you redeem Series I bonds or Series EE bonds purchased after 1989 and use the money to pay for qualified higher education expenses, you can exclude the bond interest from your taxable income. This includes expenses for yourself, your spouse, or a qualified dependent. You can also roll savings bonds into a college savings account, such as a 529 plan or a Coverdell Education Savings Account (ESA), to avoid paying taxes on the interest.
It is important to note that certain distributions referred to as dividends may be taxable interest. Additionally, if you receive payments of interest of $10 or more, you should receive Form 1099-INT or Form 1099-OID reporting those payments. You must report all taxable and tax-exempt interest on your federal income tax return, even if you do not receive these forms.
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Interest on EE/E savings bonds
EE/E savings bonds earn interest from the first month of ownership. Paper bonds accrue interest until they are cashed, while electronic bonds accrue interest until they are cashed or reach the end of their 30-year lifespan. The interest is paid all at once when the bond is cashed or matures. The 1099-INT form, which includes all the interest the bond earned over its lifetime, is available by January 31 of the following year if the bonds are held in a TreasuryDirect account.
The interest rate for Series EE bonds issued from May 1997 to April 2005 is set at 90% of the average 5-year Treasury securities yields for the preceding six months. These rates are updated every May 1 and November 1. Series EE bonds issued before May 1997 have varying rates depending on their issue dates. Bonds issued between January 1980 and May 1995 are no longer earning interest, while those issued from June 1995 to October 1995 will stop earning interest in the next six months.
It's important to note that if you use the money from EE/E savings bonds for qualified higher education expenses for yourself, your spouse, or your dependent, you may be able to exclude some or all of the interest from your gross income.
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Tax-exempt bonds
Municipal bonds are a type of tax-exempt bond that has been used for over 100 years to fund infrastructure and other facilities in communities across the United States. They are issued for projects such as nonprofit hospitals, housing developments, colleges and universities, transportation hubs, student loan programs, and public works projects. The interest on these bonds is generally exempt from federal income tax and, in some cases, state or local income tax, depending on whether the bondholder resides in the state that issued the bond.
Original-issue discount bonds are municipal bonds issued at a price below face value, which qualify for special treatment under federal tax law. The difference between the issue price and the face value is treated as tax-exempt income rather than capital gains if the bonds are held until maturity. Market discount bonds are municipal bonds purchased for less than their face value in the secondary market. Pre-refunded bonds are the result of the advance refunding of bonds that are not currently redeemable.
Conduit bonds are a type of tax-exempt municipal bond where the third-party borrower, not the issuing conduit agency, is responsible for interest payments and principal repayments. Unless the official statements indicate otherwise, investors in conduit bonds should not view the issuing governmental agency as a guarantor.
While municipal bonds are generally tax-exempt, there are certain cases where the interest on municipal bonds is taxable. For example, the federal government will not subsidize the financing of activities that do not provide a significant benefit to the public, such as stadiums, replenishment of a municipality's underfunded pension plan, or investor-led housing. Build America Bonds (BABs), introduced after the 2008 financial crisis, are another category of taxable municipal bonds. Issuers of BABs receive a 35% federal rebate on interest costs, but there is no implied backing from the federal government.
For a tax-exempt bond acquired on or after January 1, 2017, a Form 1099-OID, or a similar statement, of tax-exempt OID must be provided. This form is reportable as tax-exempt interest, but it does not convert tax-exempt interest into taxable interest.
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Avoid taxes on savings bond interest
Banks do withhold taxes on savings bonds, and the interest earned on savings bonds is generally taxable. However, there are strategies to minimise tax liability on savings bond interest. Here are some ways to do so:
Higher Education Expenses
Using savings bond interest to pay for qualified higher education costs for yourself, your spouse, or a qualified dependent can help you avoid taxes. This includes expenses such as tuition, fees, and, in some cases, room and board or activity fees. However, there are certain conditions that must be met. The savings bonds must be Series EE or I bonds issued after 1989, and the owner of the bond must be 24 years or older when the bond is issued. Additionally, the expenses must be paid using bond funds in the same tax year that the bonds are redeemed.
Rollover into a College Savings Account
You can roll over your savings bonds into a 529 college savings plan or a Coverdell Education Savings Account (ESA) to avoid taxes on the interest. The 529 plan offers tax advantages for higher education savings, and withdrawals are tax-free when used for qualified education expenses. However, keep in mind that there are contribution limits and potential tax penalties if the funds are not used by a certain age.
Defer Reporting Interest
If you have savings bonds in a child's name, you may find it advantageous to defer reporting the interest until they file a federal income tax return for the year in which they actually receive the interest. This is because the child may be paying taxes at a lower rate than they will as an adult when the bond matures.
Tax-Exempt Bonds
Interest on some government-issued bonds used to finance operations may be tax-exempt at the federal level. These include bonds issued by state governments, the District of Columbia, or a U.S. territory. However, this is an information-reporting requirement, and it is essential to consult the relevant IRS publications for specific guidelines.
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Frequently asked questions
Banks do not withhold taxes on savings bonds. The interest accrued on savings bonds is taxable, but the tax is not withheld by banks. The interest is reported to the IRS, and the tax is paid by the taxpayer when filing their tax return.
You can report the interest accrued on your savings bonds by filling out Form 1099-INT, which is provided by the bank when the bond matures or is cashed. You can choose to report the interest annually or in the year the bond matures or is cashed.
Yes, interest accrued on savings bonds is exempt from state and local income taxes. However, it is subject to federal gift, estate, and excise taxes.
Yes, there are a few strategies to avoid or minimize taxes on savings bond interest. One way is to use the money from the savings bonds for qualified higher education expenses for yourself, your spouse, or a dependent. Another strategy is to roll over the savings bonds into a college savings account, such as a 529 plan or a Coverdell Education Savings Account (ESA).
If you do not receive a Form 1099-INT, you can still report the interest on your savings bonds when filing your tax return. You may not receive the form every year, but you can report the interest annually to distribute your income more evenly over the years.
