Understand the Taxation of Savings Bonds
Interest earned on EE U.S. savings bonds is taxed federally, while no state or local taxes apply to this interest income. This interest income is the additional amount the bond can be redeemed for above its face value, which is its original purchase price. It is crucial to remember that savings bond interest is also subject to federal gift, estate, and excise taxes. At the state level, taxes on savings bonds typically apply to estates or inheritances.
Key Takeaways
- Federal-Level Taxation: Interest from EE U.S. savings bonds is taxed federally, exempt from state or local income taxes.
- Income Generation: The interest you earn represents the difference between the bond’s face value and its redemption value.
- Additional Taxes: Savings bonds’ interest may also be subject to federal gift, estate, and excise taxes. State-level taxation usually revolves around estates or inheritances.
Who Pays the Taxes? Understanding Savings Bond Ownership and Tax Responsibilities
Simple Ownership
The individual who purchases and wholly owns the bond for its entire duration is responsible for paying the tax on the interest. In cases where a child is the sole owner, a parent might opt to report the interest on their own tax return and shoulder the tax responsibility.
Multiple Ownership Scenarios
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Adding Another Owner: If an individual purchases a savings bond and includes another person as a co-owner, the initial purchaser is liable for the taxes during the bond’s life. Conversely, if the bond is purchased in one name initially but lists another individual as the sole owner, the listed owner becomes responsible for the taxes on the interest earned.
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Proportional Ownership: This occurs when two or more people split the bond purchase cost. Each individual is responsible for taxes proportional to their ownership share. For instance, if Jim contributes $400 and Bill $600 towards a $1,000 bond, Jim is liable for 40% of the taxes while Bill covers 60%.
Exceptions in Community Property States
In community property states, spouses can split the tax responsibilities evenly if they file separately. If the ownership passes on, each prior and new owner bears the tax burden for the interest accrued during their ownership period. Suppose Jill owned a bond from 2003 to 2007 and then handed it over to Amy. Jill would be liable for the taxes accrued from 2003 to 2007, while Amy would handle the tax for interest since 2007.
Reporting Bond Interest for Taxes
Savings bond owners have a choice on when to pay the taxes—either when cashing in the bond, upon its maturity, or when transferring it to another holder. An alternative is paying the taxes annually as the interest accrues, though most choose to defer taxes until the bond’s redemption.
When a bond matures and ceases earning interest, it’s considered automatically redeemed, reporting the interest income to the IRS. Such income is declared on a 1099-INT and integrated into the annual tax return. Should owners report annually, all bond interest income must continue to be reported every year until the bond’s maturity, at which point the IRS would be informed that taxes have been consistently paid annually.
Related Terms: Treasury bonds, investment taxes, estate taxes, tax returns.
References
- Treasury Direct. “Series EE/E Savings Bonds Tax Considerations”.
