Mastering Savings Bonds Taxation: Who Pays and When?

Thomas J Catalano, a Certified Financial Planner and Registered Investment Adviser from South Carolina, founded his own advisory firm in 2018. His expertise spans investments, retirement planning, insurance, and comprehensive financial strategies.

According to Treasury Direct, interest earned from U.S. EE savings bonds is subject to federal income tax but is exempt from state and local income taxes. The interest represents the amount by which the bond's redemption value exceeds its original purchase price, also known as the face value. Additionally, savings bond interest may be subject to federal gift, estate, and excise taxes, while at the state level, such taxes typically apply to estates or inheritances.

Key Insights

• Interest from U.S. EE savings bonds is federally taxable but exempt from state and local income taxes.
• The interest is the difference between the bond's redemption value and its original purchase price.
• Federal gift, estate, and excise taxes may apply to savings bond interest; state taxes generally affect estates or inheritances.

Understanding Tax Responsibilities for Savings Bonds

The bond owner is responsible for reporting and paying taxes on the interest earned. If a single individual owns the bond throughout its life, they are liable for the taxes. In cases where a child owns the bond, a parent may report the interest on their tax return and pay the taxes accordingly.

Tax obligations can vary depending on ownership arrangements. The Treasury Direct website outlines these tax considerations in detail. Below are common scenarios affecting who pays the taxes on savings bond interest. Tax rates and policies may change, so consulting a tax professional for personalized advice is recommended.

Adding a Co-Owner

If a purchaser adds a co-owner who remains on the bond for its duration, the original purchaser remains responsible for the taxes. Conversely, if the bond is issued solely in another person’s name, that individual is responsible for the interest taxes.

Shared Ownership and Tax Allocation

When two individuals share ownership proportional to their contribution, each is responsible for taxes relative to their ownership stake. For example, if Jim pays $400 and Bill pays $600 for a $1,000 bond, Jim owes 40% and Bill owes 60% of the taxes.

Exceptions for Community Property and Ownership Transfers

Spouses in community property states split tax responsibilities evenly if filing separately. Also, when ownership transfers, each owner pays taxes only on interest accrued during their ownership period. For instance, if Jill owned the bond from 2020 to 2024 and Amy thereafter, Jill pays taxes on interest earned during her ownership, and Amy pays for interest earned after 2024.

Important Note

Inherited Series EE and Series I savings bonds can be redeemed tax-free if used for qualified higher education expenses for yourself, your spouse, or dependents.

When and How to Report Savings Bond Interest

Bond owners may choose to report interest annually as it accrues or defer reporting until redemption or maturity. Most defer taxes until the bond is cashed in. Upon maturity, bonds stop earning interest and are considered redeemed, generating a 1099-INT form for tax reporting.

If opting for annual reporting, all bonds owned must be reported yearly until maturity. Once matured, the owner must notify the IRS that interest has been reported annually.

How EE Savings Bonds Work

EE savings bonds are U.S. government securities purchased at face value with a fixed interest rate. The government guarantees the bond will double in value within 20 years. Interest accrues monthly and compounds semiannually over 30 years. Early redemption is possible after one year but withdrawing before five years incurs a penalty of three months’ interest.

EE Savings Bond Maturity Timeline

EE bonds mature after 30 years. While you can cash them after one year, redeeming before five years results in a three-month interest penalty.

Value Growth of EE Bonds After 20 Years

Guaranteed by the U.S. government, EE bonds double in value after 20 years. For example, a $50 bond will be worth at least $100 after two decades. The minimum purchase amount is $25.

Final Thoughts

Interest earned on EE savings bonds is subject to federal income, gift, estate, and excise taxes but exempt from state and local income taxes. Tax responsibility depends on ownership structure, whether sole or shared. Investors can choose to defer taxes until redemption or maturity or pay annually. Understanding these rules helps optimize tax planning around savings bonds.

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