How to Avoid Paying Taxes on U.S. Savings Bonds (2024)

How to Avoid Paying Taxes on U.S. Savings Bonds (1)

I was born during the late 80s. During that time it was popular for people to buy savings bonds for children. It was an investment into the child's future. I would go as far as to say it was a popular gift from grandparents, great aunts, and great uncles. Well, now my fellow Millennials are having to deal with this savings tool from the past. Why? Because they are maturing.

What Grandma and Grandpa didn't tell you is that you will have to pay taxes on some of the bond when it matures. The interest. Today I'm going to walk you through a tax strategy that can help you avoid paying that tax. So grab your pen and paper as I break down how to avoid paying taxes on savings bonds.

What is a U.S. Savings Bond?

Before I get too deep into the process it's important that you understand what a savings bond is. A U.S. savings bond is a loan to the government. When you buy a bond you are giving your money to the United States. They then guarantee that they will pay it back with interest at a predetermined date.

Note: There are many types of bonds so I want to make a distinction that we are talking only talking about U.S. savings bonds today.

These bonds were born in 1935 during President Franklin D. Roosevelt's time in office. He signed a law allowing the Treasury Department to sell the first bonds at $25. Since that time the U.S. has issued many more bonds. Until 2012 taxpayers could purchase them at banks. Now you can only buy U.S. savings bonds from the government online. You can even purchase them with your tax refund.

There are two different types of U.S. savings bonds:

Series I Bonds

Series I bonds pay a fixed interest rate based on inflation. This protects you as an investor from inflation and is very low risk. You earn a fixed rate of interest and a rate that changes. The inflation rate is set in 6-month intervals.

You can have a bond for 30 years but you can cash it in after 12 months. There are consequences to cashing it in early. If you cash it in less than 5 years you lose the last 3 months of interest.

This means if Joyce purchases a Series I U.S. savings bond and holds it for 48 months she will only receive 45 months of interest.

You do have to pay Federal income taxes on Series I savings bond interest. But you do not have to pay taxes at the state and local levels. You can report the interest each year you earn it or when you cash the bond. You will report it on Schedule B of your 1040. You can avoid these taxes by using the money for qualified higher education expenses.

Series EE Bonds

Series EE bonds earn interest regularly for 30 years. They do not protect you from inflation. However, they have a guarantee that your investment will double after 20 years. Even if the government has to add the difference at year 20.

Let's say Kim's grandparents purchased a $10,000 series EE savings bond for her in 1992. In 2012 the bond would have been worth $20,000.

The interest on series EE bonds compounds semiannually. This means that every 6 months the government applies the interest rate to a new principle amount. This allows it to grow faster because the principle is also growing.

New series EE bonds, since May 2005, earn a fixed rate of interest for the first 20 years. The government may adjust the rate after that time. There are different rules for how the interest is compounded for earlier years. The time frames are:

  • Before May 1995

  • May 1995 - April 1997

  • May 1997 - April 2005

  • May 2005 - present

You do have to pay Federal taxes on the interest your series EE savings bond earns. You do not have to pay taxes at the state and local levels. The reporting is the same as series I bonds. You can also avoid paying taxes on the interest if you use the funds for qualified higher education expenses.

How to avoid paying taxes on U.S. savings bonds

The part we have all been waiting for...who can cash in their bonds tax-free? Like most IRS topics, it depends. You may qualify if you meet certain criteria. Part of that criteria includes an income threshold.

  • Your filing status is not married filing separately.

  • Your 2022 Modified Adjust Gross Income (MAGI) is less than $158,650 if married filing jointly and $100,800 if head of household status.

  • The owner of the bond is at least 24 years old before the bond's issue date.

  • The government issued the bond after 1989.

  • You pay qualified education expenses for yourself, your spouse, or a dependent.

If your dependent is not college-age yet you can roll the money into a college savings account. These qualified tuition programs are better known as 529 accounts. Coverdell education savings accounts also qualify. This strategy will allow the money to grow even more to help pay for your dependent's higher education expenses. The principle will be tax-free if your dependent uses the money for the intended purposes. Then only the interest will be taxable.

If you do have current higher education expenses to pay these are the qualified expenses.

  • Tuition and fees are required for enrollment.

  • Contributions to a qualified tuition program (QTP).

  • Contributions to a qualified Coverdell education savings account (ESA).

You will have to reduce those expenses by any of the following tax-free benefits if you have them.

  • The tax-free part of scholarships and fellowship grants.

  • Expenses used to figure tax-free distribution from a Coverdell ESA

  • Expenses used to figure tax-free distribution from a QTP

  • Any tax-free payments (excluding gifts or inheritance) such as Veteran's educational benefits. Qualified tuition reductions and employer-provided educational assistance also count.

  • Any expenses used to figure out the American opportunity and Lifetime learning credits.

Unfortunately, if your income is above the thresholds mentioned above will not qualify for the U.S. savings bond exclusion.

Form 8815

If you have met all of the criteria so far, congratulations! You can exclude the interest from your series EE and series I U.S. savings bonds on Form 8815 of the 1040. Form 8815 helps calculate the amount of interest that you can exclude from your tax return. If all the interest was not used for a qualified higher education expense you will stay pay taxes on that amount.

Let's say that Kelli and Jarrod are a married couple filing jointly for 2022. In December of 2022, they cashed a qualified series EE U.S. savings bond from Kelli's grandparents. They received $12,000. $9,000 of that was principal and $3,000 was interest. In 2022 they paid $10,700 of their son's college tuition. They are not claiming any education credits and their son did not receive any education assistance. Their MAGI was $120,000. This is below the phase-out level so they can exclude the full eligible amount.

Kelli and Jarrod will be able to exclude $1,700 in interest from their income. They will still have to pay taxes on the remaining $2,300 that was not used for higher education expenses.

If in your planning you find that you were not able to exclude the interest, and now have a tax bill you can't pay don't fret. If you otherwise tax compliant and can pay it off within 36-72 months you may qualify for a Guaranteed Payment Plan. Check out my e-book Guaranteed Payment Plan to have your payment arrangement set up as soon as possible.

Summary

Savings bonds are a very low-risk savings tool. Qualifying taxpayers that have U.S. savings bonds maturing can avoid paying tax on the interest. The taxpayer will have to pay taxes on the interest if it is not used to pay a qualified higher education expense. Rolling the interest into a Qualified Tuition Program (529) or Coverdell education savings account is a good tax strategy for parents. It can help them lower their tax bill and save for their children's education at the same time.

Timalyn S. Bowens EA is America's Favorite EA and Tax Expert who will work hard to find a customized legal solution for you! As an Enrolled Agent licensed through the Internal Revenue Service Timalyn is able to fight the IRS for taxpayers in all 50 states. As the host of Tax Relief with Timalyn Bowens and a YouTube content creator she empowers taxpayers to make educated decisions about their tax situation.

When you are facing questions regarding your personal or business taxes, working with a professional makes all the difference. At Bowens Tax Solutions, we serve our Louisville-area neighbors by providing the tax services and knowledge needed to succeed. We are here to assist you with your tax issues and preventative care. Visit our website at www.bowenstaxsolutions.com for more information..

How to Avoid Paying Taxes on U.S. Savings Bonds (2024)

FAQs

How to Avoid Paying Taxes on U.S. Savings Bonds? ›

You can exclude the interest from your series EE and series I U.S. savings bonds on Form 8815 of the 1040. Form 8815 helps calculate the amount of interest that you can exclude from your tax return. If all the interest was not used for a qualified higher education expense you will stay pay taxes on that amount.

Is there any way to avoid taxes on savings bonds? ›

You can skip paying taxes on interest earned with Series EE and Series I savings bonds if you're using the money to pay for qualified higher education costs. That includes expenses you pay for yourself, your spouse or a qualified dependent. Only certain qualified higher education costs are covered, including: Tuition.

How much tax will I pay on my EE savings bonds? ›

The interest on EE bonds isn't taxed as it accrues unless the owner elects to have it taxed annually. If an election is made, all previously accrued but untaxed interest is also reported in the election year. In most cases, this election isn't made so bond holders receive the benefits of tax deferral.

Do I have to report savings bonds on my taxes? ›

Savings bond interest is subject to federal income tax; however, taxation can be deferred until redemption, final maturity, or other taxable disposition, whichever occurs first. You also have the option of claiming interest annually for federal income tax purposes.

Are US savings bonds interest exempt from state tax? ›

Interest income from Treasury bills, notes and bonds - This interest is subject to federal income tax, but is exempt from all state and local income taxes.

How much is a $100 savings bond worth after 30 years? ›

How to get the most value from your savings bonds
Face ValuePurchase Amount30-Year Value (Purchased May 1990)
$50 Bond$100$207.36
$100 Bond$200$414.72
$500 Bond$400$1,036.80
$1,000 Bond$800$2,073.60

How to avoid paying taxes on interest income? ›

You can make a number of moves to ease the tax burden from savings account interest, which include:
  1. Investing in a tax-deferred account such as a traditional individual retirement account or a 401(k).
  2. Stashing money in a tax-exempt account such as a Roth 401(k) or a Roth IRA.
Jan 25, 2024

Will I get a 1099 for cashing in savings bonds? ›

If you cash a paper savings bond at a local bank, that bank is responsible for giving you a 1099. If you cash a paper savings bond by mailing it to Treasury Retail Securities Services, we mail you a 1099 by January 31 of the following year. (You can call us for a duplicate statement, if needed, beginning February 15.)

Will TreasuryDirect send me a 1099? ›

If you invest in TreasuryDirect, your 1099 will be available electronically and you can print the form from your account. 1099 forms are available by January 31 of each tax year.

Do I have to pay tax on inherited savings bonds? ›

As a result, when inheritors redeem inherited bonds on which the tax has been deferred, they will owe tax on all the interest that has accumulated.

What US bonds are tax free? ›

Municipal Bonds

Most bonds issued by government agencies are tax-exempt. This means interest on these bonds are excluded from gross income for federal tax purposes.

Do you pay taxes on bonds when they mature? ›

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. 1 Most owners choose to defer the taxes until they redeem the bond.

What is the difference between a savings bond and a Treasury bond? ›

Finally, savings bonds can't be traded or sold between individuals (no secondary market) and must be redeemed through the government itself. By comparison, Treasury bonds, municipal bonds, and corporate bonds are much more liquid; all three types can be traded on a secondary market before maturity.

How do I invest in bonds to avoid capital gains tax? ›

If you buy a bond when it is issued and hold it until maturity, you generally won't have a capital gain or loss. If you sell the bond before its maturity date, you'll typically have a capital gain or capital loss, depending on the selling price.

What is the most tax efficient way to buy bonds? ›

Municipal bonds are very tax-efficient because the interest income isn't taxable at the federal level and it's often tax-exempt at the state and local level, too.

How to avoid tax on CD interest? ›

If the CD is placed in a tax-deferred 401(k) or individual retirement account (IRA), any interest earned on the CD may be exempt from paying taxes in the year it was earned. 2 Instead, you will pay taxes on that money when it is withdrawn from the 401(k) or IRA after you retire.

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