While still considered savings bonds, HH bonds are a different breed from the EE bonds you may be most familiar with. EE bonds are purchased at less than face value and accrue interest to equal or exceed that value. You typically pay income tax on the interest only when you redeem the bond. HH bonds, which stopped being issued in 2004, were purchased at face value and paid interest every six months. That interest is declared on annual income tax filings. However, many HH bonds also have deferred interest, and this is what can kill you when you redeem them.
A History Lesson
Chances are the HH bonds you have were inherited or gifted to you by an older relative. They were available only between 1980 and 2004 in increments of $500, $1,000, $5,000 and $10,000. Starting after November 1982, you could no longer purchase HH bonds directly. You could only get them by exchanging saving bonds you already owned. If the exchanged bonds had accrued interest, HH bond purchasers could pay taxes on that interest in the year they rolled the bonds over or deferred the payment. Taxes on that interest must be paid when the bonds are redeemed or when they are reissued due to a significant change in ownership.
Whose Tax Is It Anyway
If your name is the only one on the HH bond, then you have no choice but to pay the taxes on deferred interest. If your name and someone else's name is on the bond — for instance, if your parent purchased a bond in both your names — but your parent had provided all the bonds that were rolled over, then your parent is responsible for the taxes. If you both owned bonds that were rolled into the HH bonds, then you are responsible only for the deferred interest attributable to the bonds you rolled over. In all cases, the IRS will issue only one 1099-INT to the person who is listed first.
If you inherited HH bonds with deferred interest, and the deceased had owned all the rolled-over bonds, you may have some options for handling income tax. As long as the deceased's name is on the bonds, you can include that interest on the deceased's final tax return or on the deceased's estate return, even if your name is on them, too. If your name is on the bonds, you also have the option of holding onto them and redeeming them incrementally. You'll need to inform the U.S. Treasury that interest should now go into your account, and you'll continue to receive the regular interest every six months until they are redeemed. You may want to have a tax professional review your options to determine which would lead to the lower tax.
Other Tax Triggers
If your name was not on the inherited bonds, you can't hold on to them without having them reissued in your name. Doing that is the same as redeeming them in the eyes of the Internal Revenue Service. While the bond will keep its face value and receive regular interest, you will be responsible for paying the income taxes on any deferred interest in the year they are reissued. Also, taxes automatically become due on deferred-interest HH bonds on the date they stop earning regular interest. This date is 20 years following their purchase.