Savings bonds offer security that almost no other investment can match: even if the government runs out of money, it is legally authorized to print more. Savings bonds also offer additional tax benefits, including a choice of when to include the interest income in your taxes. However, you cannot elect for the interest to be taxed at capital gains rates.
When Savings Bond Interest is Taxed
Savings bond interest is taxable on your federal tax return, and you have two options when it comes to reporting the interest. The default rule is that you don't pay any taxes on the accrued interest until you cash in the bond. This allows you to avoid paying taxes until you have actually received the interest. Alternatively, you can choose to report the accrued interest every year. This helps avoid having to report a large lump sum interest amount in the year of redemption. Depending on how much interest you earned, it could bump you into a higher tax bracket if you don't opt to include it each year.
Federal Tax Rates for Savings Bond Interest
Savings bond interest is always taxed as interest income, not at capital gains rates, even if you have held the bond for more than one year. Interest income is taxed at your ordinary income tax rate, which varies depending on your income and filing status. For example, if you fall in the 28 percent tax bracket and have $2,000 of taxable savings bond interest income, you pay $460 in federal taxes.
Exemption from State Tax
Generally, states cannot tax the interest you earn on U.S. savings bonds. Depending on your state income tax rate and your income level, this could save you a tax of 10 percent or more. Conversely, if you live in a state without an income tax, this extra benefit isn't much help. The only exception to this exception is if a state imposes estate or inheritance tax. If it does, it can include the value of the savings bonds as part of the taxable estate.
Reporting Savings Bond Interest
When you cash in a savings bond, you receive a Form 1099-INT, which is used to report interest income. If you use Form 1040EZ, it goes on line 2. However, if you have more than $1,500 of total interest income, including your savings bond interest income for the year, you must use Form 1040 or Form 1040A and attach Schedule B, which lists all of your interest income sources. If using Form 1040 or Form 1040A, the interest is reported on line 8a.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."