It's hard to find a safer investment than U.S. Treasury securities, such as T-bills. Their principal and interest are both backed by the full faith and credit of the U.S. government. The trade-off for all that security is a relatively low interest rate, but T-bill investments come with a built-in tax break. Although the interest is fully taxable at the federal level, it is exempt from state and local income taxes.
Treasury securities, such as T-bills, T-notes and T-bonds, are debt obligations of the federal government. They differ primarily in their maturity and how they pay interest. T-notes and T-bonds are intermediate to long-term investments with maturities of longer than one year. They pay interest twice a year.
T-bills are short-term investments with maturities of up to one year. They're typically issued with maturities of 52 weeks, 26 weeks, 13 weeks or four weeks. T-bills are purchased at a discount from their face value, and they don't make regular interest payments. Instead, you get the full face value upon maturity. The IRS considers the difference between the face value and the purchase price to be interest.
The interest on all U.S. Treasury securities, including T-bills, is fully taxable at the federal level. After the end of the year, the Department of the Treasury should send you a Form 1099-INT that details how much interest you were paid. You are responsible for reporting the interest on your T-bills and paying taxes on that amount, even if you don't receive a Form 1099-INT.
The interest is taxable in the year the T-bill matures. If your T-bill matures on the last day of the year, the interest on that T-bill is considered taxable income for that year.
State and Local Exemption
The interest you earn on U.S. Treasury securities, including T-bills, is exempt from taxation at the state and local level. States might require you to report the income from your T-bill interest, but you will not have to pay state or local income taxes on that amount.
The U.S. Treasury Department no longer issues paper T-bills. All T-bills are issued and kept in electronic form. If you have your T-bills held by the U.S. Treasury Department's TreasuryDirect system, you can have up to 50 percent of your interest payments withheld to go toward your federal income taxes.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.