Are T-Bills Taxable? Federal, State, and Local Tax Rules Explained

U.S. Treasury Bills, commonly known as T-Bills, are a popular investment choice due to their safety and short-term nature. However, understanding the tax implications of these securities is crucial for investors seeking to optimize returns. Taxation on T-Bills varies depending on federal, state, and local regulations. This article examines how T-Bills are taxed across jurisdictions, helping investors make informed decisions when incorporating them into their portfolios.

Federal Tax Obligations

T-Bills are subject to federal taxation, with interest income treated as ordinary income and taxed at the investor’s marginal tax rate, ranging from 10% to 37%, depending on total taxable income. This interest income must be reported on the annual tax return using Form 1099-INT, issued by the financial institution holding the T-Bills.

T-Bills are sold at a discount and mature at face value, with the difference representing taxable interest. For instance, purchasing a T-Bill for $9,800 that matures at $10,000 results in $200 of taxable interest, recognized in the year the T-Bill matures. Investors should consider the timing of these transactions to manage taxable income effectively.

State and Local Exemptions

While federally taxable, T-Bill interest income is often exempt from state and local taxes. This exemption benefits investors in high-tax states like California and New York, where state income taxes can significantly reduce investment returns. The exemption is based on T-Bills being federal obligations, which states typically choose not to tax.

For example, an investor in a state with a 5% income tax rate earning $200 in T-Bill interest could save $10 in state taxes. Not all states offer this exemption, so investors should consult their state tax codes to ensure compliance and optimize their tax strategies.

Reporting Requirements

Accurate reporting of T-Bill transactions is essential for compliance with tax laws. Form 1099-INT, detailing interest earned during the year, must be issued by January 31. Investors should verify this information to avoid errors that could lead to audits or penalties.

The tax filing deadline for the 2024 tax year is April 15, 2025, unless extensions are granted. Staying proactive in reporting helps investors meet compliance requirements and avoid last-minute complications.

Gains or Losses

T-Bills generally do not produce capital gains in the traditional sense, as they are issued at a discount and mature at face value. However, selling a T-Bill in the secondary market before maturity can lead to a capital gain or loss. Short-term gains, from assets held for less than a year, are taxed at the ordinary income tax rate, while long-term gains benefit from lower rates. Proper documentation of these transactions is necessary to comply with IRS regulations.

Withholding and Estimated Tax Payments

Interest income from T-Bills does not include automatic tax withholding, requiring investors to plan ahead. The IRS mandates taxpayers pay at least 90% of their current year’s tax liability or 100% of the previous year’s liability through withholding or estimated payments to avoid penalties.

Estimated Tax Payments

Investors with significant income from T-Bills or other sources without withholding should make quarterly estimated tax payments. Deadlines for these payments are in April, June, September, and January of the following year. Using Form 1040-ES, individuals can calculate and submit payments. Missing payment thresholds can result in penalties and interest, reducing net returns. Tax software or professional advice can help ensure compliance and optimize payment strategies.

Planning Ahead for Withholding

Investors can adjust withholding on other income sources, such as wages or pensions, to cover taxes on T-Bill interest. Adjusting withholding allowances on Form W-4 or submitting a new Form W-4P for pensions ensures tax payments align with actual liabilities. This strategy helps avoid underpayment penalties and supports broader tax planning efforts.