Do You Pay Taxes on Treasury Bonds?

U.S. Treasury securities represent a loan to the federal government and are considered a secure investment because they are backed by the full faith and credit of the United States. While they are known for their safety, investors should understand the unique tax rules that apply to the income these securities generate. These tax implications can affect the overall return on the investment.

Tax Treatment of Treasury Interest

Interest earned from Treasury securities is subject to federal income tax. This income is taxed at the investor’s ordinary income tax rate, which corresponds to their tax bracket, rather than the potentially lower long-term capital gains rates. For example, an investor in the 24% federal income tax bracket will pay a 24% tax on the Treasury interest they receive for the year.

A feature of Treasury securities is that the interest income is exempt from all state and local income taxes. This exemption can provide considerable tax savings, particularly for individuals residing in areas with high state and local tax rates. For instance, an investor in a state with a 9% income tax rate would save $90 in state taxes for every $1,000 of Treasury interest earned. This state and local tax exemption makes Treasuries an attractive option for those looking to reduce their state tax liability.

Taxation Across Different Treasury Securities

The timing of when interest income is taxed varies depending on the specific type of Treasury security. This distinction affects when an investor must report the income to the IRS. Understanding these differences is important for proper tax planning.

Treasury Bills (T-Bills)

Treasury Bills, or T-Bills, are short-term securities with maturities of one year or less. They are purchased at a discount to their face value and, upon maturity, the investor receives the full face value. The difference between the purchase price and the face value represents the interest earned. This interest is taxable in the year the bill matures, not the year it was purchased.

Treasury Notes (T-Notes) and Bonds (T-Bonds)

Treasury Notes (T-Notes) have maturities ranging from two to ten years, while Treasury Bonds (T-Bonds) have maturities of 20 or 30 years. Both T-Notes and T-Bonds pay interest to the investor semi-annually. This interest income is taxable at the federal level in the year it is received by the investor.

U.S. Savings Bonds (Series EE and I)

U.S. Savings Bonds, specifically Series EE and Series I bonds, offer more flexibility in when the interest is taxed. Investors can choose to defer reporting the interest income for tax purposes until the bond is redeemed or it reaches its final maturity, whichever occurs first. A tax exclusion exists for interest earned on these bonds if the proceeds are used to pay for qualified higher education expenses, potentially making the income federally tax-free.

Reporting Treasury Income to the IRS

After the tax year concludes, investors will receive Form 1099-INT, “Interest Income,” from the bank or brokerage firm that holds their securities. This form details the amount of interest earned during the year.

The interest from Treasury securities is reported in Box 3 of Form 1099-INT, labeled “Interest on U.S. Savings Bonds and Treasury obligations.” This amount must be reported on the investor’s federal income tax return. This figure is transferred to Schedule B (Interest and Ordinary Dividends), assuming the total taxable interest from all sources exceeds $1,500 for the year.

Because Treasury interest is exempt from state and local taxes, a specific adjustment is required on the state tax return. State income tax forms have a designated line item for subtractions from income. An investor must identify the amount of Treasury interest reported on their federal return and subtract it on their state return.

Tax Implications of Selling a Treasury Bond

Selling a Treasury security on the secondary market before it reaches its maturity date can create a separate tax event, resulting in a capital gain or a capital loss. The gain or loss is calculated by subtracting the bond’s purchase price from the sale price.

The tax treatment of this gain or loss depends on how long the investor held the security. If the holding period was one year or less, the result is a short-term capital gain or loss, which is taxed at the investor’s ordinary income tax rate. If the holding period was more than one year, it is a long-term capital gain or loss, taxed at lower rates. These transactions must be reported on Form 8949 and summarized on Schedule D (Capital Gains and Losses).