How to Report Savings Bond Interest on Your Tax Return

Savings bonds are a popular investment due to their low risk and potential tax benefits. However, accurately reporting the interest earned on these bonds is crucial for compliance with IRS regulations and avoiding penalties.

Calculating Total Interest

To report savings bond interest, you first need to calculate the total interest accrued. Savings bonds like Series EE and Series I earn interest over time, compounded semiannually, which is paid when the bond is redeemed or matures. The U.S. Treasury provides an online Savings Bond Calculator to determine the current value and accrued interest of your bonds using details like the bond’s series, denomination, and issue date.

The interest earned is the difference between the bond’s redemption value and its purchase price. For instance, if a Series EE bond was purchased for $50 and is now worth $100, the total interest earned is $50. This interest is subject to federal income tax but not state or local taxes. The IRS requires reporting in the year the bond is redeemed, matures, or is otherwise disposed of unless you choose to report it annually.

Determining When to Report

The timing of reporting savings bond interest depends on the method you choose. The IRS allows two approaches: cash basis and accrual basis reporting.

Under the cash basis method, interest is reported in the year the bond is redeemed or matures. This approach defers taxes until the bond’s maturity or redemption, which can align with many taxpayers’ cash flow preferences.

With the accrual basis method, interest is reported annually as it accrues, even if the bond hasn’t been redeemed. This option spreads the tax liability over time, potentially reducing the burden in the year of redemption. Taxpayers opting for this method must consistently report interest annually and obtain IRS approval to change methods. This can be advantageous for those expecting to be in a lower tax bracket during the bond’s accrual period.

Filing on the Tax Return

When filing savings bond interest, IRS Form 1099-INT is key. This form, issued by the U.S. Treasury upon bond redemption, details the interest earned and must be reported on Line 2a of Form 1040. Cross-check the form’s information with your records to ensure accuracy and avoid discrepancies that might trigger an audit.

If you’ve elected to report interest annually, ensure your records reflect this consistently to prevent potential penalties. Savings bond interest can also increase your adjusted gross income (AGI), which may affect eligibility for tax credits or deductions like the Child Tax Credit or education-related tax benefits. Understanding these implications can aid in minimizing your overall tax liability.

State and Local Tax Treatment

A key advantage of savings bonds is that their interest is exempt from state and local income taxes, which is particularly beneficial for residents in high-tax states like California or New York. This exemption enhances the tax efficiency of savings bonds, allowing bondholders to retain more of their returns.

While federal tax considerations are more prominent, state and local tax nuances should not be overlooked. For example, increases in AGI due to federal tax treatment of bond interest could indirectly impact state-specific tax credits or exemptions tied to education savings or retirement contributions.

Education Exclusion Considerations

Savings bonds offer a federal tax exclusion when used for qualified education expenses, applying to Series EE and Series I bonds issued after 1989. To qualify, the bondholder must meet criteria such as income limits, eligible expenses, and proper titling of the bonds.

The exclusion applies only to qualified higher education expenses, such as tuition and fees, and must be claimed in the same tax year the expenses are paid. For example, if $5,000 in bonds is redeemed to pay $4,000 in tuition, only the portion of interest corresponding to the $4,000 qualifies for exclusion.

Income limits also apply. For 2023, the exclusion begins phasing out for single filers with a modified adjusted gross income (MAGI) above $91,850 and is fully phased out at $106,850. For married couples filing jointly, the phase-out range is $137,800 to $167,800. These thresholds are adjusted annually for inflation. Proper documentation, including receipts for educational expenses and Form 8815, is required to claim the exclusion. Failure to meet these requirements can result in disqualification and additional tax liability.