What Is the Tax Rate on Treasury Bills?

Treasury Bills, or T-bills, are short-term debt instruments issued by the U.S. Department of the Treasury. They are purchased for a price less than their face value, and when the T-bill matures, the investor receives the full face value. This structure allows the U.S. government to borrow funds for short periods, typically one year or less. The tax rules for T-bills have distinct treatments at the federal and state levels, which can influence an investor’s overall return.

Calculating Taxable Income from Treasury Bills

The income earned from a Treasury Bill is not a periodic interest payment. Instead, the taxable income is the difference between the security’s face value (also known as par value) and the discounted price an investor pays at purchase. This income is considered realized for tax purposes in the year the bill matures and is paid out, or in the year it is sold on the secondary market, not in the year it was bought.

For instance, if an investor purchases a T-bill with a $1,000 face value for a discounted price of $980, the taxable interest income is $20. This $20 is the profit the investor makes for lending money to the government. The entire amount is treated as interest income, which has specific consequences for how it is taxed at the federal level.

Federal Income Tax on T-Bill Interest

Interest income generated from Treasury Bills is fully subject to federal income tax. This income is taxed at an investor’s ordinary income tax rate, the same rate that applies to wages, salaries, and other forms of regular income. The earnings from T-bills are added to the investor’s other income and taxed according to the standard federal income tax brackets for that year.

The income does not qualify for the lower long-term capital gains tax rates, regardless of how long the T-bill was held. Ordinary income tax rates are progressive, meaning the rate increases as an individual’s income rises, and are generally higher than the rates for long-term capital gains. For example, if an investor is in the 24% federal tax bracket, their T-bill interest will also be taxed at 24%.

State and Local Tax Exemption

A primary advantage of investing in Treasury Bills is that the interest income earned from them is exempt from all state and local income taxes. This exemption can result in considerable tax savings, especially for individuals residing in states with high income tax rates. The principle behind this rule is rooted in the U.S. Constitution, which prevents states from taxing the debt obligations of the federal government. This tax benefit makes T-bills an attractive option compared to taxable investments like corporate bonds or bank certificates of deposit (CDs), as the after-tax return on a T-bill could be greater.

Reporting T-Bill Income on Your Tax Return

Investors will receive a Form 1099-INT, “Interest Income,” from the bank, broker, or the TreasuryDirect platform where the T-bills are held. The taxable interest amount will be reported in Box 3 of this form, which is designated for interest on U.S. Savings Bonds and Treasury obligations.

On the federal tax return, Form 1040, the amount from Box 3 of the 1099-INT is included with other interest income. If the total taxable interest from all sources exceeds a certain threshold, the filer must also complete Schedule B, “Interest and Ordinary Dividends,” and list the Treasury interest there. The total from Schedule B then flows to the main Form 1040.

To benefit from the state tax exemption, a specific action is required on the state income tax return. Filers must identify the amount of T-bill interest included in their federal adjusted gross income and then subtract it on their state return. Most state tax forms have a specific line item for subtractions from income, often labeled “Interest from U.S. Government Obligations.” This adjustment ensures that the tax-exempt income is removed before the state’s income tax liability is calculated.