The interest that your savings bonds earn, regardless of whether you receive it, is subject to federal income tax, but not to state and local income tax. It is also subject to any federal estate, gift, and excise taxes as well as any state estate or inheritance taxes.
Using the money from Series EE savings bonds for higher education may keep you from paying federal income tax on your savings bond interest.
So, when must you report the interest on your tax returns? The great news is that you have a choice!
- You can report the interest every year even if you don’t receive the cash interest. This is a great tax planning opportunity!
- You can put off (defer) reporting the interest until you file a federal income tax return for the year in which the first of these events occurs:
a. you cash the bond and receive what the bond is worth, including the interest, or
b. you give up ownership of the bond and the bond is reissued, or
c. the bonds stop earning interest because it has reached final maturity
Most taxpayers with savings bonds end up choosing number 2 by default because they don’t know about number 1. But reporting interest every year may be the best tax planning opportunity for younger people with savings bonds.
This creates some good tax planning opportunities around when to recognize the earned interest on savings bonds. For instance, if you are young, perhaps a Millennial, and find yourself starting out in a new career that will see your salary increase over the next several years, it may be better for you to report the interest sooner at a lower income tax rate than waiting until the bonds mature or are sold when your income tax will be higher.
Tax Filing ALERT! – if you decide to recognize and pay tax on the income sooner than when it is received and reported on a Form 1099-INT, you must keep good records for yourself, otherwise when you cash in the bonds and actually receive the Form 1099-INT it is going to report more interest in the year in which you cash in the bonds because you paid tax on interest years before.
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