How Are I Bonds Taxed?

I bonds are a safe way to earn a return that’s somewhat protected from inflation—an especially wise investment when inflation is racing at the fastest pace in 40 years.

These bonds are backed by the U.S. government and pay an interest rate that consists of two measures: a fixed rate and a variable rate that changes with inflation, as measured by the consumer price index. Adjustments on the variable rate are made twice a year.

But as with any other investment, it’s important to understand the tax implications to determine if they are really right for your portfolio and long-term goals.

Pretty much, yes. Like almost every investment you own, the tax man will cometh. Fortunately, there are some tax advantages to owning I bonds versus other investments to help keep your bill lower.

The face value, or original amount you invested in the bonds, isn’t taxed but the interest your savings bonds earn is. The good news is that it’s only subject to federal income tax, not to state or local income tax, which can be attractive for those who live in high-tax locations. If the I bonds are given to you in any way, the interest is also subject to any federal estate, gift and excise taxes as well as any state estate or inheritance taxes.

The only time I bonds may escape federal taxes is if the money is used to pay for higher education. Among the many criteria you need to meet to take the tax exclusion, you must meet certain income limits and apply the money to a qualified institution the same year you redeem the bond. You can learn more about what you need to qualify at the Treasury’s website. To take the exemption, you’ll need to complete IRS tax form 8815.[1]

If your name appears as the owner of record for the I bond, you are responsible for the taxes. If you co-own the bond, you and the other person must each report the interest in proportion to how much you each paid for the bond.

If you give up the bond and it is reissued, you’re responsible for the taxes on the interest up until the time the bond is reissued. If you’re the new owner of a reissued bond, you owe tax on the interest you earn from when the I bond is reissued.

A 1099-INT issued when you cash the I bond will show all interest earned from the date of issue, including interest earned before it was reissued. IRS Publication 550 has instructions for paying tax only on interest earned after the bond was reissued.

Only if the proceeds of the bond are used to pay for higher education might you get away with not paying any tax on I bonds. But make sure you check the fine print in IRS Form 8815 because there are many criteria, including income limits, you need to meet to take advantage of this.

You choose when you report the interest on the bonds, which is another advantage of I bonds.

Most people report the interest on their federal income tax the year they give up ownership of the bond and receive what the bond is worth, including the interest. But some may find it advantageous, especially for someone who has little to no taxable income like a child, to report the interest each year.

The interest on your I bond falls on the same line with other interest income whether you choose to report it every year or at once at the end of your ownership.

Interest that the bond earns is reported on a 1099-INT after the bond is cashed or is reissued. The 1099-INT will show all the interest the bond has earned over the years.You can find instructions in IRS Publication 550 on how to tell the IRS that you already reported some or all of that interest in earlier years.

Even if you don’t receive a 1099-INT, you still need to report the amount as part of your interest income on your federal tax return. You don’t need to attach it to your return.

If you’re not sure how much to report, you can try to contact the payer, which is the Treasury in this case, or request an IRS transcript of your tax information or check your account online. If worse comes to worst, you can contact the IRS for help but beware, wait times are notoriously long.

Yes. One of the drawbacks of investing in I bonds is that the cap on how much you can buy is relatively low at $10,000 per person in a calendar year. But you can sneak in another $5,000 if you use your federal income tax refund to buy them.

If you spend the proceeds of your I bond on higher education, you may be able to skip paying taxes on the bond. There are many criteria you must meet to take this exemption. For example, you have to meet certain income requirements and the money can only be used to pay tuition, fees and other related expenses for an eligible student at eligible institutions.[8]

For further details on higher education eligibility, check out the IRS or Treasury websites.

Flexibility in when you can report the interest on your I bonds allows you to strategize to minimize your federal income tax on them. Since I bonds don’t make regular interest payments, you don’t have to pay any taxes on the investment until you sell the I bonds or they mature.

There’s another option: report interest each year as it is accrued.

For someone who has little to no taxable income, like a child, this could be a wise choice. Putting the I bond in a child’s name means the interest will likely be taxed at a lower rate than if an adult held the bond. Just note that once you choose to report the interest every year, you have to do so each year after that for all your savings bonds and any you acquire later, according to the Treasury.

Tax-wise, there’s little difference between I bonds and EE bonds so deciding which to buy depends on your investment goals. As with I bonds, investors have the option to report the interest earned on them each year or once in the year the holder relinquishes ownership or the bond matures. Both bonds are also subject only to federal income taxes, not state and local, but can be exempted if the money is used toward college costs under some circumstances.[6]

Tip

EE bonds are also government bonds but differ from I bonds in that they will double in value if kept for 20 years.[5] Treasury Inflation-Protected Securities (TIPS) also provide protection against inflation but you can buy up to $5 million worth and sell at any time.[4]

Some of the investment differences are that EE bonds pay a fixed interest rate but are guaranteed to double in value after 20 years regardless of rate, compared with the I bond, whose interest rate is adjusted twice per year to the consumer inflation rate. An I bond’s value isn’t guaranteed to grow a certain amount. To learn more about EE bonds, you can check out the Treasury’s website.

Treasury Inflation-Protected Securities (TIPS), on the other hand, have a major tax disadvantage that makes them better held in tax advantaged accounts like a 401(k).[3]

Both TIPS and I bonds are adjusted for consumer inflation, but the difference is that the adjustment is made twice a year to the principal on TIPS instead of the interest rate.

Because TIPS pay out interest twice per year, these are good for people seeking regular income but bad for tax purposes. You have to pay tax on each payout as well as the inflation adjustment to the bond’s principal.

This makes them a far better choice for tax-sheltered accounts like your IRA or 401(k) than your taxable account, says Christine Benz, director of personal finance at Morningstar.