Are Savings Bonds Tax Free?
U.S. savings bonds provide tax-advantaged earnings in several different ways. Savings bonds can be purchased in amounts from $25 to $5,000 and earn interest monthly for up to 30 years. How the proceeds from redeemed bonds is used and the type of ownership determines of the interest earnings are tax free or just tax deferred.
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Tax Deferred Earnings
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The interest earned on U.S. savings bonds is not taxed until a bond is redeemed. Bonds earn interest every month In a regular savings account, the investor would have to declare and pay taxes on the annual interest earned. For the savings bond investor, no taxes are due until the bond is cashed and the original investment amount plus the interest earned is received from the U.S. Treasury. With savings bonds, taxes on interest earnings can be deferred for many years, allowing the value to grow without paying taxes.
No State Income Taxes
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Interest earned from U.S. savings bonds is tax-free in respect to state income taxes. States with high income tax rates can take 8 to 10 percent of regular interest earnings. The state tax free interest on savings bonds means tax savings of $80 to $100 on $1,000 worth of savings bond interest.
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Tax Free for Education
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It is possible for savings bond interest to be entirely tax free if the proceeds from redeemed bonds are used to pay for a college education. To qualify as tax free income for education, the savings bond owner must be 24 or older when the bonds were purchased and the redemption proceeds used to pay post-secondary education expenses for the owner or the dependent children of the bond owner. The education expenses must have occurred in the same year the bonds were redeemed.
Tax Reporting
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When savings bonds are redeemed, the Treasury Department will send the bond owner an IRS Form 1099-INT. The form will be sent soon after a bond is redeemed or at the end of the year in which the redemption occurred. Federal income tax will be due on the interest earned on bonds redeemed during the year and reported on the 1099-INT. To claim the education exemption and make the savings bond interest tax free, the bond owner must complete IRS Form 8815 and send it in with his income taxes.
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