- I Bonds are hot investments thanks to their inflation-linked rates as we watch everything from diapers to cars jump in price.
- I Bonds are subject to taxation, however, you may be able to avoid having to pay those taxes if you spend the funds on higher education.
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 like any other investments, it’s important to understand the tax implications to determine if they are really right for your portfolio and long-term goals.
Inside this article
Do I have to pay taxes on I Bonds?
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.
Does everyone have to pay taxes on I Bonds?
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 the 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.
When do I need to report interest on bonds?
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.
How do you report interest on your tax return?
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.
What if I don't receive a 1099-INT?
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.
Can I use my tax refund to buy I Bonds?
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.
What is the Qualified Education Expense?
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.
Strategies to avoid or minimize taxes on I Bonds
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 advantages of Series I Bonds vs EE vs TIPS
Tax-wise, there’s little difference between I-Bonds and EE bonds so deciding which to buy depends on your investment goals. Like 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 towards college costs under some circumstances.
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).
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.
Is I Bonds interest income taxed as capital gains?
No, interest income on these bonds are taxed as ordinary income. You have to pay federal tax on the interest income but not state and local.
When will I receive the 1099-INT?
You should receive a 1099-INT after the bond is cashed or reissued to reflect a taxable change in ownership. The 1099-INT will show all the interest the bond has earned over the years. Go to IRS Publication 550, Investment Income and Expenses, for instructions on how to tell the IRS that you already reported some or all of that interest in earlier years.
Do I have to pay taxes on inherited series I Bonds?
In most cases, the person who inherits the I Bonds takes over the taxes on interest accrued after the last owner’s death. More details can be found IRS form 550 and 559.
How are I Bonds taxed at death?
Interest accrued from the I Bonds up to the person’s death is included on the deceased’s last federal income tax return, as explained in IRS Form 559 and 550.