Posted by Simon Hase, CPA

What You Need to Know About Purchasing Bonds

What You Need to Know  About Purchasing Bonds

Bonds can be a great benefit in terms of investing and saving for a variety of financial goals. However, you may soon find yourself tackling the tax implications of these investment purchases. So how can you manage your tax liabilities for the bonds that you have already purchased or the ones that you are considering purchasing in the future? Consulting with a tax professional or accountant, such as Kaufmann Advisors in San Francisco,CA you can determine the tax implications based on your personal investment strategy.

Bond Interest May Be Taxable

When purchasing a savings bond, part of the agreement is that you will be paid interest on that money throughout the year. This interest is considered income by the IRS. As a result, there will be taxes that must be paid on that income. However, this interest income is typically only taxed at the federal level, but not by your local state and county. One point to consider is why the bond is being purchased. If you are using it as part of savings plan for higher education, you may not have to pay the federal income tax. Check with your Avant-Tax professional to determine if your interest is taxable.

Who Owes the Taxes on the Interest Income?

Depending on how the bond was purchased, the interest income tax will need to be paid either by you or the owners of the bond. For example, you buy a savings bond for your child and put it in their name. They are now the owner and will then owe the taxes for the interest income on that bond. If you purchase the bond with your spouse and you each file separate tax returns, you and your spouse are responsible each are considered to have received one half of the interest income. Therefore, you must report your half and pay the taxes accordingly.

What if the bond is reissued?

If a bond is reissued, then various scenarios may need to be discussed with your tax professional. The first is that you give up ownership after the bond is reissued. If that is the case, you will owe taxes on the income earned prior to the bond being reissued and the change in ownership. However, if you maintain ownership, then you will owe taxes on all the interest income earned, both before and after it was reissued.

How Do I Report the Interest Income

Your tax form will include a specific line for interest income reporting. This is where you will report the income received from your bonds, either on a yearly basis or at the time of maturity. A 1099-INT will be issued when the bond is redeemed or matures. So if you have chosen to defer the interest income reporting, this 1099 will provide a signal that it is time to report that income.

Depending on whether or not you are redeeming the bond that year and collecting all the interest, you have a few options regarding reporting the interest income. The first option is to report the interest income every year, even if the bond is still in place. Otherwise, you have the option to defer reporting the interest until you cash the bond in, relinquish ownership of the bond or the bond has reached maturity and is no longer collecting interest.

When choosing to defer reporting the interest, the bond holder is essentially delaying the tax payment. However, when a bond reaches maturity, the bond is considered redeemed and the interest income is reported to the IRS. If you have chosen to defer, the bond reaching maturity will be the year that you have to pay the taxes on that interest income.

Individuals can choose to pay the taxes on that income yearly, thereby eliminating a larger payment upon reaching the bond’s maturity. This might be an attractive option if the bond is bought for a child, because the tax rate now is typically lower than the future rate at the bond’s maturity date. Keep in mind, that once you choose this option, you must continue to report the interest income every year until the bond has matured or been redeemed. The IRS doesn’t allow you to choose deferment later.

Bonds are a solid savings tool for individuals across the country. They provide a great way to save for both retirement or higher education. There is also the benefit of not owing additional taxes on these bonds at the local level. 

Simon Hase, CPA
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