Tax on Savings Bonds

When choosing an investment, many individuals look to savings bonds. While the interest rate might not necessarily match the rate of return on certain stocks, these bonds are typically less volatile and more likely to see a return versus a loss. Yet, when purchasing these bonds, there are several points to consider regarding their impact on your taxable income. Working with a tax professional, such as L. James & Associates in Denver, CO, can help you to determine how you should handle the income from these savings bonds.
 Here are a few of the important facts for you to be aware of when choosing to purchase savings bonds as an investment:
 Not Subject to State Income Tax – Typically savings bonds are not subject to state income tax, but are only taxed at the federal level. Thus, your tax liability for this income should also be less as a result of not having local level taxes.
 Tax Payment Can Be Deferred – Savings bonds are unique in that you can earn the interest income but choose to defer your tax payment for this income until the bond is redeemed or reaches its final maturity, depending on what happens first.
 Gifted or Inherited Bonds – When bonds are gifted or inherited, you will be subject to estate, gift, inheritance or other excise taxes that might apply, depending on the various factors involved. Talk with your tax professional about when the taxes for these bonds would be due, or if they can also be deferred until the bond reaches maturity.
 Education Savings Bond Program -  For individuals who choose to purchase bonds through this program, there are additional benefits available. Here are few of the important things to know:

• If used for educational purposes, you do not have to pay taxes on these savings bonds. Thus, all the interest income can be excluded from their gross income, but the educational expense must be paid to a qualified institution.
• A qualified institution is one where their students can receive student loans through the federal government. If the students cannot receive federal student loans, then it probably doesn’t qualify as an appropriate institution.

As you can see, savings bonds can provide a way to earn steady income, without all of the taxes associated with more traditional income streams. Yet there are a few things to keep in mind when filing your taxes and prior to purchasing a savings bond.

• Married couple that file individual tax returns will not receive the full exemption on their bonds. The full exemption is only available when filing jointly or as a single individual.
• You have to be 24 to purchase a savings bond.
• A child can only be listed as a beneficiary, not a co-owner or owner of the bond itself.
• Educational expenses need to be primarily tuition. Simply put, living and book expenses do not count as proper uses of educational savings bonds.
• Depending on your income, especially if you make more than a certain amount, you may have to pay taxes on your savings bonds.
• The expense must be paid in the same year that you take the deduction for the expense.
• The entire bond being redeemed, including principal and interest income, must go to the educational expense. Otherwise, you can only deduct a portion of the interest.
• Buying bonds in smaller dominations can help you to avoid a partial deduction.

Reporting Your Interest

There are several methods of reporting your interest. When you redeem a bond through TreasuryDirect.com, a 1099-INT is generated and you can print a copy for your records. If redeeming a paper bond, the institution redeeming the bond will report the interest earned to you, as well as the IRS. A 1099-INT will be sent at the end of the year or received when the bond is received.
 You have two options available to report the interest on your tax return. You can choose to defer the federal tax payment until the bond is redeemed or matures, whichever comes first. Otherwise, you can use an accrual method that allows you to pay the tax on the interest income every year as it accrues. Once you start with this method, you must follow it through for all bonds purchased in the future. Thus, when the bond does mature or is redeemed, the interest income to be taxed will be limited to that current year.
 Working with your accountant, you can determine the calculations necessary to report your interest income on these bonds annually.
 Call or click on the link below to speak with a tax professional or accountant at L. James & Associates in Denver, CO, about your savings bonds and how to appropriately report your taxable interest income.