There are about $173 billion in U.S. savings bonds outstanding. This makes this type of investment one of the largest assets held by individuals. Savings bonds enjoy certain special tax treatment. Here are five things to know about Series EE and I bonds, referred to collectively here as U.S. savings bonds (other types of federal savings bonds are not discussed here).
1. Deferring interest
The interest that accrues on U.S. savings bonds usually is currently taxable even though it is not paid until the bonds are redeemed. However, you can automatically defer the interest by not reporting it currently. Of course, all of the accrued interest becomes taxable when the bonds are redeemed.
Note: U.S. savings bonds cease to earn interest when they reach their final maturity (e.g., 30 years for Series EE bonds). Thus a Series EE bond issued in November 1985 ceases earning additional interest at the end of November of this year.
2. Excluding interest
Interest on U.S. savings bonds may be tax free if bonds are redeemed to pay qualified higher education costs and certain conditions are met. There is no dollar limit on the amount of interest that is excludable under this rule. However, your income may limit or bar the exclusion. For 2015, no exclusion is available if your modified adjusted gross income exceeds $145,750 on joint returns, or $92,200 for all other filers. For 2016, the MAGI limit is projected to be $146,300 for joint filers and $92,550 for all other filers.
3. Transferring bonds
Bonds are transferrable, but accrued interest usually becomes fully taxable to the owner at that time. However, if you want to transfer bonds to a grantor trust (a trust in which the creator remains taxable on the income in the trust, such as a revocable or living trust), the accrued interest is not immediately taxable. To make such a transfer, file Form PD F 1851, Request to Reissue United States Savings Bonds to a Personal Trust, with the U.S. Treasury.
4. Purchasing bonds with tax refund
You can use your federal tax refund to purchase up to $5,000 in Series I bonds; this purchase method cannot be used for Series EE bonds. The purchase request must be in multiples of $50. The bonds can be registered to you (and your spouse) or to another co-owner or beneficiary. Complete Form 8888, Allocation of Refund, to direct the Treasury to buy the savings bonds. Once the purchase request has been made, you can track the status at Treasury Retail Securities at 800-553-2663.
5. Treatment on death
When the owner of a savings bond dies before redeeming a savings bond on which interest has been deferred, the accrued interest becomes taxable to the new owner. However, an election can be made to report the accrued interest on the decedent’s final income tax return. This election may result in little or no tax on the interest (e.g., a decedent dies early in the year with very little other income to report).
Despite low interest rates on these investments, U.S. savings bonds still offer some important advantages. Principal is guaranteed by the full faith and credit of the U.S. government. And there may be helpful tax rules available to you.