Federal income tax on U.S. government bonds

Interest from U.S. Treasury bonds, bills, and notes is taxable at the federal level. You report this interest as ordinary income on your federal tax return each year, and it is taxed at your regular income tax rate — the same rate that applies to wages or other income.

The IRS requires you to report Treasury interest even if you do not receive a 1099 form. If you hold bonds through a brokerage or bank, they will typically send you a 1099-INT showing the interest paid. If you bought bonds directly from TreasuryDirect (the U.S. Department of the Treasury's online platform), you are responsible for tracking the interest yourself and reporting it when you file.

Interest accrues differently depending on the bond type. Treasury bills mature in one year or less and are sold at a discount, so the difference between what you paid and what you receive at maturity counts as interest. Treasury notes and bonds pay interest twice per year, and you owe tax on that interest in the year it is paid to you, not when the bond matures.

Key Takeaways

  • Interest from U.S. Treasury securities is taxable at the federal level and must be reported as ordinary income on your tax return.
  • State and local income taxes do not apply to Treasury interest, which is one tax advantage these bonds offer compared to corporate or municipal bonds.
  • You owe federal tax on Treasury interest in the year it is paid or accrued, regardless of whether you sell the bond before maturity.
  • If you sell a Treasury bond before it matures for more than you paid, the profit (capital gain) is also taxable at the federal level.
  • Holding Treasury bonds in a tax-advantaged retirement account like an IRA or 401(k) lets you defer or avoid federal tax on the interest.

State and local tax exemption for Treasury interest

Interest from U.S. Treasury securities is exempt from state and local income taxes. This is a significant advantage over corporate bonds or other taxable investments, because it means you keep more of the interest you earn if you live in a state with high income tax rates.

The exemption applies to Treasury bills, notes, bonds, and Treasury Inflation-Protected Securities (TIPS). It does not apply to savings bonds (Series EE or I bonds), which are subject to state and local tax on the interest, though they do have other tax benefits at the federal level.

If you live in a state without income tax, this exemption has no practical effect for you. But if you live in California, New York, or another state with income tax above 5 percent, the state tax savings can be meaningful over time.

Capital gains tax when you sell before maturity

If you sell a Treasury bond on the secondary market (through a broker) before it matures, any profit you make is subject to federal capital gains tax. The profit is the difference between what you paid for the bond and what you sold it for.

Capital gains tax rates depend on how long you held the bond. If you held it for one year or less, the gain is taxed as a short-term capital gain at your ordinary income tax rate. If you held it for more than one year, it is taxed as a long-term capital gain, which has lower tax rates (0 percent, 15 percent, or 20 percent depending on your income).

If you sell at a loss, you can use that loss to offset other capital gains or up to $3,000 of ordinary income in a single tax year. Any remaining loss can be carried forward to future years.

How holding bonds in retirement accounts changes the tax picture

If you own Treasury bonds inside a traditional IRA, SEP-IRA, or 401(k), you do not owe federal tax on the interest in the year it is paid. Instead, you defer tax until you withdraw money from the account in retirement, at which point withdrawals are taxed as ordinary income.

In a Roth IRA or Roth 401(k), Treasury interest is not taxed at all, as long as you follow the withdrawal rules (generally, you must be at least 59½ and have held the account for at least five years). This makes Roth accounts particularly valuable if you expect to be in a higher tax bracket in retirement or if you want the interest to compound tax-free.

Many people use Treasury bonds in retirement accounts as a stable, low-risk holding because the interest is not taxed annually, which lets it compound more efficiently than it would in a taxable account.

Tax reporting and record-keeping for Treasury bonds

If you own Treasury bonds in a taxable account, you need to track the interest paid each year and report it on your federal tax return. The form you use depends on how you own the bonds. If you bought them through a bank or brokerage, you will receive a 1099-INT. If you bought them directly from TreasuryDirect, you will not receive a form, so you must keep your own records of the interest paid.

TreasuryDirect sends you an annual statement showing all interest paid during the year. Save this statement for your tax records. If you sold a bond before maturity, you will receive a 1099-B from your broker showing the sale price and the date of sale, which you use to calculate your capital gain or loss.

Keep records of what you paid for each bond (your cost basis) and when you bought it. This information is essential for calculating capital gains tax if you sell before maturity and for determining whether a gain qualifies for long-term or short-term treatment.

Differences between Treasury bonds and savings bonds for tax purposes

Series EE and Series I savings bonds are issued by the U.S. Treasury but have different tax rules than Treasury securities. Interest from savings bonds is subject to state and local income tax, unlike Treasury bonds. However, savings bonds have a federal tax advantage: you can defer federal tax on the interest until you cash in the bond or it reaches final maturity (usually 30 years).

If you use savings bond proceeds to pay for may have access to education expenses, you may be able to exclude the interest from federal tax entirely. This education exclusion is not available for Treasury bonds. Because of these differences, savings bonds are often used for education savings, while Treasury bonds are more common for general investment purposes.

Frequently Asked Questions

Do I owe federal tax on Treasury bond interest every year?

Yes. You report Treasury interest as ordinary income on your federal tax return for the year it is paid or accrued, even if you do not sell the bond. If you hold the bond until maturity, you still owe tax on all the interest it earned each year along the way.

Can I avoid paying tax on Treasury bond interest?

You cannot avoid federal tax on Treasury interest, but you can defer it by holding the bonds in a traditional IRA or 401(k). You can eliminate federal tax on the interest by holding the bonds in a Roth IRA or Roth 401(k), provided you follow the account withdrawal rules.

What if I bought a Treasury bond at a discount and it matures at face value?

The difference between the discounted price you paid and the full face value you receive at maturity is treated as interest and is taxable at the federal level. This is common with Treasury bills, which are always sold at a discount.

Are Treasury bonds better than corporate bonds for taxes?

Treasury bonds have a tax advantage because the interest is exempt from state and local tax, while corporate bond interest is not. However, both are taxed at the federal level. If you live in a high-tax state, this exemption can make Treasury bonds more attractive after taxes, even if the interest rate is slightly lower.

Do I need to report Treasury bond interest if I did not receive a 1099 form?

Yes. If you bought bonds directly from TreasuryDirect, you will not receive a 1099-INT, but you are still required to report the interest on your tax return. Use your TreasuryDirect statement as your record of the interest paid.