Interest from U.S. government bonds is taxable income at the federal level, but exempt from state and local income taxes

When you own a Treasury bond, bill, or note, the interest you earn must be reported to the IRS and is subject to federal income tax. However, that same interest is not subject to state or local income tax — a significant advantage over corporate bonds or savings accounts in high-tax states. The tax treatment depends on which type of Treasury security you hold and how you report it.

The exemption from state and local tax applies to all Treasury securities: bills (under one year), notes (two to ten years), and bonds (20+ years). It does not matter whether you bought them directly from the Treasury or through a broker. This state-tax advantage can add up substantially if you live in a state with high income tax rates.

Key Takeaways

  • Treasury interest is always taxed at the federal level but never taxed by your state or local government, regardless of where you live.
  • You report Treasury interest on your federal tax return in the year you receive it, even if you hold the bond to maturity.
  • If you sell a Treasury bond before maturity for more than you paid, the profit (capital gain) is taxed federally and at the state level.
  • Series I and Series EE savings bonds have different rules: interest is not taxed until you cash them in or they mature.
  • Treasury interest counts as income for purposes of Social Security taxation and Medicare premium calculations.

Federal tax on Treasury interest and how to report it

You owe federal income tax on Treasury interest at your ordinary income tax rate — the same rate that applies to wages or salary. If you hold a Treasury note that pays $500 in interest during the year, that $500 is added to your taxable income and taxed according to your tax bracket.

The Treasury or your broker will send you a Form 1099-INT in January showing the interest you earned in the previous year. You report this amount on your federal tax return (Form 1040) on the line for interest income. If you hold multiple Treasury securities, the 1099-INT will show the total interest from all of them combined.

If you hold a Treasury bond that matures or is redeemed during the year, you report the interest earned up to that point. If you bought the bond between interest payment dates, you may have paid accrued interest to the seller — that portion is not taxable to you, because it was already taxed to the previous owner.

Why state and local governments cannot tax Treasury interest

The exemption from state and local tax comes from federal law, specifically the principle that states cannot tax federal government securities. This rule has been in place since the 1800s and reflects the idea that the federal government and the states should not tax each other's obligations.

This exemption applies regardless of your state's tax rate or your residency. If you live in California (which has a 13.3% top state income tax rate) or New York (which has rates up to 10.9%), you still owe no state income tax on Treasury interest. The same is true in lower-tax states. Your state cannot require you to report Treasury interest on your state tax return.

This advantage does not extend to corporate bonds, municipal bonds from other states, or bank interest. Only Treasury securities receive this state-tax exemption.

Capital gains when you sell a Treasury bond before maturity

If you sell a Treasury bond before it matures, any profit you make is treated as a capital gain and is taxed both federally and at the state level. This is different from the interest you earned while holding the bond.

For example, if you bought a Treasury note for $10,000 and sold it for $10,500 six months later, your $500 profit is a capital gain. That gain is taxed at the federal level (at your capital gains rate, which may be lower than your ordinary income rate if you held it more than one year) and also at your state's capital gains or income tax rate. The interest you received during those six months remains exempt from state tax.

If you sell at a loss, you can use that loss to offset other capital gains or, in some cases, ordinary income. Keep records of what you paid for the bond and what you sold it for, because you will need those figures when you file your taxes.

Series I and Series EE savings bonds have deferred taxation

Savings bonds work differently from Treasury notes and bonds. With Series I and Series EE bonds, you do not pay federal tax on the interest each year. Instead, you pay tax on all the accumulated interest when you cash in the bond or when it reaches final maturity (usually 30 years).

This deferral can be useful if you want to delay income into a year when your tax bracket is lower, such as after retirement. However, you must still report the interest in the year you redeem the bond or it matures, even if you do not receive the money until later.

Savings bonds are also exempt from state and local income tax on the interest, just like Treasury notes and bonds. If you use Series EE or I bond proceeds to pay for may have access to education expenses, you may be able to exclude some or all of the interest from federal taxation — this is a separate benefit with its own rules and income limits.

How Treasury interest affects Social Security and Medicare costs

Treasury interest counts as income for calculating whether your Social Security benefits are taxable. If your combined income (adjusted gross income plus nontaxable interest, including Treasury interest, plus half your Social Security benefits) exceeds certain thresholds, a portion of your Social Security becomes taxable.

Treasury interest also counts toward the income limits that determine your Medicare Part B and Part D premiums. Higher income can result in higher premiums through a mechanism called Income-Related Monthly Adjustment Amounts (IRMAA). This is an often-overlooked consequence of holding Treasury securities in retirement.

If you are near these thresholds, the state-tax exemption on Treasury interest may be offset by the impact on your Social Security taxation or Medicare premiums. It is worth calculating the full tax picture before deciding how much to hold in Treasuries versus other investments.

Reporting Treasury interest if you hold bonds in a brokerage account

If you buy Treasury securities through a broker rather than directly from the Treasury, the broker reports your interest on Form 1099-INT, just as they would for any other investment. You report this on your federal return the same way.

If you hold Treasuries in a tax-deferred account such as an IRA or 401(k), you do not report the interest at all while it is in the account. The interest grows tax-free inside the account. When you withdraw money from the account in retirement, that withdrawal is taxed as ordinary income (in a traditional IRA) or not taxed at all (in a Roth IRA), depending on the account type.

If you hold Treasuries in a taxable brokerage account, you must report the interest each year, even if you reinvest it and do not withdraw it. The tax is due on the interest earned, not on the money you withdraw.

Frequently Asked Questions

Do I have to pay state income tax on Treasury bond interest?

No. Federal law exempts all Treasury interest from state and local income tax. This applies to Treasury bills, notes, bonds, and TIPS (Treasury Inflation-Protected Securities), regardless of which state you live in or whether you hold the securities directly or through a broker.

What if I buy a Treasury bond at a discount and it matures at face value — is that profit taxable?

Yes, but it is treated as interest income, not a capital gain. If you buy a Treasury bond for $9,500 and it matures at $10,000, the $500 difference is reported as interest income on your federal return. It is still exempt from state and local tax. This is different from selling the bond before maturity, which would create a capital gain.

Can I avoid federal tax on Treasury interest by holding it in a certain type of account?

You cannot avoid federal tax on Treasury interest in a regular taxable account. However, if you hold Treasuries in a traditional IRA, 401(k), or other tax-deferred retirement account, the interest is not taxed while it remains in the account. When you withdraw from the account, the withdrawal is taxed as ordinary income.

Does Treasury interest count as income for financial aid purposes?

Yes. Treasury interest is counted as income when calculating may be able to access for federal student aid (FAFSA), need-based aid, and other income-based programs. It does not receive special treatment for these purposes, even though it is exempt from state tax.

What happens to Treasury interest if I inherit bonds from someone else?

Interest earned by the deceased person up to the date of death is taxable income on their final tax return. Interest earned after that date is taxable to the estate or to you as the beneficiary, depending on how the estate is structured. You will receive a 1099-INT showing the interest earned after the death date.