Savings bonds have tax advantages.
U.S. savings bonds have many advantages for the investor. You can purchase both EE bonds and inflation-protected I bonds conveniently online at Treasury Direct. You may also possess E, HH or H bonds, which the government no longer issues. Although you have to pay some taxes on their interest, they do provide several tax advantages.
Federal IncomeTax
The owner or principal co-owner must pay federal income tax on interest on U.S. savings bonds. You can choose one of two main methods of reporting interest. The first, accrual basis reporting, means reporting the interest each year as you receive it. Choose this method for a child who has no other income, and she may owe nothing. The second method, cash basis reporting, means reporting the interest when the bond reaches final maturity, when you redeem it or when another taxable event occurs, such as death of the owner. You may also have to pay tax when you have a bond reissued.
Responsibility for Reporting
You pay tax on a bond listing you as sole owner. If you use your own money to buy savings bonds for yourself and another co-owner, you must file the interest on your own return. However, if you purchase a bond as a gift with the recipient as owner, he must report and pay tax on the interest. If two people pool funds to buy a bond as co-owners, each co-owner reports and pays taxes on her percentage of the price, for example, 50 percent each. In a community property state, a married couple buying a bond should pay one-half of the tax each if they file separate federal tax returns.
Bonds Cashed for Education
You can exclude the interest on Series EE or Series I Bonds bought after 1989 from federal income tax if you use them for educational expenses and meet a number of requirements. For example, you must be 24 or older when buying the bonds. If you use the money for your child, the bonds must list you, your spouse or both as owner or co-owners. You must meet income and tax filing requirements and use the entire redemption amount for qualifying expenses during the tax year you cash the bonds. Tuition qualifies, but housing and books do not.
State and Local Income Taxes
You do not have to pay state or local income taxes on interest from U.S. savings bonds. The state income tax exemption makes the bonds a good tax-advantaged investment If you live in a state with a high income tax.
Other Taxes
You have to pay other taxes on savings bond interest, including inheritance or estate taxes, gift taxes and any other excise taxes. You owe these taxes to any level of government, whether federal, state or local.
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