Taxes on Savings BondsAuthor: David WaringTaxes on Savings BondsIn this article we will discuss everything you need to know about taxes on savings bonds. First, the interest that you earn on a savings bond is subject to federal income tax only. There are no state or local income taxes paid on interest income from saving bonds.Taxes on savings bonds can be deferred until you either redeem the bond or the bond reaches final maturity, whichever happens first. In the case of a gift or inheritance, savings bonds are subject to estate, gift, inheritance or any other excise taxes. Special benefits are given to those who purchase savings bonds under the Education Savings Bond Program.Tax Reporting for the Education Savings Bond ProgramIf they are used for education purposes you may not have to pay taxes on your savings bonds, as they may qualify for education tax exclusion. This allows taxpayers to exclude all or part of the interest paid on their bond from their gross income, so long as the bond owner pays education expenses to a qualified education institution. What determines if an institution is qualified? A good litmus test is student loans. If the federal government would issue a student loan for a person to attending the college or university, its a qualified institution.Please keep in mind the following:Married couples that file individual tax returns don’t get the full exemption. You can get the full exemption only if you file a joint return or if your single.You must be at least 24 when you purchase the bond.The child must not be listed on the bond as an owner or co-owner. Beneficiary is OK.The expenses basically need to be for tuition. Books and living expenses don’t count.If you make more than a certain amount of money, you must still pay taxes on your savings bonds. In 2010, a married couple could take the full deduction only if they make less than $105,100. For single filers, the amount was $70,100.The expense must be paid in the same year for which the deduction is being taken. The entire bond that is being redeemed, principal and interest, must go towards education expense. If not, you can only deduct part of the interest. Tip: To avoid a partial deduction, you should buy bonds in smaller face value denominations like $100.Taxes on Savings Bonds: Paper Versus Electronic BondsWhen you redeem a bond electronically through TreasuryDirect.com a 1099-INT is automatically generated and you are able print a copy for your records. When you redeem a paper savings bond, the institution that pays out the bond will report the interest earned to both you and the IRS. To report taxes on your savings bonds you will receive an IRS form 1099-INT either at the time of redemption, or it will be sent to you after the end of the year.Methods of Reporting InterestYou have the choice of reporting interest earned on savings bonds in two ways. However, when you report interest on your federal return, it should be included with any other interest income you received. You have two optionsCash Basis Reporting – This method allows you to defer the federal tax on your savings bonds until the year of redemption, final maturity or other taxable disposition, whichever happens first.Accrual Basis Reporting – Using this method means you are reporting interest earned every year as it accrues. Once you start this method, you must continue with the method for all savings bonds you own and purchase later. This method is more commonly used when bonds are purchased under a child’s name.If you decide to report interest each year its your responsibility to calculate and report the interest. With electronic saving bonds, the calculations can be done online and necessary paperwork printed using the TreasuryDirect website. However with paper bonds you will need to get a copy of the Public Debt Form 3501. This table compares bond values from one year to the next in order to help you figure out the amount of interest earned. If you decide to defer interest you should refer to IRS Publication 550 for instructions and information.ConclusionWhen calculating the taxes on your savings bonds, whether you defer taxes or pay them annually is up to you. If you purchase a bond under your name or as a co-owner, you have to report the income. If you purchase a bond as a gift, that person is required to report the income. You do not have to pay any state taxes on savings bonds, just federal.