Steadfast FinancesWho Pays Taxes on Government Savings Bonds and When?

Who Pays Taxes on Government Savings Bonds and When?

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It’s hard to earn interest on your money these days. The returns on CD and savings accounts are so small, they rarely beat inflation. It’s difficult to watch the purchasing power of your savings dwindle every year. No doubt, many are tempted to roll the dice with buying stocks. Stocks may be risky, but most safe investments are guaranteed losers. There is still one bright spot for safe investing; government savings bonds.

In particular, I bonds, which have interest rates pegged to inflation. This guarantees a return that won’t erode with higher prices. The best part is; there are unique tax advantages that help increase your potential returns.

When Do You Pay Taxes on Interest?

Government savings bonds offer two options for paying tax on interest. You can either pay as you go or pay a lump sum the year that you redeem the bond.

If you choose the pay as you go, accrual method, you will need to fill out and include your bond interest in your tax filings every year. Since you pay taxes on the interest every year, in the year you redeem the bond, you will only need to pay for the last year’s interest that accrued.

You can also choose to defer tax obligations on the bonds until the year you redeem the bond. When you do redeem, you are liable to pay taxes on the full amount of capitalized interest.

You must choose one method for all bonds. There is no mixing and matching tax accounting methods. One more perk; federal bond interest is tax exempt from state income tax.

Who Pays the Interest?

The general rule is that the person who is named the bond owner is responsible for the taxes. If a parent purchased a bond in a child’s name, the child must report the taxes. If the parent is the owner and the child the beneficiary, the parent is liable for taxes since they are the bond owner.

It is possible for there to be two listed bond owners. In this case, the bond owner that paid for the bond is liable to pay the taxes on earned interest. If two people are equal owners in the bond, they split the tax between them.

Owners and beneficiaries can be changed through revision so long as you do it before the bond is cashed or matured.

Not only do government savings bonds provide the option of earning interest without losing to inflation. They also have unique tax advantages. They allow you to time income by either paying taxes annually or in a lump sum at redemption. They also give you the option of shifting tax burden by listing the bond owner.

What’s not to like?

JP is an MBA and works in finance. He is the author of the blog My Family Finances where he writes about how families can better manage their money and budgets.

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Posted by JP   @   2 August 2012 0 comments
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