is interest on federal bonds federally taxable income?

Answer 1

First, let's clarify: US Treasury "bonds" "bills" & "Notes" are similar except for their term & certain tax treatment. Generally interest on federal obligations is taxable to the Fed, but not the states. However, there are some exceptions applicable only to US Savings bonds.

First, if you dot your i's & cross your t's, you can exclude from income the amount used to pay qualifyng education expenses. See pg 55 of IRS pub 970:
http://www.irs.gov/pub/irs-pdf/p970.pdf

Next, you may elect to accrue the interest (Even if you are a cash-basis taxpayer)http://www.irs.gov/publications/p550/ch01.html#d0e1502

Click "investment income", then under "Interest" click "US Savings Bonds". Scroll down to :"Reporting options for cash method taxpayers. "

This may make sense if in many of the years of the Bonds' life you are in a Lower bracket than you will be when the bonds mature. For example a newborn electing this method will pay $0 tax on the first $850 of accrued interest each year. If the child does not elect and the increase in value at date of cash-in exceeds $850 there will be Fed tax. This is a basis examole and does not include all possible sets of facts & circumstances.

Hank Roitman, EA
Sacramento, CA

Answer 2

Savings bond interest is taxable on your Federal return but not your state return. You may either pay the tax on the interest annually or defer payment of the tax until you redeem the bonds. If you use the proceeds for educational expenses you may be able to exempt the interest income from taxes.