Taxes on Series EE Bonds

When are Series EE Savings Bonds taxed?

The interest on U.S. Series EE Savings Bonds is not taxable until the earlier of:

• The bonds are redeemed or gifted,
• The bonds mature,
• The holder of the bonds elects to have the interest taxed to him or her on an annual basis, or
• The bondholder dies.

How are Savings Bonds taxed upon the owner’s death?

At death, all accrued income is subject to estate tax and possibly income tax. This is an example of income in respect of a decedent (IRD).

While the estate must pay the estate taxes on the fair market value of the bonds, the executor of the estate can elect who will pay the income taxes on the accrued income - either the estate or the bond’s inheritor.

The interest is always exempt from state income taxes. If the decedent did report the income annually, the final year’s interest income must be reported on the decedent’s final income tax return.

The options the executor should consider with respect to U.S. Series EE Savings Bonds are as follows:

• Elect to accrue all income on the decedent’s final Form 1040 and pay the necessary income tax. This income tax may then be deducted on the decedent’s estate tax return.
• If the beneficiaries of the estate are in low income tax brackets, the estate could redeem all the bonds and distribute out the income to the beneficiaries. The beneficiaries would pay income tax on the accrued interest and receive a deduction for some of the estate taxes paid.
• The bonds could be distributed in-kind to the beneficiaries without realizing gain or loss. The beneficiaries would then decide whether to accrue the income on an annual basis or hold the bonds to maturity.

Note:

If beneficiaries are named directly on the face of the bond, then the executor may only utilize election “A” above, since the bonds pass directly to the named beneficiary and are not under the control of the executor.