How government bonds are taxed | Vanguard (2024)

FAQs

How government bonds are taxed | Vanguard? ›

Income from bonds issued by state, city, and local governments (municipal bonds, or munis) is generally free from federal taxes. * You will, however, have to report this income when filing your taxes. Municipal bond income is also usually free from state tax in the state where the bond was issued.

Key Takeaways

Bonds typically pay a fixed amount of interest (usually paid twice per year). Interest from corporate bonds and U.S. Treasury bonds interest is typically taxable at the federal level. U.S. Treasuries are exempt from state and local income taxes.

Interest earned on I bonds is exempt from state and local tax but subject to federal tax. The interest is taxed in the year the bond is redeemed or reaches maturity, whichever comes first.

Treasury bonds and Series I bonds (savings bonds) are also tax-efficient because they're exempt from state and local income taxes. 89 But corporate bonds don't have any tax-free provisions, and, as such, are better off in tax-advantaged accounts.

How bonds generate income. As we discussed in Topic 1 of this series, governments and corporations issue bonds when they need to raise money. In return for buying the bonds, the investor – or bondholder– receives periodic interest payments known as coupons.

Interest income from Treasury bills, notes and bonds - This interest is subject to federal income tax, but is exempt from all state and local income taxes.

Individuals do not pay tax on their bond gains until a chargeable event occurs. This tax 'deferral' is one of the features that sets bonds aside from other investments. However, when a chargeable event does occur, a gain will be taxed in the tax year of that event.

The interest income of the savings bond will be taxed to the bond's owner—i.e., the recipient of the gift—when the bond matures and is redeemed for cash (or the owner will be taxed each year if they elect to report the interest income annually).

What is safer Treasury bills or bonds? ›

For the individual investor, U.S. government debt represents a safe investment with a modest return. These bonds are considered to be among the safest investments in the world, and therefore they carry quite modest yields for investors, with short-term T-bills earning only the risk-free rate of return.

Generally speaking, bonds will tend to be less tax-efficient than stocks. That's because most of the return that bond investors earn is income, and that income is taxed at your ordinary income tax rate, which is higher than the capital gains and dividend tax rates that apply to the gains from most stock holdings.

Investors in high tax brackets benefit the most from municipal bonds, but other investors may also find them suitable for their portfolios. These municipal bond funds are some of the best ways to include munis in your portfolio.

The various types of bonds that are offered by the U.S. Treasury are considered to be among the safest in the world. Because of their relatively low risk, government bonds typically pay low interest rates.

U.S. Treasury bonds are fixed-income securities. They're considered low-risk investments and are generally risk-free when held to maturity. That's because Treasury bonds are issued with the full faith and credit of the federal government.

While Treasurys boast higher rates than CDs, you can still score a generous annual percentage yield (APY) on a CD by shopping around. Typically, online banks offer higher interest rates than brick-and-mortar ones. Some of the best CDs have APYs that top 5%.

For newly issued taxable bonds purchased at an original issue discount (OID): You'll generally be required to recognize a portion of the discount each year as taxable income (known as accretion)—which also increases the cost basis of the bond—until maturity, when the cost basis equals the bond's face value.