How Are Treasury Bills (T-Bills) Taxed?

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How Are Treasury Bills (T-Bills) Taxed?

Interest on all U.S. Treasury instruments, including Treasury bills (T-Bills), is tax-free at the state and municipal levels but fully taxable at the federal level. Owners of Treasury bills should receive a Form 1099-INT from the Department of the Treasury at the conclusion of each tax year or early in the following (by January 31). This form specifies how much interest was earned on government securities throughout the fiscal year, which is also reported to the Internal Revenue Service (IRS).

Key Takeaways

  • Interest on Treasury notes (T-bills) is taxed at the federal level but not at the state or municipal level.
  • Form 1099-INT is used to report interest income earned throughout the year.
  • Investors may choose to have up to 50% of their Treasury bill interest profits withheld automatically.
  • T-bills may be more profitable than other short-term fixed products, such as CDs, if you reside in a state with high local taxes.

Understanding Treasury Bills (T-Bills)

But first, a refresher on the asset. Treasury bills are short-term debt obligations that are completely guaranteed by the US government’s faith and credit. They are available in denominations ranging from $100 to $5 million. The maturities of T-bills are all shorter than one calendar year. The most common maturation periods are one month, three months (13 weeks), and six months (26 weeks).

T-bills, like other Treasury instruments, are considered risk-free investments. Given its capacity to tax and create money, as well as the overall power and prestige of the United States, the risk of the United States defaulting on debt commitments is very low.

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It was this reputation for safety that drove investors to rush to Treasury securities during the 2007-2008 financial crisis, as losses in stocks and other assets in their portfolios soared. Those who had previously invested extensively in Treasury securities before to the crisis were able to effectively protect their money.

Tax Rate of Treasury Bills

T-bill interest is taxed as investment income in the year the bill matures. It must be reported on Form 1040, your federal tax return, and is taxed at the investor’s marginal tax rate.

Even if you do not get a Form 1099-INT, you are still responsible for reporting and paying taxes on the interest income earned by your T-bills.

If you acquire a T-bill at a discount and subsequently sell it at a higher price, your profit may be taxed as a capital gain.

Automatic tax withholding helps reduce the federal tax burden. Investors who possess Treasury notes may choose to have up to 50% of their interest earnings withheld automatically; the precise proportion can be chosen on any retail securities site. The Treasury sends withholdings automatically to the Internal Revenue Service (IRS) and records the amount withheld on the 1099-INT form.

Tax Advantages of T-Bills

Although T-bills do not pay the highest interest rate (as a result of their low risk), their exemption from state and local taxes can give them an advantage over other short-term, fixed-income assets, such as certificates of deposit (CDs), particularly for investors in high-income-tax states such as California, Massachusetts, New York, and Oregon. CDs are completely taxed.

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To compare the interest rates on CDs and Treasury bills and discover which is better tax-wise, you must compute the after-tax returns on both assets.

Assume you are a single taxpayer in New York with a yearly income of $100,000, and the one-year Treasury bill you are considering returns 0.07%. (as it is as of April 21, 2021).Your federal income tax rate is 24%, while your state income tax rate is 6.33%.

Your net profits from the Treasury bill after federal taxes will be merely 0.053%, or 0.07% x (100% – 24%). However, the tax rate on the CD is greater since it includes state taxes.

After taxes, you would only retain 69.67% of the earnings (100% – 24% – 6.33%). Divide the after-tax yield on a Treasury bill, 0.00053, by 0.7003 to obtain the same rate on a certificate of deposit, 0.00076. To be a better value than the Treasury at your income level, a CD must yield more than 0.076%.

Correction—June 9, 2022: An previous version of this article computed the comparable rates of Treasuries and CDs inaccurately.

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