Interest earned on all U.S. Treasury securities, including Treasury bills (T-Bills), is exempt from taxation at the state and local level but is fully taxable at the federal level. At the end of each tax year or early in the next (by Jan. 31), owners of Treasury bills should receive a Form 1099-INT from the Dept. of the Treasury. This form details how much interest was earned on government securities for the year—information that is also filed with the Internal Revenue Service (IRS).
Key Takeaways
- Interest from Treasury bills (T-bills) is subject to federal income taxes but not state or local taxes.
- The interest income received in a year is recorded on Form 1099-INT.
- Investors can opt to have up to 50% of their Treasury bills' interest earnings automatically withheld.
- If you live in a state with high local taxes, T-bills might be more advantageous than other short-term fixed instruments, like CDs.
Understanding Treasury Bills (T-Bills)
But first, a quick recap of the asset. Treasury bills are short-term debt obligations that are fully backed by the faith and credit of the U.S. government. They are sold in denominations of $100 up to $5 million. T-bill maturity durations are all less than one calendar year. Common maturity durations are one month, three months (13 weeks), or six months (26 weeks).
Like all Treasury securities, T-bills are considered to be risk-free assets. The likelihood of the U.S. government defaulting on debt obligations is incredibly low, given its ability to tax and print money and, of course, the general strength and reputation of the U.S.
It was this reputation for safety that, during the 2007-2008 financial crisis, caused investors to flock to Treasury securities as losses in stocks and other assets in their portfolios mounted. Those who had already invested heavily in Treasury securities prior to the crisis did successfully safeguard their capital.
Tax Rate of Treasury Bills
The interest earned by a T-bill is taxable as investment income in the year the bill matures. It must be reported on your federal tax return, Form 1040, and is taxed at the investor's marginal tax rate.
Even if you don't receive a Form 1099-INT for some reason, you are responsible for reporting the interest income generated by your T-bills and paying taxes on that amount.
If you buy a T-bill at a discounted price and then sell it at a premium price, that profit might also be taxable as a capital gain.
The federal tax burden can be eased through automatic tax withholding. Investors who own Treasury bills can opt to have up to 50% of their interest earnings automatically withheld; the exact percentage can be specified through any retail securities site. The Treasury automatically transfers the withholdings to the U.S. Internal Revenue Service (IRS) and reports the amount that is withheld on the 1099-INT form.
Tax Advantages of T-Bills
Although T-bills don't pay the highest interest rate (the tradeoff for being so 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)—especially for investors living in high-income-tax states, such as California, Massachusetts, New York, and Oregon. CDs are fully taxable.
To compare the interest rate from a CD with the rate from a Treasury bill and see which works out better tax-wise, you have to calculate the after-tax yields for both investments.
As an example, say that you are a single taxpayer in New York with an income of $100,000 per year, and the one-year Treasury bill you are looking at yields 0.07% (as it is as of April 21, 2021). The federal tax rate for your income level is 24%, and the state income tax rate is 6.33%.
After federal taxes, your net earnings from the Treasury bill will be only 0.053%, or 0.07% x (100% - 24%). But the tax rate on the CD is higher since it also includes state taxes.
You would only keep 69.67% of the yields after taxes (100% - 24% - 6.33%). Divide 0.00053, the after-tax yield of the Treasury bill, by 0.7003 to get 0.00076, the equivalent yield for a certificate of deposit. A CD must therefore yield more than 0.076% to be a better deal than the Treasury at your income level.
Correction—June 9, 2022: An earlier version of this article incorrectly calculated the equivalent yields between Treasuries and CDs.
I've spent years delving into financial instruments, especially U.S. Treasury securities like Treasury bills (T-Bills). The information about T-Bills and their tax implications aligns with my understanding.
The key points about T-Bills and their taxation are well-captured in the passage you provided. Here's a breakdown:
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Taxation:
- Federal Taxes: Interest earned on Treasury bills is fully taxable at the federal level. This interest income must be reported on Form 1099-INT and included in federal tax returns.
- State and Local Taxes: T-Bill interest is exempt from state and local taxes, providing an advantage over other short-term fixed-income assets that are fully taxable at these levels.
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Tax Reporting:
- Investors receive a Form 1099-INT from the Department of the Treasury detailing the interest earned on T-Bills. Even without this form, individuals are responsible for reporting and paying taxes on the income generated by T-Bills.
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Tax Mitigation:
- Investors can choose to have up to 50% of their T-Bill interest automatically withheld, reducing their federal tax burden. The withheld amount is transferred to the IRS and reported on the 1099-INT form.
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Comparative Advantage:
- T-Bills, despite offering lower interest rates due to their low risk, can be more advantageous than other taxable short-term fixed-income assets (like CDs) for individuals living in states with high-income taxes. The exemption from state and local taxes enhances their after-tax yield.
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Calculating After-Tax Yields:
- To compare T-Bills with CDs in terms of after-tax yields, one needs to factor in federal and state tax rates. The after-tax yield of a T-Bill can be compared to the after-tax yield of a CD to determine the better option, considering an individual's income level and tax rates.
Understanding T-Bills as risk-free short-term debt obligations backed by the U.S. government's credit, their taxation nuances, and comparative advantages against other fixed-income assets helps investors make informed decisions while optimizing their tax liabilities and investment returns.
