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.
FAQs
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.
How is income from T-bills taxed? ›
T-Bill Tax Considerations
The interest income that you may receive from investing in a treasury bill is exempt from any state or local income taxes, regardless of the state where you file your taxes. However, you will need to report interest income from these investments on your federal tax return.
How are zero coupon T-bills taxed? ›
Income from Treasury bills is paid at maturity and, thus, tax-reportable in the year in which it is received. Although not paid until maturity, income from zero-coupon STRIPS is taxable in the year in which it accrues.
How are Treasury bills taxed if sold before maturity? ›
The interest income earned on Treasury bills is taxable at the federal level, and earnings from Treasury bills sold on the secondary market can be taxed via capital gains taxes.
Are T-bills a good investment right now? ›
Are Treasury bills a good investment? T-bills are known to be low-risk, short-term investments when held to maturity because the U.S. government guarantees them. Investors owe federal taxes on any income earned, but no state or local tax.
What happens when a T-bill matures? ›
When the bill matures, you are paid its face value. You can hold a bill until it matures or sell it before it matures.
Are Treasury bills better than CDs? ›
Choosing between a CD and Treasuries depends on how long of a term you want. For terms of one to six months, as well as 10 years, rates are close enough that Treasuries are the better pick. For terms of one to five years, CDs are currently paying more, and it's a large enough difference to give them the edge.
How much does a $1000 T bill cost? ›
Purchase Price: You buy a 1-year T-bill with a face value of $1,000. If the annual yield is 5%, you would pay approximately $950 for the T-bill upfront (the exact price would be calculated using the discount rate formula, but for simplicity, we'll use this close approximation).
Why buy zero coupon Treasury bills? ›
Zero-coupon bonds are more volatile than coupon bonds, so speculators can use them to profit more from anticipated short-term price movements. Zero-coupon bonds can help investors to avoid gift taxes, but they also create phantom income tax issues.
How are treasuries taxed when purchased at a discount? ›
For bonds with very small discounts: If the discount is less than 0.25% of the bond's face value times the number of years to maturity, the discount is taxed as a capital gain in the year the bond matures.
You can sell a T-Bill before its maturity date without penalty, although you will be charged a commission. (With CDs, you pay a sizeable penalty for early withdrawals.)
Are T-bills FDIC insured? ›
The FDIC does not insure U.S. Treasury bills, bonds or notes, but these investments are backed by the full faith and credit of the United States government.
How do you make money with Treasury bills? ›
Treasury bills are short-term investments backed by the U.S. Treasury, making them a safe place to hold your cash and earn a modest interest rate. These investments are typically for one year or less, and you purchase them at a discount. At maturity, you receive the face value, letting you earn a return.
Is there a downside to T-bills? ›
The Potential Downside
Taxes: Treasury bills are exempt from state and local taxes but still subject to federal income taxes. That makes them less attractive holdings for taxable accounts.
Why does Warren Buffett buy T-bills? ›
Buffett favors three-month and six-month T-bills. Bid/ask spreads are tight—usually just a penny, or equivalent to one basis point in yield, or a hundredth of a percentage point. Fees are low, at about a tenth of a percentage point annually. There is very little price volatility due to the short maturities of T-bills.
Are T-bills safe if the market crashes? ›
Treasury securities are issued on behalf of the U.S. Treasury Department. They are backed by the full faith and credit of the U.S. government, making them the safest of all bond types.
Are treasury bonds taxed as capital gains or ordinary income? ›
The income from taxable bond funds is generally taxed at the federal and state level at ordinary income tax rates in the year it was earned. Funds that exclusively hold U.S. Treasury bonds may be exempt from state taxes.
How do you calculate income from T bills? ›
To calculate yield, subtract the bill's purchase price from its face value and then divide the result by the bill's purchase price. Finally, multiply your answer by 100 to convert it to a percentage.
Are T bills considered cash or fixed income? ›
Treasury bonds (T-bonds), Treasury notes (T-notes), and Treasury bills (T-bills) are government-issued fixed-income securities that are very low risk. Treasury bonds typically mature in 20 or 30 years and offer the highest coupons or interest, which are paid twice yearly.
Is income from Treasury direct taxable? ›
What you earn from your Treasury marketable securities is subject to federal tax but is exempt from state and local taxes.
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