How Are Treasury Bills (T-Bills) Taxed?

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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. Following the end of the tax year, in January of the new year, owners of Treasury bills should receive a Form 1099-INT from the Department 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 that charges a high income tax, T-bills might be more advantageous than other short-term fixed instruments, like CDs.

Understanding Treasury Bills (T-Bills)

Treasury bills are short-term debt obligations that are backed by the full faith and credit of the U.S. government. They are sold in denominations of $100 up to $10 million. T-bill maturity durations are one calendar year or less. Six maturity durations are offered: 4, 8, 13, 17, 26, and 52 weeks.

Like all Treasury securities, T-bills are considered "risk-free" assets. Technically, they are not risk-free, but they are viewed as securities with the lowest likelihood of loss, and many use them as a risk reference rate called the risk-free rate. 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. economy and government.

This reputation for safety caused investors to flock to Treasury securities during the 2007-2008 financial crisis as losses in stocks and other assets in their portfolios mounted. Those who had already invested heavily in Treasury securities before the crisis successfully safeguarded their capital.

Treasury Bills Tax Rate

The interest earned by a T-bill is taxable as investment income in the year the interest was received and must be reported on your federal tax return, Form 1040. The interest is taxed at your 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 and sell it for a profit, that profit will be taxable as a capital gain if you hold it for more than one year. If you hold it for less than one year, it is taxed at your income tax rate.

Paying federal taxes on T-bills can be simplified via tax withholding. You can opt to have up to 50% of your 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 withheld on the 1099-INT form.

T-Bill Tax Advantages

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, Hawaii, New York, and Oregon. CDs are fully taxable at the state and federal levels.

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, imagine you are a single taxpayer in Oregon with an income of $101,000 per year and the one-year Treasury bill you are looking at yields 4.48% (as of Aug. 8, 2024). The federal tax rate for your income level is 24%, and the state income tax rate is 9.9%.

After federal taxes, your net earnings from the Treasury bill will be only 3.40% (4.48% x 76%). But the tax rate on the CD is higher since it also includes state taxes.

You would only keep 66.1% of the yields after taxes (100% - 24% - 9.9%). Divide 3.40%, the after-tax yield of the Treasury bill, by 66.1% to get 5.15%, the equivalent after-tax yield for a certificate of deposit. A CD must yield more than 5.15% to be a better deal than the Treasury at your income level.

Do You Pay Taxes on Treasury Bills?

Yes, you pay federal taxes. However, T-Bills are not taxed at the state level.

How Do You Avoid Tax on Treasury Bonds?

You can't avoid paying taxes on Treasury Bonds, but you can use some bonds to pay for higher education tax-free if you meet certain criteria.

How Are Treasuries Taxed When Purchased at a Discount?

Tax treatments for discounted bonds are complex and depend on their terms and whether they were original issue discounts (OID) or market discounts. OID bonds use an adjusted cost basis (called accretion value) for annual income reporting, and market discount bondholders can choose between annual accretion reporting or reporting the entire market discount at maturity as income.

The Bottom Line

Treasury bills are taxed at the federal level but not by state and local governments. Many investors use them as a means to preserve capital when there is market turmoil, but they can also be used in other investment strategies.