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Dear MarketWatch,
I have many mature EE savings bonds that I inherited from my mother as a beneficiary in the event of her death.
I redeem a few each year to avoid paying a large amount of taxes at once.
What should I do if I wanted to redeem them now and pay the tax – or withhold it – and not wait to file my tax return in April?
Susanna
Dear Susan,
Savings bonds are supposed to be a simple and safe investment, but more than 30 years later, it probably doesn’t seem that way. EE bonds (and E bonds before them) were the Series I bonds of the era: popular gifts for birthdays and college savings, but not so popular today when everyone is chasing high-yield investments.
Luckily you have certificates and a clear ownership designation. Many people forget about paper savings bonds and then fail to pass them on to their heirs or provide them with instructions if they are found hidden in a box somewhere. In these cases, the bonds end up as unclaimed funds and you have to follow steps to find them and claim them as the rightful heir, which could be complicated. The Treasury’s tool for this is aptly called “Treasure Hunt”.
But there’s one thing you should know: Tax on E/EE bonds is due when you cash them in or when they reach their full maturity (regardless of whether you hold them longer).
You could have also paid tax every year on the accumulated interest, but the ship has obviously sailed on that. If you have E/EE bonds from your mother that are past their 30 year maturity date, you should have already paid tax on them. Since EE bonds have been issued since 1980 and E bonds from World War II until then, it is quite possible that you have some that are that old. They also stop earning interest after that 30-year mark, so there’s no growth incentive to hold onto them.
Another thing to note: Savings bonds don’t get a step-up in basis at death like stocks or other investments do. This means you have to pay taxes on the full amount of interest owed on the bonds as an heir.
Penalties on old savings bonds
Cashing it all in now and dealing with the taxes is probably a good way to go. Let’s just start with those issued in 1994 or later, where there would be no penalty. The interest would hit his 2024 taxes, which are due by April of the following year.
If cashing them out now generates interest income that far exceeds your normal tax liability, you should make an estimated tax payment at the time of the transaction. You can do this manually by submitting an estimated tax form with a payment. Through Treasurydirect.gov you can choose to automatically withhold up to 50% of the interest you earn.
To determine the exact amount you will need to pay up front, enter your serial numbers into the Treasury’s online calculator. If you run the calculator without the serial numbers and just the date of issue, you can get a number on the back of the envelope. For example, a $100 EE bond, purchased for $50 in February 1994, would have accrued $114.12 in interest at its final maturity. The Internal Revenue Service notes in its instructions for estate administrators that you may be able to deduct some of this interest income if you paid estate taxes on your mother’s estate.
If you have bonds that are already past due, work with a tax professional to find the best solution. “I don’t know if the IRS will look the other way if you try to extend this issue,” says David Enna, editor of Tipswatch.com. “If they were EE bonds issued in 1993 or earlier, there could be quite substantial interest coming in, with taxes due.”
Fixing the problem will involve calculating the amount of interest owed and therefore any IRS penalty, and may involve filing amended returns for the years in which the bonds matured. Hopefully you’ve kept good records of your transactions, but if not, be sure to write down all dates and amounts going forward.