For the most part, I typically assume that people who have misinformation came by it honestly. Usually, they didn’t quite understand fully what they read or were told. After all, one of the trickiest things about managing money and personal finance is that there are so many exceptions and nuances. In a lot of cases, what is absolutely true for one person is not true for someone else because of their individual circumstances.
Unfortunately, while the internet has given people easy access to vast amount of information, it does so without any verification that the information published is true.
The problem is compounded by those who read something inaccurate and then repeat it elsewhere. This makes the false information seem more valid because it is corroborated by another source, which, in fact, is just repeating something that was wrong.
That is why it is so important to verify financial planning information you read with an authoritative or trusted source.
You Owe Taxes On Matured Savings Bonds
Which brings us to IRS Publication 550 – Investment Income (that, my friends, is an authoritative source) and a popular, but dead wrong tax-savings strategy.
U.S. savings bonds are a safe, and therefore low-paying, investment issued directly by the United States Treasury Department. Grandmothers have been giving their grandchildren savings bonds since World War II. In fact, a lot of people have amassed a bunch of savings bonds in safe-deposit boxes, and even shoeboxes, over the years.
Savings bonds are easy to buy directly from the government at the TreasuryDirect.gov website (dot gov — not dot com).
Savings bonds mature after a certain number of years. When they reach their final maturity, they stop earning interest. But, something else happens too; the taxes become due on the interest.
Taxes Due On Saving Bond Interest at Final Maturity
Here is where that not-fully understanding the nuances of savvy personal finance comes into play.
Savings bond interest is exempt from state and local taxes. It is, however, not exempt from federal income taxes. In fact, interest on savings bonds is taxed just like any other interest, with one exception. The taxes on savings bond interest may be deferred until the bond is cashed, or the bond reaches final maturity.
The misinformation comes from folks who don’t notice the last clause of that sentence, likely because when they first learned about it, their bonds were years from maturity.
Now, there are numerous people who think that you can avoid taxes on savings bond interest from bonds that have already matured by not cashing them.
Of course, that is not true. Don’t believe me, read IRS Publication 550 under the U.S. Savings Bonds section and you will see under the heading Reporting options for cash method taxpayers:
Method 1. Postpone reporting the interest until the earlier of the year you cash or dispose of the bonds or the year in which they mature.
That "the earlier of" is IRS-speak for whichever one of these these things happens first. In other words, they IRS does not care if you never cash in your savings bonds. There is no IRS penalty for not cashing in mature savings bonds, but you still owe the taxes on the interest.
The bad news is that many savings bonds are tagged with the social security number of the owner, so it’s only a matter of time before a computer gets around to deciding that the dollar amount is big enough to worry about. Worse, yet, for anyone being targeted for an audit, you can be this is a big fat red flag on your file.
Obviously, if you only have $300 of savings bonds, no one is going to bother unless they figure out a way to automate it. Of course, if you only have $300 worth of savings bonds, then why are trying to avoid the taxes? When you cash them in you’ll get $300 and you’ll owe less than a $100. You are still coming out ahead and you can start earning interest on what is left.
Otherwise, you can roll the dice and hope the IRS never bothers. Of course, if they do make the effort, you’ll owe interest and penalties on the taxes you owed but never paid on your unreported income.
Cash in your savings bonds when they mature. Don’t try and make this one of your tax tricks.