Series E and EE U.S. savings bonds are zero coupon investments issued at a discount. The interest is paid at maturity when the coupons are redeemed for their full face value. For each year prior to maturity, the bond’s redemption value increases. This annual increase in value represents the interest accrual for each year. Series E bonds were last issued in 1979. Since then, U.S. savings bonds have been designated as Series EE.
Series H and HH U.S. savings bonds
Series H and HH U.S. savings bonds were issued at face value and pay interest in cash twice a year (taxable on receipt by cash-basis taxpayers). Series H bonds were issued until 1979. Since then, these coupon payment bonds have been designated as Series HH. HH bonds were no longer offered to the public starting September 1, 2004. Series HH bonds were acquired only by exchanging Series E or EE bonds. Exchanging a Series E or EE bond for a Series HH bond did not cause a cash-basis taxpayer to recognize the deferred interest income associated with the Series E or EE bond. Instead, that income is recognized when the Series HH bond matures, which can be up to 20 years later. This exception to income recognition does not apply, however, to corporations or to taxpayers who have elected to accrue the income on the Series E or EE bond.
Series I U.S. savings bonds
Series I U.S. savings bonds combine the features of deferring taxes on the interest until maturity with inflation protected growth. Series I bonds are 30-year instruments. They were first issued in September 1998 and contain a fixed interest rate and an inflation-adjusted rate. The bonds are issued at face value. Interest is added to the bond monthly, compounded semi-annually, and paid when the bond is redeemed. Series EE bonds cannot be exchanged for Series I bonds.
The government has extended the maturity date for some Series EE bonds. Interest continues to accrue on these bonds past the original maturity date. This post-maturity date interest is reported using the same method as applied before maturity.
Election to convert to the accrual method for Series EE and I U.S. savings bond interest
The election to convert to the accrual method for Series EE and I U.S. savings bond interest should be considered when it is likely that the income will be taxed at a higher rate in the year the bond matures or is redeemed. For example, a child (or other low-income taxpayer) who elects to accrue the income will likely be subject to little or no tax each year, while bunching all the income into the year of maturity could push that taxpayer into a higher tax bracket or, if a child, cause a portion of the income to be subject to the parent’s tax rate under the kiddie tax rules.
Accrue Income on Government Bonds
Likewise, it may make sense to elect to accrue the income on the return of a deceased taxpayer if the tax rate on that taxpayer’s final return will be lower than that of the estate or beneficiaries. The election could also be useful for taxpayers with otherwise unusable deductions, such as NOL carryforwards or investment interest expense limited to net investment income.