Inherited treasuries

[kathyc2]

Client inherited about 20K of treasury bonds from his father. This is a new one for me. Does he pay the tax on full interest when he cashes them in?

[TaxGuyBill]

I THINK this answers it:

Interest accrued on U.S. Treasury bonds. The interest accrued on U.S. Treasury bonds owned by a cash method taxpayer and redeemable for the payment of federal estate taxes that was not received as of the date of the individual's death is income in respect of a decedent. This interest is not included in the decedent's final income tax return. The estate will treat such interest as taxable income in the tax year received if it chooses to redeem the U.S. Treasury bonds to pay federal estate taxes. If the person entitled to the bonds (by bequest, devise, or inheritance, or because of the death of the individual) receives them, that person will treat the accrued interest as taxable income in the year the interest is received. Interest that accrues on the U.S. Treasury bonds after the owner's death does not represent income in respect of a decedent. The interest, however, is taxable income and must be included in the income of the respective recipients.

https://www.irs.gov/publications/p559/ar02.html#en_US_2014_publink100099599

[Roland Slugg]

Does he pay the tax on full interest when he cashes them in?

Unlike U.S. Savings Bonds, Treasury Bonds are not "cashed in." Rather, they are normally either: (A) held to maturity, or (B) sold on the secondary bond market prior to maturity. They pay interest semiannually, and that interest is taxable by the person who receives it and in the year it is received. Thus, all the interest received by your client will be taxable on his federal (but not his state) income tax return.

If your client's father left a "taxable estate," the person who received the first interest payment(s) after the DOD may be entitled to an IRD deduction. If this is the case, your client may take that deduction on Schedule A, line 28, and is not subject to the 2% haircut. (Note: An IRD deduction is usually quite small, and it only applies in the relatively few instances when the decedent left a taxable estate.)

In the OP you described the bonds as "treasury bonds," so I assume you were using the term correctly ... referring to the long-term category of debt instruments issued by the U.S. Treasury. If instead the bonds were U.S. Savings Bonds, the interest reporting may be different, depending on the bond's series and whether or not the father had made the election to report accrued interest on the bonds annually on his own tax returns.

[kathyc2]

In the OP you described the bonds as "treasury bonds," so I assume you were using the term correctly ... referring to the long-term category of debt instruments issued by the U.S. Treasury. If instead the bonds were U.S. Savings Bonds, the interest reporting may be different, depending on the bond's series and whether or not the father had made the election to report accrued interest on the bonds annually on his own tax returns.

Shouldn't assume. They are actually Series E bonds. I think to be "fair" they should receive a step-up, although I wasn't finding anything to indicate that they could receive step up. I just wanted to make sure I was not missing something with different tax treatment with them being inherited.

[Burke]

Unfortunately, US Savings Bonds (like annuities) do not get a stepped-up basis at death.