Taxes on Bonds When Cashed In: Rates, Discounts, and NIIT

The taxes you owe when you cash in a bond depend on what kind of bond it is and how you got the money out. Interest from a corporate bond is taxed as ordinary income at every level. Treasury interest is federally taxable but exempt from state and local tax. Municipal bond interest is generally free of federal tax. Savings bonds defer federal tax until you redeem them. And if you sold a bond before maturity rather than holding it, part of what you receive may be a capital gain instead of interest, taxed under a different set of rules.

What You Owe by Type of Bond

The issuer determines almost everything about the tax bill.

Corporate Bonds

Interest from a corporate bond is ordinary income, taxed at your marginal federal rate plus any state and local income tax. For 2026, federal rates run from 10% to 37%.¹ Your brokerage reports the interest on Form 1099-INT whether you took the cash or reinvested it.² There is no special exemption anywhere in the code for corporate bond interest.

Treasury Bills, Notes, and Bonds

Treasury interest is federally taxable at ordinary income rates but exempt from state and local income tax.³ Your broker reports it in Box 3 of Form 1099-INT, kept separate from other interest for that reason.⁴ In a high-tax state, that state-level exemption meaningfully improves your after-tax yield compared to a corporate bond paying the same coupon.

Municipal Bonds

Interest on a state or local government bond is generally exempt from federal income tax, an exclusion written directly into the Internal Revenue Code.⁵ Most states also exempt interest on bonds issued within their own borders, so an in-state resident pays no federal, state, or local income tax on that interest. Buy a muni from another state and your home state will typically tax the interest.

Two boundaries matter. First, the federal exemption covers interest only. If you sell a muni for more than you paid, the gain is a fully taxable capital gain. Second, even tax-exempt muni interest counts when the IRS calculates whether your Social Security benefits are taxable: the formula adds tax-exempt interest back in to determine provisional income.⁶ Retirees with large muni portfolios sometimes find their “tax-free” income pushes more of their Social Security into the taxable column.

U.S. Savings Bonds (Series EE and I)

Savings bonds are the ones people most often “cash in,” and their tax treatment is different enough that they get their own section below.

Cashing In a Savings Bond

Interest on Series EE and Series I bonds is subject to federal income tax and exempt from all state and local income tax.⁷ Unlike a corporate or Treasury bond that pays interest each year, a savings bond lets you defer that federal tax until you actually redeem the bond or it reaches final maturity at 30 years, whichever comes first.³ When you cash in, every dollar above your purchase price is interest income at ordinary rates. Savings bonds don’t trade on the open market, so redemption never produces a capital gain or loss.

The practical consequence: if you’ve held a bond for years or decades and never reported the interest annually, you’ll get a 1099-INT for the entire accumulated interest in the year you cash out. That can be a large one-time hit.

You do have the option to report the interest each year as it accrues instead of deferring. Some taxpayers in low brackets take that route. But once you start reporting annually, you have to do it for every savings bond you own, and switching back to deferral requires IRS permission.⁸

Redeem within the first five years and you forfeit the last three months of interest. That isn’t a tax, but it reduces the interest you receive and report. Bonds can’t be redeemed at all during the first 12 months.

The Education Exclusion

If you use the redemption proceeds to pay qualified higher education expenses in the same tax year, you may be able to exclude the interest from federal income tax entirely. Qualified expenses include tuition and required fees at an eligible institution, plus contributions to a Coverdell ESA or a 529 plan.⁹ Room and board don’t qualify.

The requirements catch a lot of people:

The bond owner must have been at least 24 years old when the bond was issued. A bond bought in a child’s name will never qualify.¹⁰
You have to cash the bond in the same tax year you pay the expenses.
Married filing separately cannot claim the exclusion.⁹
The exclusion phases out with income. For 2026, the phase-out runs from $101,800 to $116,800 for single filers and from $152,650 to $182,650 for married filing jointly.

If your redemption proceeds exceed the qualified expenses, only a proportional share of the interest is excludable.

Inherited Savings Bonds

Inheriting a savings bond is where the deferred-interest structure produces its biggest surprise. If the previous owner was deferring interest (as most owners do), the person who cashes the bond receives a 1099-INT for the entire accumulated interest, potentially covering decades. There is an alternative: the deceased owner’s estate can elect to include all accrued interest on the final tax return, leaving the beneficiary responsible only for interest that accrues after the date of death.³

Selling a Bond Before Maturity

Cashing out a corporate, Treasury, or municipal bond before it matures usually means selling it, and that creates a capital gain or loss on top of any interest you received while holding it. How long you held it decides the rate.

Held one year or less: gain is short-term, taxed at your ordinary income rate (up to 37% for 2026).¹¹
Held more than one year: gain is long-term, taxed at 0%, 15%, or 20% depending on your taxable income.¹¹

For 2026, single filers pay 0% on long-term gains up to $49,450 of taxable income, 15% through $545,500, and 20% above that. For married couples filing jointly, the 0% bracket runs to $98,900, 15% applies up to $613,700, and 20% kicks in above.¹

Selling at a loss? That loss offsets other capital gains, and if losses exceed gains you can deduct up to $3,000 of the net loss against ordinary income per year ($1,500 if married filing separately). Anything left over carries forward indefinitely.¹²

Discounts and Premiums That Change Your Bill

Bonds bought below or above face value carry rules that reshape what you owe when you cash out.

Original Issue Discount

When a bond is first sold below its face value (a zero-coupon bond is the classic case), the difference is original issue discount. The IRS treats OID as interest that accrues each year, and you have to report it annually even though you receive no cash until the bond matures or you sell.¹³ Each year’s OID gets added to your cost basis, so you aren’t taxed twice on the same income when you finally cash out.⁸

Market Discount

Market discount is different. It happens when you buy a bond on the secondary market for less than face value, usually because interest rates rose after it was issued. When you sell or the bond matures, any gain up to the accrued market discount is taxed as ordinary income, not as a capital gain.¹⁴ Only the portion of the gain above the accrued discount gets capital gains treatment.

A de minimis rule provides relief for small discounts. If the discount is less than one-quarter of 1% of face value multiplied by the years remaining to maturity, the discount is treated as zero and the entire gain is a capital gain.⁸ On a $1,000 bond with 10 years left, that threshold is $25.

Bond Premium

Buy a taxable bond above face value and you can elect to amortize the premium over the remaining life of the bond, reducing your reported interest income each year with an “ABP Adjustment” on Schedule B.¹⁵ The amortization also reduces your cost basis, so your eventual gain when you cash out will be larger (or your loss smaller). The election applies to all your taxable bonds and can’t be revoked without IRS consent.⁸ For tax-exempt munis bought at a premium, amortization is required rather than optional, and it reduces basis without producing any deduction (since the interest is already tax-free).

The 3.8% Net Investment Income Tax

Higher-income investors face an extra 3.8% surtax on net investment income, which includes bond interest, OID, and capital gains from selling bonds.¹⁶ It applies to the lesser of your net investment income or the amount your modified adjusted gross income exceeds these thresholds:

Single or head of household: $200,000
Married filing jointly: $250,000
Married filing separately: $125,000

These figures aren’t adjusted for inflation, so more filers cross them each year.¹⁷ Tax-exempt municipal bond interest is excluded from the calculation, which is another advantage of munis for investors near these thresholds.¹⁸

How the Income Shows Up on Your Return

Bond income lands on several forms depending on the type and how you cashed out.

Form 1099-INT reports interest paid or credited during the year. Box 1 covers taxable interest from corporate bonds, Box 3 covers Treasury and savings bond interest, and Box 8 covers tax-exempt interest from municipal bonds.⁴ These amounts flow to Form 1040 and Schedule B. When you cash in a savings bond after years of deferral, the 1099-INT reports the entire accumulated interest in one lump. If you’re claiming the education exclusion, report the full interest on Schedule B first, then subtract the excludable portion using Form 8815.⁹

Form 1099-OID reports the annual OID you must include as interest even though no cash changed hands.¹³ Each year’s reported OID also increases your basis in the bond.

Accrued interest adjustment. If you bought a bond between interest payment dates, you paid the seller for interest that accrued before your purchase. Your first 1099-INT will include that in your total. Fix it by listing the accrued interest you paid on Schedule B and subtracting it with the label “Accrued Interest.”¹⁵ Skip this and you overpay.

Form 8949 and Schedule D handle the capital gain or loss from selling a bond before maturity.¹⁹ Your cost basis is the original purchase price plus any OID you’ve already included in income, minus any amortized bond premium. Errors on long-held bonds usually come from getting the basis wrong after years of adjustments.

1
Internal Revenue Service. Tax Inflation Adjustments for Tax Year 2026
2
Internal Revenue Service. About Form 1099-INT, Interest Income
3
TreasuryDirect. Tax Information for EE and I Bonds
4
Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID
5
Office of the Law Revision Counsel. 26 USC 103, Interest on State and Local Bonds
6
Internal Revenue Service. Social Security Income
7
TreasuryDirect. EE Bonds
8
Internal Revenue Service. Publication 550, Investment Income and Expenses
9
Internal Revenue Service. Form 8815, Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989
10
TreasuryDirect. Using Bonds for Higher Education
11
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
12
Office of the Law Revision Counsel. 26 USC 1211, Limitation on Capital Losses
13
Internal Revenue Service. About Form 1099-OID, Original Issue Discount
14
Office of the Law Revision Counsel. 26 USC 1276, Disposition Gain Representing Accrued Market Discount Treated as Ordinary Income
15
Internal Revenue Service. Instructions for Schedule B (Form 1040)
16
Internal Revenue Service. Topic No. 559, Net Investment Income Tax
17
Internal Revenue Service. Net Investment Income Tax
18
eCFR. 26 CFR 1.1411-4, Definition of Net Investment Income
19
Internal Revenue Service. Instructions for Form 8949