Treasury bills are not fully tax exempt. The interest you earn on a T-bill is taxable as ordinary income on your federal return, but it is exempt from every state and local income tax in the country. That split is the whole answer, and it can noticeably improve your after-tax return if you live in a state with a high income tax.
Federal Tax on T-Bill Interest
You buy a Treasury bill at a discount to its face value. At maturity, the Treasury pays you the face value, and the difference is your return. The IRS treats that difference as interest income, not a capital gain, no matter how briefly you held the bill.1Internal Revenue Service. Topic No. 403, Interest Received
Because it is ordinary interest, it is taxed at your regular federal rate. For the 2026 tax year, those rates run from 10% on the lowest bracket up to 37% on income above $640,600 for single filers.2Internal Revenue Service. Tax Inflation Adjustments for Tax Year 2026 T-bills don’t pay periodic coupons, so the full discount lands as income in the year the bill matures or is sold. Rolling the proceeds straight into another T-bill does not defer the tax.
The 3.8% Surtax for Higher Earners
If your modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly), an additional 3.8% Net Investment Income Tax applies to T-bill interest.3Internal Revenue Service. Net Investment Income Tax These thresholds are not indexed for inflation. The surtax applies to the lesser of your net investment income or the amount by which your MAGI exceeds the threshold.
T-bill interest counts as net investment income because it is federally taxable interest, not “tax-exempt interest” the way municipal bond income is.4Internal Revenue Service. Questions and Answers on the Net Investment Income Tax A top-bracket investor who also owes the surtax faces an effective federal rate of 40.8% on T-bill interest.
State and Local Exemption
Federal law bars every state and every local government from taxing interest on U.S. government obligations, including Treasury bills.5Office of the Law Revision Counsel. 31 USC 3124 – Exemption From Taxation It doesn’t matter whether your state uses a flat tax, a progressive schedule, or no income tax at all. If your state does tax income, T-bill interest is protected.
That protection is what distinguishes T-bills from corporate bonds and bank CDs, where the full yield is exposed to both federal and state tax. The value of the exemption scales directly with your state’s rate: it is worth a lot in California or New York and nothing in Texas or Florida.
Where the State Exemption Stops
The same federal statute that grants the exemption carves out two situations where states can still reach the assets or the interest:5Office of the Law Revision Counsel. 31 USC 3124 – Exemption From Taxation
- State estate and inheritance taxes. States that impose their own death taxes can include the value of T-bills in the taxable estate. The interest is shielded during your lifetime; the underlying holdings are not shielded at death.
- Nondiscriminatory franchise taxes on corporations. States can include T-bill interest when measuring a corporation’s franchise tax or a similar tax imposed in place of one. This carve-out affects corporations only, not individual investors.
For an individual holding T-bills through their lifetime, the state and local income tax exemption is effectively complete.
What the Exemption Is Worth to You
Because T-bill interest avoids state and local tax, a T-bill with a lower stated yield can match the after-tax return of a higher-yielding taxable bond or CD. The tax-equivalent yield formula shows the comparison:
Tax-equivalent yield = T-bill yield ÷ (1 − your state income tax rate)
A 4.5% T-bill for a resident of a state with a 6% income tax works out to 4.5% ÷ (1 − 0.06), or 4.79%. A CD would need to pay at least 4.79% before federal tax to leave you with the same amount. In a no-income-tax state, the T-bill’s stated yield and its tax-equivalent yield are identical, and the exemption adds nothing.
Reporting T-Bill Interest Correctly
The 1099-INT You Will Receive
Early in the year, your broker or TreasuryDirect will send you Form 1099-INT. T-bill interest belongs in Box 3, which covers interest on U.S. savings bonds and Treasury obligations, not Box 1.6Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID Check the figure against your own purchase and maturity records.
On Your Federal Return
The Box 3 amount goes on Form 1040 as taxable interest. If your total taxable interest for the year exceeds $1,500, you also have to file Schedule B and list each payer, including TreasuryDirect or your brokerage.7Internal Revenue Service. Instructions for Schedule B (Form 1040)
On Your State Return
The T-bill interest arrives on your state return through your federal adjusted gross income, so you have to subtract it back out to claim the exemption. Most state income tax forms have a dedicated adjustment line for interest on U.S. government obligations. The line number and label vary; your state’s instructions will point to the right entry. Skipping this step means paying state tax you don’t owe.
Federal Estate and Gift Tax Still Apply
T-bills are not exempt from federal estate or gift tax. If your total estate exceeds the federal exemption of $15,000,000 for decedents dying in 2026, T-bill holdings are counted in the taxable estate, along with any interest that had accrued but not been paid by the date of death.2Internal Revenue Service. Tax Inflation Adjustments for Tax Year 2026
Giving T-bills to someone during your lifetime is a gift for federal purposes. You can transfer up to $19,000 per recipient in 2026 without a gift tax filing.8Internal Revenue Service. What’s New – Estate and Gift Tax Larger transfers require Form 709, though actual gift tax generally isn’t due until your cumulative lifetime gifts exceed the estate tax exemption.