How Are Treasury Bonds Taxed? Interest, TIPS, and STRIPS

Interest on Treasury bonds is taxed as ordinary income at the federal level and exempt from state and local income tax. If you sell a Treasury bond before it matures and pocket a profit, that capital gain is taxed at both the federal and state level. The size of the bill depends on your federal bracket, how long you held the bond, and whether your income is high enough to trigger an extra 3.8% surtax on investment income.

Federal Tax on Coupon Interest

Treasury notes and bonds pay interest every six months. Those coupon payments count as ordinary income, taxed at the same federal rates as a paycheck. For 2026, federal income tax rates run from 10% to 37%, with the top rate kicking in on income above $640,600 for single filers and $768,700 for married couples filing jointly.1Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026

Most individuals report the interest in the year they receive it. Your broker or TreasuryDirect account will send a Form 1099-INT, with Treasury interest shown in Box 3.2Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID If your total interest income tops $1,500 for the year, you also attach Schedule B to your Form 1040.3Internal Revenue Service. Instructions for Schedule B (Form 1040)

The State and Local Exemption

Federal law bars states and localities from taxing U.S. government obligations or the interest they produce.4Office of the Law Revision Counsel. 31 USC 3124 – Exemption From Taxation Every dollar of coupon interest from a Treasury bond is free of state and local income tax.5Internal Revenue Service. Topic No. 403, Interest Received In a high-tax state, that exemption meaningfully raises your after-tax yield compared to a corporate bond paying the same stated rate.

The exemption has two important limits. It covers interest only, not capital gains from selling a Treasury before maturity. And it does not extend to state estate or inheritance taxes, so Treasuries in a decedent’s estate can still be reached by those levies.

Selling a Treasury Bond Before Maturity

If you sell a Treasury note or bond on the secondary market, you have a capital gain or loss equal to the difference between the sale price and your adjusted tax basis. Holding period determines the federal rate:

  • Held one year or less: short-term gain, taxed at ordinary income rates up to 37%.
  • Held more than one year: long-term gain, taxed at 0%, 15%, or 20% depending on your taxable income. For 2026, a single filer pays 0% on long-term gains up to $49,450, with the 20% rate applying above $545,500.

The state exemption does not reach these gains. Section 3124 covers the obligation and its interest, and explicitly leaves the tax treatment of gains and losses to the Internal Revenue Code.4Office of the Law Revision Counsel. 31 USC 3124 – Exemption From Taxation Your state can tax a Treasury sale profit the same way it taxes any other investment gain.

Capital losses offset capital gains dollar for dollar. If your losses exceed your gains, you can deduct up to $3,000 of the net loss against ordinary income ($1,500 if married filing separately), and any remainder carries forward indefinitely.6Internal Revenue Service. Topic No. 409, Capital Gains and Losses

Market Discount Bonds

If you buy a Treasury bond on the secondary market for less than its face value, that difference is called market discount. When you sell or redeem the bond, the portion of your gain attributable to accrued market discount is taxed as ordinary income rather than capital gain. A de minimis rule applies: if the discount is less than one-quarter of one percent of face value multiplied by the complete years remaining to maturity, it is treated as zero and the entire gain gets capital gain treatment.7Office of the Law Revision Counsel. 26 USC 1278 – Definitions and Special Rules

Phantom Income: TIPS and STRIPS

Two kinds of Treasury securities generate a tax bill before you see any cash. The IRS calls this original issue discount, or OID. Investors call it phantom income.

Treasury Inflation-Protected Securities

TIPS pay a fixed coupon rate, but the underlying principal adjusts every six months based on the Consumer Price Index.8TreasuryDirect. Treasury Inflation-Protected Securities (TIPS) When inflation rises, principal rises, and each coupon payment rises with it. The upward adjustment to principal is itself taxable in the year it occurs, even though you will not receive that extra principal until maturity.9Internal Revenue Service. Publication 550, Investment Income and Expenses

Each year you pay tax on two streams: the coupon you actually receive and the inflation adjustment you will not see for years. Both are ordinary income. Your broker reports the inflation adjustment on Form 1099-OID.2Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID Each adjustment also raises your tax basis, so you are not taxed again on the same dollars when the TIPS matures. In a deflationary year, the adjustment can go negative and reduce the OID you owe.

Zero-Coupon Treasury STRIPS

STRIPS are created by separating a Treasury bond’s coupon payments and principal into individual zero-coupon securities, each sold at a deep discount. You pay far less than face value up front and receive the full face amount at maturity, with nothing in between. Even though no cash arrives along the way, you must report a portion of the total discount as OID income every year you hold the security.10Office of the Law Revision Counsel. 26 USC 1272 – Current Inclusion in Income of Original Issue Discount

The annual OID accrual uses a constant-yield method, so the taxable amount grows larger each year as the STRIP nears maturity. Each year’s accrual increases your basis, which means when the security finally pays out, there is no second tax on amounts you already reported.11Office of the Law Revision Counsel. 26 USC 1286 – Tax Treatment of Stripped Bonds The yearly tax without matching cash flow is why STRIPS often make more sense inside tax-advantaged accounts.

Related Treasury Securities

Treasury bills and savings bonds share the state-tax exemption but have their own quirks. T-Bills are sold below face value and redeemed at face, and the difference is taxed as ordinary interest rather than capital gain, even though it arrives as a lump sum at maturity.12TreasuryDirect. Treasury Bills In Depth The tax hits when the bill matures or when you sell, whichever comes first.

Series EE and Series I savings bonds let you choose when to report federal tax. The default is to defer all interest until you cash the bond or it reaches final maturity; alternatively, you can elect to report interest annually as it accrues, and the election then applies to every savings bond you own and any you later acquire.13TreasuryDirect. Tax Information for EE and I Bonds An education exclusion can shelter some or all of the interest when proceeds pay qualifying higher-education expenses, subject to age, ownership, filing status, and income phase-out requirements.14Internal Revenue Service. About Form 8815, Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989

The 3.8% Net Investment Income Tax

Higher-income investors face an additional 3.8% surtax on net investment income. It applies to individuals with modified adjusted gross income above $200,000 (single) or $250,000 (married filing jointly), and those thresholds are not indexed for inflation.15Internal Revenue Service. Questions and Answers on the Net Investment Income Tax

Treasury coupon interest, TIPS inflation adjustments, STRIPS OID, and capital gains from selling Treasuries all count as net investment income for this purpose.15Internal Revenue Service. Questions and Answers on the Net Investment Income Tax A single filer in the 37% bracket can therefore face a combined federal rate of 40.8% on Treasury interest, which eats into the state-tax advantage when you compare yields against alternatives.

Treasuries in an IRA or 401(k)

Holding Treasuries inside a traditional IRA or 401(k) stops the annual tax on interest, OID, and phantom income, but it comes with a trade-off. Distributions from traditional retirement accounts are taxed as ordinary income at both the federal and state level, regardless of what the account held. The state exemption that would have protected Treasury interest in a taxable brokerage account is effectively lost, because the money leaving the IRA is classified as a retirement distribution rather than Treasury interest.

A Roth IRA flips the result. You get no deduction going in, but qualified distributions come out tax-free federally and at the state level. For TIPS and STRIPS, a Roth account solves the phantom-income problem outright: no annual tax on accruals, and no tax at withdrawal.

If you are holding Treasuries specifically to capture the state-tax exemption, keep them in a taxable account. Moving them into a traditional retirement account turns state-exempt interest into fully state-taxable distributions later on.

Tax Forms You Will See

Your broker or TreasuryDirect sends the relevant forms each year:

If you own Treasuries through a mutual fund or ETF rather than individual securities, you will need to calculate the share of fund income attributable to Treasury obligations to claim the state-tax exemption. Fund companies usually publish that percentage after year-end, but it does not appear automatically on your 1099 forms.