T-Bill Tax Treatment: Federal Rates, NIIT, and State Exemptions

Treasury bill tax treatment works on three layers: interest is taxed federally as ordinary income at rates from 10% to 37% for 2026, it is exempt from state and local income taxes, and higher earners may owe an additional 3.8% net investment income tax. The rate that applies depends on your total taxable income for the year, because T-bill interest stacks on top of your wages and other earnings.

Why the Discount Counts as Interest, Not Capital Gain

Treasury bills do not pay periodic interest. You buy the bill below face value, and the government pays you the full face value at maturity. A $10,000 T-bill purchased for $9,750 produces $250 of income.¹

The IRS treats that $250 as interest income, not as a capital gain.² The classification matters because interest is taxed at ordinary rates, while long-term capital gains would qualify for lower rates. T-bills never qualify for long-term treatment because they mature in 4 to 52 weeks.

Federal law carves T-bills out of the standard original issue discount accrual rules that apply to longer-term discount bonds.³ For cash-method individuals, that means you generally report the discount as interest in the year the bill matures or is sold, rather than accruing income daily as you hold it.⁴

Federal Ordinary Income Rates for 2026

Because T-bill interest is ordinary income, your marginal bracket depends on your total taxable income. For single filers in tax year 2026:⁵

10% up to $12,400
12% from $12,401 to $50,400
22% from $50,401 to $105,700
24% from $105,701 to $201,775
32% from $201,776 to $256,225
35% from $256,226 to $640,600
37% above $640,600

Married couples filing jointly have wider brackets. The top 37% rate begins at $768,700 for joint filers.⁵

The 3.8% Net Investment Income Tax

Higher-income investors face an added surtax. The net investment income tax adds 3.8% on top of your ordinary rate for interest, dividends, and other investment income when your modified adjusted gross income crosses these thresholds:⁶

$200,000 for single filers
$250,000 for married filing jointly
$125,000 for married filing separately

T-bill interest counts as net investment income and can trigger the surtax. These thresholds are not indexed for inflation, so more taxpayers cross them each year. A single filer in the 35% bracket with substantial T-bill interest can face a combined federal rate of 38.8%.

State and Local Tax Exemption

Federal law prohibits state and local governments from taxing interest on U.S. government obligations, including T-bills.⁷ For an investor in a state with a top income tax rate above 10%, this meaningfully boosts after-tax returns compared to a corporate bond or CD yielding the same nominal rate.

Two carve-outs are worth knowing. States can still impose nondiscriminatory franchise taxes on corporations, and T-bill values can be included in estate or inheritance tax calculations.⁷ The shield applies to personal income tax, not to every possible state levy.

On your state return, you subtract the Treasury interest from the federal adjusted gross income figure your state uses as a starting point. Tax software usually handles this once you flag the income source as a U.S. government obligation. Overpaying because the exemption was not claimed is one of the most common mistakes T-bill investors make.

Selling Before Maturity

You can sell a T-bill on the secondary market. The tax picture then splits in two. The portion of the discount that accrued between your purchase and sale dates is interest income, taxed at ordinary rates. Any remaining difference between your sale price and your adjusted basis is treated as a short-term capital gain or loss.⁸

Because T-bills always mature within a year, any gain from a secondary-market sale is short-term and taxed at ordinary rates. The distinction between “interest” and “short-term capital gain” is largely a reporting matter when both hit the same rate, but it affects how losses are categorized.

If you sell below your adjusted basis, you have a capital loss. Capital losses first offset capital gains from other investments. If losses exceed gains, you can deduct up to $3,000 per year against ordinary income ($1,500 if married filing separately), with any remainder carrying forward.⁹

Effects on Social Security and Medicare

T-bill interest also feeds into two calculations retirees often forget. It flows into adjusted gross income, which flows into the “combined income” figure the IRS uses to decide how much of your Social Security benefit is taxable. Combined income equals your AGI, plus nontaxable interest, plus half of your Social Security benefits.¹⁰

The thresholds have never been adjusted for inflation:

Single filers: combined income between $25,000 and $34,000 makes up to 50% of benefits taxable; above $34,000, up to 85% is taxable.
Married filing jointly: combined income between $32,000 and $44,000 makes up to 50% taxable; above $44,000, up to 85% is taxable.

A retiree who parks a large sum in T-bills can easily generate enough interest to cross these lines. The effective tax rate near the thresholds is deceptively steep, because each additional dollar of interest can drag more Social Security income into taxable territory at the same time.

Medicare premiums work similarly. The income-related monthly adjustment amount, or IRMAA, raises Part B and Part D premiums when modified AGI exceeds $109,000 for singles or $218,000 for joint filers. IRMAA uses your return from two years earlier, so T-bill interest earned in 2024 sets your 2026 Medicare premiums.¹¹ Surcharges can add over $575 per month at the highest tier, and crossing a threshold applies the extra premium to every month of the year.

Holding T-Bills Through Funds and ETFs

Owning T-bills indirectly through a money market fund, ETF, or mutual fund changes the reporting picture. The state exemption can still apply to your share of the fund’s Treasury interest, but not automatically. Fund companies publish an annual tax supplement showing the percentage of income from direct U.S. government obligations, and you use that percentage to calculate the exempt portion on your state return.

Some states require a fund to hold a minimum percentage of its assets in government obligations before the exemption applies at all. If the fund falls below that threshold, the entire distribution may be taxable at the state level even though part of the income came from Treasuries. Your broker’s 1099-DIV will not reflect this on its own, so the math falls to you or your preparer.

At the federal level, ordinary dividends from a T-bill fund are taxed as interest at your marginal rate, and the NIIT and Social Security and Medicare effects apply the same way as direct holdings.

Forms, Reporting, and Estimated Payments

Expect one or more of these forms:

Form 1099-INT, Box 3 reports interest on U.S. savings bonds and Treasury obligations. This is the common form for T-bills held to maturity through a brokerage or TreasuryDirect.¹²
Form 1099-OID, Box 8 is used by some brokers to report T-bill discount as original issue discount on Treasury obligations instead of on Form 1099-INT.⁸
Form 1099-B reports gross proceeds if you sold a T-bill on the secondary market before maturity or a bill you bought on the secondary market has matured.¹³

You report interest income on Schedule B of Form 1040 if your total taxable interest for the year exceeds $1,500. Below that, you report on line 2b of the 1040 without filing Schedule B.¹⁴ Identify the income as coming from U.S. government obligations so the state exemption applies.

Unlike wages, T-bill interest does not have taxes automatically withheld. TreasuryDirect offers voluntary backup withholding at rates up to 50%, applied to your proceeds before deposit.¹⁵ Brokers may offer a similar option. If you skip withholding and expect to owe at least $1,000 in federal tax beyond what is withheld from other sources, you generally need to make quarterly estimated tax payments to avoid underpayment penalties.¹⁶

On the state return, subtract the amount in Box 3 of the 1099-INT (or Box 8 of the 1099-OID) from your state taxable income. Software handles the deduction once you confirm the source is a Treasury obligation; if filing manually, look for the line allowing a subtraction for federally exempt interest and enter the Treasury portion there.¹⁷

1
TreasuryDirect. Treasury Bills
2
Office of the Law Revision Counsel. 26 U.S. Code 61 – Gross Income Defined
3
Office of the Law Revision Counsel. 26 U.S.C. 1272 – Current Inclusion in Income of Original Issue Discount
4
Office of the Law Revision Counsel. 26 U.S.C. 1281 – Current Inclusion in Income of Discount on Certain Short-Term Obligations
5
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
6
Office of the Law Revision Counsel. 26 U.S.C. 1411 – Imposition of Tax
7
Office of the Law Revision Counsel. 31 U.S.C. 3124 – Exemption From Taxation
8
Internal Revenue Service. Publication 550 (2025) – Investment Income and Expenses
9
Office of the Law Revision Counsel. 26 U.S.C. 1211 – Limitation on Capital Losses
10
Internal Revenue Service. IRS Reminds Taxpayers Their Social Security Benefits May Be Taxable
11
Centers for Medicare & Medicaid Services. 2026 Medicare Parts A and B Premiums and Deductibles
12
Internal Revenue Service. About Form 1099-INT, Interest Income
13
Internal Revenue Service. About Form 1099-B, Proceeds From Broker and Barter Exchange Transactions
14
Internal Revenue Service. Instructions for Schedule B (Form 1040)
15
TreasuryDirect. User Guide Sections 261 Through 270
16
Internal Revenue Service. Estimated Tax
17
TreasuryDirect. Tax Forms and Tax Withholding