If you inherit cash from a relative or friend, you do not need to pay tax on it as you would other types of income. The same mostly holds true for saving bonds you inherit. You won't owe tax on the original amount of the bond, but may have to pay income tax on any interest that it has earned.
Some people choose to pay interest on savings bonds as it accrues, adding the amount of interest yearly to their federal tax return. If the person you inherit a bond from decided to pay tax on the interest yearly, you can also pay tax on the interest as it accrues, instead of in a single lump sum at the end. Even if the person who had the bond before you didn't pay tax using accrual basis reporting, you can decide to and pay taxes on the interest the year you inherit the bond, as well as in the years following, until you redeem the bond.
Most people prefer not to pay tax on the interest using the accrual basis reporting, and instead opt to put off the tax until the bond matures or is cashed in. If you decide to have the savings bond reissued in your name, and no taxes have yet been paid on the interest, you will owe tax at the time of the reissue. Depending on the value of the bond and the amount of interest, putting off paying taxes can increase your tax bill substantially.
Estate Pays the Tax
The estate of the person who passed away may decide to report any interest that has accrued on the bond at the time of death on the person's final tax return. Any tax on the bond's interest is then paid by the estate. If that is the case, the person who inherits the bond will only need to pay tax on the interest that accrues after the original holder's death.
Tax Already Paid
When you inherit a bond, it is your responsibility to find out if tax has been paid on accrued interest. For example, if you inherit a savings bond from your aunt, she may have paid yearly taxes on the interest. In this case, you would not be responsible for reporting the interest that has already been taxed when you redeem the bond, or when it reaches maturity. If you are unsure about the tax status of the bond, ask a tax professional for assistance.
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