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Savings Bonds

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U.S. Savings Bonds are unlikely to ever be the stars of the investment world. However, they come with a special tax benefit that has helped make them attractive to a generation of savers. You can purchase the bonds and then basically ignore them for the next 30 years if you like because unless you elect otherwise, the interest they earn isn’t taxable until the bonds mature or are redeemed for cash. Because of this feature, and the fact that they’re considered by many to be one of the safest investments around, millions of taxpayers have savings bonds tucked away somewhere.

At the bondholder’s death, one of the downsides to the bonds comes into play. As you may know, stock or mutual fund investments are “stepped up” (or down) to their value at the decedent’s date of death (so that if the beneficiary immediately sells the inherited asset, there is no gain or loss). However, U.S. Savings Bonds are inherited by the beneficiary at the decedent’s original cost basis (unless the decedent previously elected, which is unlikely, to include the bonds’ interest as income in the years it accrued). Thus, if you cash in a significant amount of inherited U.S. Savings Bonds, there’s likely to be substantial interest income that’s going to be taxable to you at your highest marginal tax rate. That’s obviously not good news.

A recent Tax Court decision explains a potential solution to this problem. The decedent’s executor can elect to include the accrued interest to the date of death in the decedent’s final return. In situations where the decedent had little or no other taxable income in the year of death, this can substantially lower the tax on the interest income. This option is even available in situations where after including the accrued interest from the bonds, the decedent still doesn’t owe any income tax on the final return (you have to file the return to report the interest income, the return just won’t show a balance due).

If you have any questions about how this planning opportunity might work in your situation, please feel free to contact us.