7688 / How is interest on a Series E or EE bond taxed after the death of the owner?

An executor or administrator may make an election on behalf of a decedent (who has not previously elected) to include all interest in the decedent’s final income tax return.¹ If the decedent or the decedent’s representative had not elected to include interest in the decedent’s gross income annually, all interest earned before and after death is income to the estate or other beneficiary receiving the bond, either on the election to include interest annually or on redemption, final maturity, or disposal of the bond. Either may defer reporting or elect to report just as any owner. See Q 7679.

Unreported interest earned on E and EE bonds up to the date of death and unreported interest that was part of the consideration for H and HH bonds held at death are income in respect of a decedent.² The person who eventually includes the deferred interest in income may take a deduction in the year he or she reports the interest for any estate tax attributable to the income in respect of a decedent. See Q 747.³ The Service has ruled that in determining the fair market value of Series E savings bonds for estate tax purposes, the estate should not calculate a discount for lack of marketability for the income taxes due on the interest that accrued on the bonds from the date of purchase to the date of maturity.⁴

Like the owner of any other E or EE bond, the owner of E and EE bonds acquired from a decedent could exchange them for Series HH bonds (or H bonds before 1980 – but see Editor’s Note, below) without recognition of unreported interest.⁵ However, the interest must be included in income on disposal, redemption, or final maturity of the H or HH bonds received in the exchange, or on the election of the owner to report annually interest on E and EE bonds. (Editor’s Note: The Bureau of the Public Debt stopped offering Series HH Savings Bonds to the public after August 31, 2004. HH bonds issued through August 2004 will continue to earn interest until they reach final maturity 20 years after issue.⁶)

The Service privately ruled that: (1) the distribution of Series E and Series HH savings bonds from a decedent’s estate to several tax-exempt organizations did not result in the recognition of income by the estate; (2) the accrued interest attributable to the bonds would be includable in the gross income of the exempt organizations in the year in which the bonds were disposed of, redeemed, or reached maturity; and (3) assuming that the organizations continued their exempt status, the accrued interest would be exempt when recognized by the organizations.⁷

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1.   Rev. Rul. 68-145, 1968-1 CB 203; Rev. Rul. 79-409, 1979-2 CB 208.