Let's say I cash out some government savings bonds with a face value of $2,000. Since they are 10% bonds the total amount I get when I cash them out is $2,200.

Do I owe taxes on the full $2,200 (principal and interest) or only on the $200 interest?

Everything I am reading says that the interest of earnings from bonds is taxable, but an IRS notice I just received seems to imply that I owe taxes on the entire amount.

Anyone know and have a source they can point to? Thanks!

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    Savings bonds defer all years' interest into the year cashed, could that be the issue? – user662852 Oct 18 '16 at 22:14
  • This page on investopedia should tell you all you need to know : investopedia.com/articles/tax/08/bond-tax.asp . You do not pay tax on the principle, only on the capital gain and interest earned. Capital losses can be offset against other capital gains. – user41790 Oct 18 '16 at 22:19
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    See irs.gov/publications/p17/ch07.html#en_US_2015_publink1000171458 (or the downloadable PDF if you prefer). Also if you don't understand an IRS notice, at the bottom of www.irs.gov find Resolve an Issue Respond to a Notice, then choose Information for Individual Filers, and search or select your particular notice type. @user662852: to be exact, most savings bonds accrue interest and defer tax until redemption for most taxpayers who don't elect otherwise. – dave_thompson_085 Oct 19 '16 at 22:05

You only pay tax on the capital gain of the bond, not the principal, unless the source of the money for the principal was gain from another investment, if that makes sense.

In other words, if you bought the bond with income earned from your job, that money was already taxed as income, so it isn't subject to taxation again when you redeem the bond. On the other hand, if you cashed out of one investment and used those proceeds to buy a bond, then the entire amount might be taxable.

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  • What if you receive the bond as a gift? – quid Oct 18 '16 at 22:31
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    If it's a gift then the responsibility for taxes ordinarily falls on whoever gave it to you. Here's a link to the IRS on the issue: irs.gov/businesses/small-businesses-self-employed/… – Daniel Anderson Oct 18 '16 at 22:33
  • Any semi-official source I can point to on this? A woman I spoke to at the IRS said otherwise, but she didn't really sound very sure of herself. I am going to dispute a claim but some backup would be a huge help if anyone has it... Thanks! – Lime Oct 19 '16 at 19:24

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