Key Takeaways
- Suze Orman warned that heirs who inherit unredeemed I bonds don’t get a step-up in basis, so they owe federal tax on the interest the bonds built up.
- The executor who files a parent’s final tax return can instead choose to report all the interest earned before death on that return.
- For a single parent 65 or older with $20,000 of other income, $50,000 of I bond interest would cost $5,254 in federal tax on the final return, against $12,000 for a child in the 24% bracket.
- A large required minimum distribution or other income in the parent’s final year shrinks the saving, so the executor should work out the return both ways before filing.
If you’re holding I bonds you’ve never paid tax on, or your parents are, the tax doesn’t go away when the owner dies. Suze Orman made the point on the Nov. 8 episode of Suze Orman’s Women & Money. She was talking about owners who die before cashing their I bonds: “your beneficiaries do not get a step up in basis like they do in stocks, ETFs, real estate, and all of that.”
That’s bad news for heirs, since they can end up owing tax on decades of interest at their own rates. But fortunately, whoever files the parent’s last tax return has a choice that can cut that bill by more than half.
Say a parent dies with the bonds uncashed
Let’s take a hypothetical single parent, 65 or older, who dies holding I bonds with $50,000 of interest that’s never been taxed. That’s the amount Orman said $10,000 of I bonds bought in 2000 could earn by 2030, when they reach their 30-year maturity. Most owners report I bond interest only when they cash the bonds or the bonds mature, so a pile like that can sit untaxed for decades. Say the parent also had $20,000 of other taxable income in their final year and leaves the bonds to a grown child whose income already puts them in the 24% bracket. If nobody does anything, that child owes the tax on all $50,000.
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Heirs inherit the tax along with the bonds
Under the rules in IRS Publication 550, the interest earned before death can go in one of two places when the owner never reported it along the way and bought the bonds with their own money. By default, it stays off the parent’s final return, and all the interest, from before and after the death, counts as income to whoever gets the bonds. A child who doesn’t report it each year can wait until the year they cash the bonds or the bonds mature, whichever comes first. Either way, the tax is charged at the child’s own rate.
But there’s another option. The surviving spouse or executor who files the final return can choose to put all the interest earned before death on that return instead.
The final return can be far cheaper
On the parent’s final return, the $50,000 of interest is added to the $20,000 of other income, for $70,000 in all. Against that, the parent gets $24,150 of deductions between the $16,100 standard deduction, the extra $2,050 for an unmarried filer 65 or older and the $6,000 senior deduction. The senior deduction stays whole, since $70,000 is under the $75,000 of modified adjusted gross income where it starts phasing out. That leaves $45,850 of taxable income. The first $12,400 is taxed at 10%, or $1,240, and the other $33,450 at 12%, or $4,014, for $5,254 in federal tax.
Since the parent’s $20,000 of other income alone would fall entirely under those deductions, they’d owe nothing without the bonds. So all $5,254 is tax on the interest.
For the child, all $50,000 lands on top of income already in the 24% bracket, so it costs $12,000. That means the family keeps $6,746 more when the executor puts the interest on the final return. The $5,254 is paid out of the estate, so the child still bears it, just at the parent’s lower rates. (Neither the parent nor the child owes state or local tax on it, since I bond interest is exempt from both.)
What the executor has to do
The executor, or a surviving spouse, who files the parent’s final return makes the choice by including as income all the interest the bonds earned before the death. They report either all of that interest or none of it. Interest the bonds earn after the death still goes on the child’s return. When the child eventually cashes the bonds, the Form 1099-INT they get will still include the $50,000 the parent already reported. So they’ll need a copy of the final return to subtract it on their own.
Run both numbers before filing
The family comes out ahead when the parent’s final year falls in a lower bracket than the child’s. With $20,000 of other income, the parent’s taxable income stops at $45,850, which is $4,550 short of the 22% bracket that starts at $50,400. A big required minimum distribution or pension income in the final year could push some of the interest into 22%. Once income passes $75,000, the $6,000 senior deduction starts shrinking too. And if the parent’s income already puts them in the child’s bracket or higher, the family gains nothing from this choice.
If I were settling a parent’s estate with old I bonds in it, I’d have the final return worked out both ways before filing anything. In a modest final year, the family can save thousands with that one decision. Just keep in mind that the $6,000 senior deduction runs only from 2025 through 2028. A parent who dies in 2029 or later would lose it on that final return unless Congress extends it.
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Disclaimer:
Please note that the articles on TIKR are not intended to serve as investment or financial advice from TIKR or our content team, nor are they recommendations to buy or sell any stocks. We create our content based on TIKR Terminal’s investment data and analysts’ estimates. Our analysis might not include recent company news or important updates. TIKR has no position in any of the stocks mentioned. Thank you for reading, and happy investing!
