Voluntary Tax Withholding on Selling I Bonds at TreasuryDirect

Many people bought I Bonds last year when rates were high. As inflation has come down and interest rates have gone up elsewhere, some are planning to sell their I Bonds to buy new I Bonds at a higher fixed rate. I Bonds purchased between May 2020 and October 2022 have a 0% fixed rate for life. The fixed rate on new I Bonds to be announced on November 1 may potentially go higher, possibly to 1.5%. See Cash Out Old I Bonds to Buy New Ones for a Better Rate.

I chose to buy TIPS for better inflation protection than I Bonds after I sold some of my I Bonds on August 1. The money went into Fidelity’s TIPS fund (ticker FIPDX). The yield on 5-year TIPS is above 2% as I’m writing this on August 30, 2023. I’m planning to sell more older I Bonds on October 1 to buy more shares in that TIPS fund. Please read more on this in Better Inflation Protection with TIPS Than I Bonds.

Most people go by the default tax treatment on I Bonds and defer taxes on the interest until they sell (see I Bonds Tax Treatment During Your Lifetime and After You Die). By default, TreasuryDirect doesn’t withhold any taxes from the proceeds because the IRS doesn’t require tax withholding on interest payments. Banks typically don’t withhold taxes when they pay interest in savings accounts or CDs either. You download a 1099 from TreasuryDirect next year and report the interest income on your tax return.

Some people prefer to have taxes withheld even when tax withholding isn’t required. Taxes paid through withholding are assumed to have been paid throughout the year. It helps with some timing issues.

If you’d like to have TreasuryDirect withhold taxes when you sell I Bonds, here’s how to do it.

Log in to your TreasuryDirect account and click on “ManageDirect” on the top.

Click on “Update my personal information” under the heading “Manage My Account.”

Answer a security question. Scroll to the bottom. Change the “Withholding Rate” from the default 0% to your desired rate (up to 50%). This new withholding rate will be used on all future sales. If you buy regular Treasuries at TreasuryDirect, it affects payments from those regular Treasuries as well.

The withholding rate applies only when you sell I Bonds. It doesn’t reduce the interest credited to your I Bonds while you still hold them.

To sell (cash out) your I Bonds, go back to ManageDirect and click on “Redeem securities.” You will see this on the review page after you select the I Bonds to cash out:

I set the withholding rate to 20% for this test. TreasuryDirect knows how much interest is included in the sale. The withholding rate only applies to the interest portion, not to the gross amount. TreasuryDirect does not withhold state taxes because I Bonds are exempt from state taxes.

If you choose to have TreasuryDirect withhold taxes, the amount withheld for federal income tax will be in Box 4 of Form 1099-INT together with the interest amount in Box 3. Tax software will take them into account when you enter both amounts from the 1099 form. Make sure you download the 1099 form from TreasuryDirect next year. TreasuryDirect will send an email when the form is ready but you should set a reminder on your calendar in case you miss the email.

Having TreasuryDirect withhold taxes from the sale is completely optional. I choose not to do that because I prefer to pay quarterly estimated taxes myself, but it works perfectly well if you prefer withholding.

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