First, a U.S. Savings Bond is a bond instrument issued by the U.S. Government and can be purchased on the U.S. Treasury website. They are purchased at a 50% discount on the face value and at maturity can be surrendered at their face value. The difference between the purchase price and the maturity proceeds (face value) is considered the interest earned on the bond. These bonds have a 30 year bond maturity term, so in each year, one-thirtieth of the difference is deemed to be earned interest.

Virtually all of us are cash basis taxpayers, and as such we would normally recognize interest on the savings bonds only at maturity or redemption of the bond, which is the default method. The bank or the U.S. Treasury would issue the 1099-INT for the amount of interest and we simply pay income tax on that interest amount.

An alternative method allowed would be to pay tax on the interest earned a prorate basis for each year the bond is owned. This method is referred to as the accrual method. By way of example, if you purchase a $1,000 bond for $500, the prorated interest earned each year would be 1/30th of $500, or about $17 per year. Once you start using this method, you must continue to use it for all U.S. Bonds you own (E, EE, and I) forever, unless you request, and receive, permission from the IRS to change back to cash basis method of reporting.