Not all aspects of individual tax planning are clear-cut, especially when it comes to savings and investments, and this is certainly true in investment bonds.
Bonds can serve as a great opportunity to diversify your portfolio with a low-risk investment, but when it comes to tax planning, not all bonds are created equal.
An exceptional accounting services partner can tackle the heavy lifting of your annual tax preparation and maximize your savings when the annual tax season rolls around. However, if you are considering investment bonds (or need more information for your annual taxes now or in the future), here are the basics of bonds and what you need to know for adept tax preparation.
What are Investment Bonds?
When an investor purchases a bond, they are lending money to a corporation, to the government, or to another entity, with the expectation of interest on said loan. Companies and local, state, or federal governments issue bonds for a myriad of reasons – to expand operations, launch large infrastructure projects, or simply conduct everyday business.
Over the term of the bond, the investor will earn interest at a rate established at the onset of the bond’s issuance. Though there are exceptions, this is typically a fixed rate, with interest being paid to the investor at a set schedule, and often twice a year. On the bond’s maturity date, the investor will receive the bond’s par or face value, completing the investment life cycle.
What Are the Advantages of Investing in Bonds?
There are several advantages to investment bonds, starting with stability. Bonds are generally deemed one of the safest investments, as their value does not fluctuate like stocks. The return on investment is traditionally lower, and they are a solid way to slowly grow your funds over a longer period of time.
When it comes to diversification, bonds can also offset the fluidity and riskiness of stocks in an overall portfolio, which is why “stocks and bonds” tend to go hand-in-hand in basic investing terminology. Having both stocks and bonds in your investment portfolio means enjoying the possible high rewards of stocks and having a safety net via the more reliable bond investments.
Types of Bonds for Investors
There are many different types of bonds available, but the three most common categories are as follows:
U.S. Treasury Bonds
The American government issues U.S. Treasury Bonds, which are generally considered the lowest risk of the bonds available on the market. As such, they also tend to have the lowest return on investment. This amount can still be more than a traditional savings account or CDs, depending on current market conditions.
These U.S. treasury bonds are, in turn, divided into three categories, which are based on the lifespan of the bond:
- T-Bills are available in four-week, eight-week, 13-week, 26-week, and 52-week maturities.
- T-Notes are available in two-year, three-year, five-year, seven-year, or 10-year maturities.
- T-Bonds are available in 30-year maturities.
Municipal Bonds, commonly referred to as “Muni bonds,” are issued by a local, city, county, or state government agency. A government entity typically issues these bonds with funding large community projects, like new hospitals, airports, schools, power or water plants, or highways.
Corporate bonds tend to have the highest return, but they can also have the highest risk, depending on the health of the issuing company or organization. These bonds are issued by well-known companies (like Walmart, Apple, or Pfizer), and they come with credit ratings issued by agencies like Standard & Poor’s and Moody’s, which should always be fielded before making an investment.
How are Bonds Taxed? Do You Have to Report them on Your Tax Returns?
You may be taxed on the interest you earn on your bonds, and any capital gains on the sale of your bonds before their maturity date. Generally speaking, whether or not you’ll owe taxes on the interest from your bond depends on the type of bond you invested in.
- Interest from U.S. Treasury bonds is subject to federal taxes but is exempt from taxes on the state and local levels.
- Interest from municipal bonds is exempt from federal tax and is likely exempt from state tax if you purchased the bonds in the state you live in full time.
- Interest from corporate bonds is always tax deductible.
This is the basic guideline when it comes to taxable interest on investment bonds, but the tax scenarios can get much more complicated from here.
For example, even if you don’t have to pay taxes on your interest, you’ll still need to note any interest earned on Form 1099-INT on your annual federal tax return. This interest may still play a role in other IRS calculations, especially if you also earn income from Social Security.
In addition, you may be subject to capital gains taxes if your bond is sold before the maturity date. This common scenario can impact multiple bonds that an investor accumulates over the months and years.
Working with an Accounting Services Specialist Can Help You Navigate Your Taxes Regarding Investment Bonds
Going strong for more than four decades, Waters Hardy & Co. has been helping clients tackle these intricate details to optimize tax situations in every scenario. When it comes to tax services, Dallas may be our home base, but we have the resources and expertise required to help individuals, small businesses, and mid-sized companies in every state of the country.
We maintain a strict and thorough quality control process to identify financial opportunities and ensure that no stone is unturned when calculating any taxes on your investment bonds. With Waters Hardy & Co. at your side, you can rest assured that you are making smart investments and financial decisions that will benefit your bottom line for decades to come.
Let’s start a conversation about how we can make your tax planning and preparation both easier and more profitable.
Consultations are always free, and we’re standing by to discuss how we can put our expertise to work to benefit your financial future.