Are 3-Month Treasury Bills Really Taxable? Avoid this Mistake + FAQs

Yes – 3-month T-bills are taxable at the federal level, but their interest is exempt from state and local income taxes.

Below, we’ll break down everything you need to know, from IRS rules to state-by-state details:

• Federal vs. State Taxes: Learn how the IRS taxes 3-month T-bill interest (and why states can’t tax it under federal law).

• Historical Rulings & Policies: Explore key court cases and IRS guidelines that shaped T-bill taxation, plus how investor category (retail, institutional, or foreign) might affect tax treatment.

• Maturity & Reporting: Understand how 3-month T-bill taxes work across maturity timelines (held to maturity vs. sold early), what forms (1099-INT/OID) to expect, and how to report this income.

• State-by-State Tax Table: See a detailed table of all 50 states + D.C. and how each treats 3-month Treasury bill interest (spoiler: no state income tax applies, but we’ll list specific nuances).

• Comparisons & Examples: Compare 3-month T-bills to 6-month and 1-year T-bills (taxation, interest, strategies, maturity implications) and review real-life examples, key terms, pros & cons, and FAQs to solidify your understanding.

Understanding the Taxability of 3-Month T-Bills

Are 3-month Treasury bills taxable? In a word, yes – but it’s important to clarify what taxes apply. 3-month Treasury bills (T-bills) are fully taxable at the federal level as interest income. That means the interest you earn on these short-term U.S. government debt instruments must be reported on your federal income tax return and is subject to ordinary income tax rates.

However, interest from U.S. Treasury obligations (including T-bills, notes, and bonds) is exempt from state and local income taxes under federal law (thanks to longstanding principles of federal immunity and specific statutes).

In practical terms, this dual treatment (taxable federally, exempt locally) makes T-bill interest “single-taxation” income – you’ll pay Uncle Sam, but your state (and city, if it has income tax) doesn’t get a cut.

This is a key advantage of T-bills, especially for investors in high-tax states. Before diving deeper, let’s outline exactly how taxes on a 3-month T-bill work:

• Federal Tax: The interest (discount yield) from a 3-month T-bill is subject to federal income tax in the year it matures (or is sold). It’s treated as interest income (ordinary income), not capital gains, so it’s taxed at your regular income tax rate (which can be as high as 37% for individuals, plus a 3.8% Net Investment Income Tax for high earners). There are no special federal tax breaks for T-bill interest – unlike, say, municipal bond interest which is federally tax-free. The IRS expects you to include T-bill interest in your gross income for the year.

• State & Local Tax: By federal statute and the doctrine of intergovernmental tax immunity, states cannot tax interest on U.S. government obligations. Thus, the interest from a 3-month T-bill is not included in taxable income on your state (or city) tax return. Most states explicitly allow taxpayers to subtract U.S. Treasury interest from state taxable income. Even if you live in a state with an income tax, you won’t owe state tax on T-bill interest. (If your state has no income tax at all, then you wouldn’t be taxed at that level regardless.)

• Example (Basic): Suppose you buy a $10,000, 3-month T-bill at issuance for $9,900 (a $100 discount) and it matures at $10,000. You’ve earned $100 of interest. For federal taxes, that $100 is taxable income – you might pay, say, $22 of federal tax if you’re in the 22% bracket. For state taxes, if you live in California (top rate ~13%) or New York (top ~10.9%), you owe $0 on that $100 interest, because it’s exempt. If you had earned $100 interest on a corporate bond or bank CD, by contrast, you’d owe state tax of up to $13 in CA or $10.90 in NY. This state-tax savings boosts the effective return of T-bills for state taxpayers. 👍

In short, 3-month T-bills are partially tax-advantaged: they provide risk-free interest that’s taxed only once (by the feds). Next, we’ll explore the federal tax rules in detail and then break down state taxation (with a full table of all states).

Federal Taxation of 3-Month Treasury Bills

Federal taxation of T-bills is governed by the Internal Revenue Code and IRS regulations, which treat interest on U.S. Treasury securities in largely the same way as interest from other taxable investments, with a couple of timing wrinkles. Here’s everything you need to know about how Uncle Sam taxes your 3-month T-bill income:

How the IRS Treats T-Bill Interest Income

Interest vs. Original Issue Discount (OID): 3-month T-bills are sold at a discount to their face value rather than paying explicit interest coupons. For example, you might pay $9,800 for a 13-week T-bill that will redeem for $10,000 at maturity. The $200 difference is interest income, technically characterized as Original Issue Discount (OID). For tax purposes, OID on short-term obligations (one year or less) like 3-month T-bills is generally treated as interest income when the bill matures. In other words, when your T-bill matures (or you sell it), the accrued discount is taxed just like interest. There’s no option to treat it as a capital gain – it’s ordinary interest. This is a crucial point: even though there’s a “buy low, redeem high” aspect, the IRS does not consider that a capital gain on Treasuries; it’s interest by definition. All interest from T-bills is taxable as ordinary income (no special lower rate).

Tax Year of Inclusion: Typically, you report the entire interest from a 3-month T-bill in the tax year it matures (because the term is so short). If you buy and redeem a T-bill all within one calendar year, all the interest is included in that year’s income.

If you happen to buy a 3-month T-bill near year-end that matures in the next year, the interest will be taxable in the year it matures (next year), because that’s when you actually receive or are credited the money. There is a provision allowing taxpayers to elect to accrue OID on short-term obligations ratably and include it in the year earned (which could split the interest between two years if the 3-month period straddles Dec 31).

However, most individual investors do not make this election for T-bills, as it’s complexity with little benefit – they simply report the full interest at maturity. Thus, practically speaking, the timing of 3-month T-bill interest inclusion is straightforward: the interest is taxed in the year you get paid at maturity (unless you sell early, which we discuss below).

Reporting the Income (1099-INT or 1099-OID): The IRS requires brokers or the Treasury (if you use TreasuryDirect) to report interest from T-bills if it’s $10 or more for the year. In most cases, interest from a matured Treasury bill is reported to you on Form 1099-INT (Interest Income) for the year. Although technically discount yield could be reported on Form 1099-OID, brokerage platforms typically simplify and put the full interest on a 1099-INT when short-term bills mature.

For example, if you had multiple 3-month T-bills in 2025 that matured and paid interest, expect a 1099-INT from your broker or TreasuryDirect in early 2026 showing the total interest earned. You’ll include that on your tax return (Schedule B if you have over $1,500 of interest income total, otherwise directly on Form 1040).

Important: The 1099-INT for Treasury interest often has a box indicating “U.S. Treasury interest” which helps you identify the portion that is exempt from state tax (tax software usually asks for that breakdown).

No Federal Tax Exemption: Unlike certain bonds (e.g. municipal bonds) that get a federal tax exemption, T-bills do not enjoy any federal tax-free status.

All interest from a 3-month T-bill counts as gross income on your federal return. (Historically, some older U.S. government bonds issued long ago had federal tax exemptions – for instance, a few Treasury bonds issued before 1941 were partially tax-exempt federally – but modern T-bills are 100% federally taxable. Congress eliminated tax-free federal bonds many decades ago.) So, if you earn $1,000 in T-bill interest, all $1,000 is subject to federal income tax at your marginal rate.

Ordinary Income Characterization: Since T-bill interest is ordinary interest income, it does not qualify for special lower tax rates. Long-term capital gains and qualified dividends can be taxed at 0%, 15%, or 20% rates depending on income – but interest from 3-month T-bills is taxed at regular rates (the same as your wages or short-term earnings). There’s no way to convert it to capital gain treatment (even if you sell the T-bill before maturity, as we’ll see, the accrued portion is still taxed as interest).

Additionally, T-bill interest counts as “investment income” for the 3.8% Net Investment Income Tax (NIIT) if your adjusted gross income is above $200k (single) / $250k (joint). So high earners may effectively pay up to 40.8% federal tax on T-bill interest (37% top bracket + 3.8% NIIT).

IRS Rules for Selling a T-Bill Before Maturity

Most investors hold 3-month T-bills to maturity due to the short duration. But if you sell a T-bill before it matures, the tax treatment requires a bit of calculation:

• Accrued Interest vs. Capital Gain: When you sell a T-bill early, the price you receive may be higher or lower than your purchase price. The IRS says that any gain up to the amount of accrued OID/discount is still taxed as ordinary interest (this is effectively the interest you earned for the period you held it). Any gain above the accrued interest is a capital gain (and since T-bills are always held short-term (≤1 year), that would be a short-term capital gain taxed at ordinary rates anyway). If you incur a loss on sale, that could be a capital loss (short-term).

  Example – Sold Early: You buy a 3-month T-bill for $9,900 (face $10,000) and after 2 months, you sell it for $9,950 on the secondary market (perhaps yields fell slightly). Your total gain is $50. Had you held to maturity, you’d have gotten $100 interest. Roughly, in 2 out of 3 months, you accrued about $67 of that interest. Under IRS rules, you’d report about $67 as interest income and the remaining $-17 would actually be a capital loss (because you didn’t get the full accrual – in this scenario you sold at a point where the buyer will get the remaining interest). In our specific numbers (selling at $9,950): The accrued interest portion might be around $67 (just illustrative), but since you only gained $50, the rule is you report $50 as interest income (the lesser of gain or accrued discount) and $0 capital gain (in fact, no extra gain beyond interest). If instead you gained more than the accrued interest, the excess would be short-term capital gain. If you sell at a loss relative to your cost, you can have a capital loss, but you still must report any accrued discount as interest first. These scenarios are complex, but the key point is: any profit from a short-term T-bill is going to end up taxed as interest to the extent of the accrued interest. Only gains beyond that (or losses) enter capital gain/loss territory.

  In practice, brokerage 1099-B forms might not delineate the interest portion for you. As a savvy taxpayer, you may need to adjust: If a 1099-B shows a $50 short-term gain on that T-bill sale, you’d actually report $50 as interest (on Schedule B) and zero capital gain, per the IRS rule (IRC §1271). Some brokers may issue a Form 1099-OID for the accrued portion in the year of sale to help; others might adjust the basis on the 1099-B. Always check if any 1099-OID is issued for partial-year holdings of T-bills you sold. If not, be prepared to manually account for the interest vs. principal in your tax reporting. This is quite an advanced scenario – again, most people hold their 3-month bills to maturity to avoid such complications.

IRS Policies and Historical Notes

The taxation of Treasury bills has some interesting legal and historical background:

• Intergovernmental Tax Immunity: There’s a long-standing principle (stemming from McCulloch v. Maryland in 1819) that states and the federal government cannot directly tax each other’s obligations. For federal taxes, Congress has the power to tax interest on its own debt (and it does). For state taxes, historically states could not tax interest on U.S. government bonds. Today, this is codified in federal law (31 U.S.C. § 3124), which explicitly exempts U.S. government interest from any state or local taxation. We’ll cover more on this in the state section, but it’s a key policy reason why T-bill interest is only taxed once (federally).

• Historic Federal Exemptions: In the past, certain U.S. Treasury securities were issued with an exemption from federal income tax on the interest (to encourage war-time investing, etc.). For example, some Liberty Bonds and other pre-1940s bonds had tax-exempt interest or a tax credit feature. However, no modern 3-month T-bill carries a federal tax exemption. Since at least the 1940s, interest on new Treasury issues has been fully taxable by the federal government. Thus, all investors, whether individuals or institutions, pay federal tax on their T-bill interest income (unless they hold them in a tax-deferred or tax-exempt account).

• IRS Guidance: The IRS routinely clarifies Treasury interest treatment in publications. IRS Publication 550 (Investment Income and Expenses) and Topic No. 403 (Interest Received) both confirm that interest from Treasury bills is taxable federally but not at the state level. The IRS also issues regulations on original issue discount (OID) in IRC §§ 1271-1273 and related regs: for short-term obligations like T-bills, Section 1271(a)(3) essentially requires that gain be treated as interest to the extent of the discount. Over the years, this framework has been stable – no major changes in how T-bill interest is taxed in recent decades. So you can invest knowing the rules are well-established.

• Notable Court Cases: While there haven’t been courtroom battles over individuals paying federal tax on T-bills (that’s a given), there have been important cases ensuring states don’t tax federal bond interest. Memphis Bank & Trust Co. v. Garner (1983) is a landmark Supreme Court case where a Tennessee tax that effectively taxed interest on U.S. bonds (while exempting Tennessee’s own bonds) was struck down as unconstitutional discrimination. This and similar cases reinforced that U.S. Treasury interest must remain free from state taxation. On the federal side, one could hark back to Pollock v. Farmers’ Loan & Trust Co. (1895), where the Supreme Court controversially ruled that a federal income tax on interest (from bonds, etc.) was a “direct tax” and unconstitutional – leading to the 16th Amendment which gave us the modern income tax. Post-1913 (16th Amendment), interest on T-bills has unequivocally been part of taxable income under federal law. So yes, historically it’s been settled that Uncle Sam can tax Treasury interest, and states cannot.

Investor Categories: Retail vs. Institutional vs. Foreign

The taxation of 3-month T-bills can vary slightly depending on who the investor is and how they hold the investment:

• Individual Investors (Retail): For everyday investors, the rules we’ve discussed apply straightforwardly. You report the interest in the year received, pay federal tax at your ordinary rate, and exclude it from state income on your state return. If you have a large amount of T-bill interest, be mindful of possibly needing to pay quarterly estimated taxes – since T-bill interest typically has no withholding. (When you earn interest in a bank account, usually there’s no withholding either, so this is similar. The IRS expects you to pay taxes via estimated payments if the amount is large enough to trigger underpayment penalties.) Individuals often ladder T-bills (rolling over every 3 months). Note: Each new T-bill and its interest is a separate taxable event. Even if you keep reinvesting your T-bill proceeds into a new T-bill, you cannot defer the tax – the interest from the maturing bill is taxable in that year, even if you immediately use the cash to buy another bill.

• Institutional Investors (Funds, Banks, Companies): Institutions like banks or mutual funds also pay tax on T-bill interest, but the context can differ. Banks, for instance, include T-bill interest in their taxable income (no special break), but they may use T-bills for liquidity and capital requirements as well. One nuance: mutual funds and ETFs that invest in Treasury bills (like money market funds or short-term Treasury ETFs) will pass through the interest to investors as dividends. Those dividends keep the character of Treasury interest for state-tax exemption purposes. For example, if a money market fund earned 80% of its income from Treasury securities, typically 80% of the dividend you get from that fund can be treated as exempt from state tax. Each fund reports the percentage of income from U.S. government securities to help shareholders with state taxes. So, institutional holdings might create an extra step for individuals (figuring out what portion of a fund’s dividend is state-tax-free). But at the federal level, it’s still ordinary income to the recipient.

• Foreign Investors: Interestingly, the U.S. offers an incentive for foreign investors to buy Treasury securities: most foreign investors are exempt from U.S. withholding tax on Treasury interest under the “portfolio interest” rules. The U.S. generally does not tax nonresident aliens on interest from Treasuries (it’s considered portfolio interest, which is exempt from the usual 30% withholding, provided proper paperwork (W-8BEN form) is filed and the investor isn’t in the U.S. trade/business). This means a foreign individual buying a 3-month T-bill often pays no U.S. tax at all on the interest. (They might owe tax in their home country, but that’s another matter.) The rationale is to encourage foreign investment in U.S. debt. So, paradoxically, a foreigner could earn interest on a U.S. T-bill and pay zero U.S. tax, whereas a U.S. citizen will pay federal tax. This is by design of U.S. tax law. However, foreign investors do not get the state tax benefit because they typically don’t file state taxes anyway (no local tax nexus just from owning Treasuries).

• Tax-Advantaged Accounts: If you hold a 3-month T-bill inside an IRA, 401(k), or other tax-deferred account, then its interest isn’t currently taxable at all – not by the feds, not by states. The interest just accumulates within the account and you’ll pay tax under the rules of that account (for example, traditional IRA distributions are taxed as ordinary income, Roth IRA distributions are tax-free, etc.). Many people use Treasury bills in IRAs for short-term parking of cash. It’s perfectly fine and you don’t have to worry about any 1099-INT in that case (the IRA’s earnings are not reported to you annually). Similarly, if a non-profit organization or other tax-exempt entity buys T-bills, they don’t pay tax on the interest because of their tax-exempt status (not because of the T-bill itself). So, context matters – the rules above assume a taxable investor in a taxable account. If you’re investing through a retirement account, the account’s rules trump the asset’s rules.

Bottom line (Federal): All taxable investors pay federal income tax on 3-month T-bill interest. The interest is ordinary income, typically reported on 1099-INT, and taxed in the year the T-bill matures (or is sold). There’s no federal exemption for this interest (with rare exceptions for certain investors like foreign persons or within IRAs). Now, let’s turn to the state side of things, where T-bills have a clear advantage.

State Taxation of 3-Month Treasury Bills

One of the most attractive features of U.S. Treasury bills is their treatment under state and local tax law. In every state of the U.S., interest from 3-month T-bills is either explicitly exempt from taxation or effectively not taxed because the state has no income tax. Here, we’ll explore why that’s the case and provide a state-by-state breakdown of T-bill taxability.

Why T-Bill Interest Is Exempt from State and Local Taxes

The exemption of Treasury interest from state taxation isn’t just a random perk – it’s rooted in the U.S. Constitution’s principles and federal statutes:

• 31 U.S.C. § 3124: This federal law provides that interest on U.S. government obligations (like Treasury bills, notes, bonds) “is exempt from taxation by a State or political subdivision of a State.” In plainer terms, states (and cities/counties) are not allowed to impose income tax on interest from U.S. Treasuries. This law codifies the doctrine of intergovernmental immunity, which prevents states from interfering with the federal government’s borrowing power by taxing it.

• Uniform Application: Because of the above federal law, all states must comply. Some states incorporate this by explicitly stating in their tax code or instructions that U.S. government bond interest is excluded from state taxable income. Typically, when you fill out a state income tax return, if your federal adjusted gross income included Treasury interest, you will subtract that interest on a specific line to arrive at state taxable income. For example, California Schedule CA has a line to subtract U.S. obligation interest (so Californians don’t pay state tax on it). New York does similarly – NY taxpayers back out any U.S. government interest from their state income. This ensures you’re not taxed at the state level.

• States with No Income Tax: There are states (e.g., Florida, Texas, Nevada, etc.) that simply do not tax income at all. In those cases, obviously your T-bill interest isn’t taxed by the state (because no income is taxed, period). We’ll list those states too. The key point: whether a state has income tax or not, none of them currently tax T-bill interest.

• Local Taxes: What about city or county income taxes? A few local jurisdictions, like New York City or some cities in Ohio, have their own income taxes. These local income taxes usually piggyback on state rules. Since states can’t tax Treasury interest, neither can a city or local authority (they are subdivisions of the state). For instance, NYC’s income tax follows New York State’s definitions of income, which exclude U.S. bond interest. So you won’t pay NYC tax on it either. The same goes for any local tax: if it’s an income tax, it cannot hit federal bond interest. (Property taxes or sales taxes are different and don’t apply to interest income anyway.)

• Historical Battles: States at times tried to indirectly tax federal obligations. The Memphis Bank case (1983) we mentioned was about a state imposing a franchise tax on banks that counted U.S. bond interest in the tax base. The Supreme Court struck that down, reinforcing the immunity. After that, states uniformly respect the exemption. In the past, a couple of states had separate taxes on interest/dividends (e.g., New Hampshire’s interest & dividends tax, which is actually being phased out by 2025). Even those explicitly exempt U.S. government interest. So, there’s solid legal grounding: no state or city can snag a piece of your Treasury bill interest.

State-by-State Tax Treatment of 3-Month T-Bill Interest

To build topical authority 😉, let’s survey all 50 states and the District of Columbia on their tax treatment of 3-month Treasury bill interest. The table below details whether the interest from U.S. T-bills is taxable or exempt in each jurisdiction (for individual income tax). As you’ll see, the answer is almost universally “exempt.” We’ll note if the state doesn’t have an income tax, or if there are any special comments.

As shown above, every U.S. state and D.C. spare your 3-month T-bill interest from taxation. The reason is either state policy (following federal law) or the absence of a tax to begin with. A few notes from the table: States like New Hampshire (which taxed interest/dividends at a low rate) specifically exempted U.S. interest – plus that tax is ending. Tennessee’s old Hall Tax (on interest/dividends) also exempted Treasuries before it was abolished. So even historically “odd” cases respected the exemption.

Practical tip: When filing state taxes, ensure you subtract your Treasury interest if your state doesn’t automatically do so. Most tax software will ask for the amount of your interest that is from U.S. obligations to handle this. If you neglect to indicate it, you might accidentally pay state tax you don’t owe. For example, a taxpayer in a state with 5% income tax who earned $1,000 of T-bill interest should make sure that $1,000 is removed from state taxable income – saving $50 in tax. 💡 It’s a common mistake for DIY filers to overlook this, effectively forfeiting the state-tax advantage of Treasuries.

Now that we’ve covered federal and state taxation in detail, let’s compare how 3-month T-bills stack up against slightly longer Treasury bills (6-month and 1-year) in terms of tax and other considerations.

Comparing 3-Month vs. 6-Month vs. 1-Year Treasury Bills (Tax & Strategy)

All Treasury bills – whether 3-month, 6-month, or 12-month (1-year) – share the same fundamental tax characteristics (taxable federally as interest, exempt from state/local tax). However, there are subtle differences in how they might be used by investors and the timing of interest recognition. The table below compares key features of 3-month, 6-month, and 1-year T-bills in terms of taxation, interest, and holding strategy:

As shown, tax rules (federal/state) are basically the same for 3, 6, and 12-month T-bills. The differences lie in timing and strategy rather than how much tax or what rate. Key takeaways:

• All have interest taxed by IRS at ordinary rates and exempt by states.

• Shorter bills give more control over when interest is realized (which can help manage taxable income year by year if needed).

• Longer bills lock in a rate but delay the interest receipt (could be good or bad for tax timing depending on your situation).

• Regardless of maturity, if you sell before maturity, the partial-period interest vs. capital gain rules we described apply uniformly.

From a tax efficiency perspective, none of these maturities offers a leg-up over the others – the state tax benefit applies equally, and federal taxation is identical in character. Thus, your choice between 3-month, 6-month, or 1-year T-bills should be driven by cash needs and interest rate views, rather than tax differences.

Real-World Examples of T-Bill Taxation

To cement the concepts, let’s walk through a few detailed examples and scenarios involving 3-month Treasury bills and their tax outcomes:

Example 1: Basic Hold-to-Maturity (Individual).
Alice purchases a $10,000 3-month T-bill at auction for $9,900. It matures 3 months later, paying $10,000. Alice earned $100 interest. Come tax time, Alice receives a 1099-INT showing $100 of interest from U.S. Treasury obligations. She is in the 24% federal tax bracket and lives in a state with 5% income tax. She will pay $24 of federal tax on that $100 interest. On her state tax return, she lists the $100 as exempt U.S. obligation interest – thus paying $0 state tax (saving $5 she would have paid if this were, say, a corporate bond interest). The process was simple: report $100 interest on Schedule B (since her total interest exceeds $1,500 including other accounts) and subtract $100 on the state income adjustment line. Takeaway: Holding a T-bill to maturity yields straightforward interest income taxed by the IRS only.

Example 2: Laddering Strategy Over a Year.
Bob has $50,000 he wants to keep safe and earn some return, but he might need it within a year. He decides to “ladder” 3-month T-bills throughout the year. He buys a $10k T-bill each month Jan–May, each at ~5% annualized yield. Each one yields about $125 in interest at maturity (since 3 months on $10k at 5% ≈ $125). Over the year, Bob essentially always has a T-bill maturing each month (after the first three months). By December, he’s earned five separate interest payments totaling around $625. Bob will get a 1099-INT showing $625 of Treasury interest for the year. He’ll pay federal tax on $625 (say Bob is 22% bracket, that’s $137.50 in tax). Bob lives in Texas (no state income tax), so he owes nothing to the state. If Bob were in a state with tax, it would still be zero on that interest. The benefit of 3-month bills for Bob was that he could continuously reinvest and also, if he needed to stop and use the money, one bill would mature soon. Tax-wise, nothing complicated – he just had multiple T-bills but the interest added up. If Bob itemizes deductions, note that state tax saving doesn’t affect him (Texas has none). If he were in a state with tax, the fact that he didn’t pay, say, $30 in state tax on that $625 interest means nothing to deduct – but under current federal law, state taxes are capped in deductibility anyway. The main point: Bob’s effective yield was higher due to no state tax.

Example 3: Selling Before Maturity (Tax Breakdown).
Carol buys a 3-month T-bill, $100,000 face, for $99,000 (implying $1,000 interest if held to maturity). After 2 months, interest rates have fallen, so the T-bill’s market price rises and Carol sells it for $99,600. Carol’s gain is $600. Now, how is this $600 taxed? Based on IRS rules for short-term OID instruments, Carol must treat the gain as interest to the extent of the accrued discount. In two out of three months, roughly $667 of the $1,000 interest had accrued. Carol’s $600 gain is less than $667, so the entire $600 is taxed as interest income (ordinary federal tax). She will receive likely a 1099-B from her broker showing proceeds $99,600 on cost $99,000 = gain $600. Because she didn’t hold to maturity, there might not be a 1099-INT for this. Carol (or her tax software) should report $600 as interest income (even though label might not be clear). Alternatively, if Carol’s broker provided a 1099-INT or OID for part of that, she’d use it accordingly. No capital gain is recognized because all her profit was basically accrued interest. If instead Carol had sold for $99,800 (gain $800, which is $133 beyond the $667 accrued interest), then $667 would be interest and $133 would be a short-term capital gain. The capital gain portion $133 would be taxed at the same rate as interest (since short-term gains = ordinary rate), so in effect Carol’s tax bill in either scenario is similar, just the character differs slightly. In either case, state tax is zero on both the interest and any possible capital gain portion, since both are income derived from a U.S. obligation (states also exempt capital gains from Treasuries, generally, though that scenario rarely needs separate mention because usually it’s interest). This example shows that selling a T-bill early doesn’t avoid taxes; you still pay for the interest earned up to that point.

Example 4: High Earner in High-Tax State (Tax-Equivalent Yield).
Dave is a high-net-worth investor in California (13.3% state tax top bracket, 37% federal bracket + 3.8% NIIT). He’s comparing a 3-month T-bill yielding 5% with a bank CD yielding 5.2%. At first glance, the CD’s rate is higher. However, the CD interest will be taxed by both federal and state. If Dave invests $100,000 in the CD for 3 months, he earns $1,300 interest (annualized 5.2% for a quarter). Federal tax at ~40.8% = $530, and CA tax at 13.3% = $173, total tax $703, net interest ~$597. If Dave invests $100,000 in T-bills at 5%, he earns $1,250 interest in 3 months. Federal tax 40.8% = $510, state tax = $0, net interest $740. Dave’s net return is higher with the T-bill despite the slightly lower nominal rate, because the state tax savings was significant. In fact, the tax-equivalent yield of a 5% state-tax-free interest for Dave is about 5% / (1 – 0.133) = ~5.77%. So a 5% T-bill is like a taxable investment yielding 5.77% to him. Clearly, the T-bill is the better after-tax deal. This example illustrates the value of the state tax exemption for those in high tax brackets or high-tax states. It also shows that even though Dave pays a hefty federal tax on the interest (no getting around that 40.8%), not having to pay California makes a difference.

Example 5: Treasury Bills in an IRA vs. Taxable Account.
Elena holds 3-month T-bills in both a taxable brokerage account and in her Traditional IRA. In her taxable account, her $20,000 T-bill yielded $250 interest, which she must report on her 1040 and pay taxes (federal only). In her IRA, her $20,000 T-bill also yielded $250 interest, but she does nothing on her tax return with that – the $250 stays in the IRA and is not taxed now. Many savvy investors use IRAs for taxable bonds to defer or eliminate taxes on interest. However, Elena should consider: in her taxable account, the T-bill interest is state-tax-free already, which is nice. In the IRA, eventually when she withdraws money, it’ll be taxable (for a Traditional IRA) at ordinary rates including state tax at that future time. If Elena had a Roth IRA, the T-bill interest would eventually come out tax-free entirely. The lesson: where possible, holding Treasuries in tax-advantaged accounts can eliminate even the federal tax, but even in taxable accounts Treasuries have the state-tax edge. Elena also noticed that her brokerage didn’t withhold any tax on the T-bill interest in her taxable account (since there’s generally no withholding on interest by default), so she might need to adjust her quarterly estimated payments if her tax bill is big enough.

These scenarios cover common situations – buying and holding, laddering, selling early, comparing after-tax yields, and placement in accounts. The consistent theme is that federal tax will always get you on the interest, but state tax never will. Smart investors factor that into their decisions.

Key Terms and Concepts in T-Bill Taxation

Let’s clarify some key terms and concepts related to Treasury bills and their taxation, to ensure you’re comfortable with the lingo:

• Treasury Bill (T-Bill): A short-term debt obligation issued by the U.S. Treasury with a maturity of one year or less. 3-month T-bills (often called 13-week bills) are a common tenor. They are sold at a discount (e.g., pay $9,800 for a $10,000 bill) and mature at full face value, the difference being the interest. T-bills pay no periodic coupon – just the difference on maturity.

• Discount Yield / Discount Rate: The interest rate implied by the discount. T-bills are often quoted by their discount rate. For example, a 5% discount yield on a 3-month T-bill means the annualized interest is 5%. Investors look at these yields to compare with other investments. From a tax perspective, the discount yield gives the amount of interest you’ll report as income.

• Original Issue Discount (OID): The technical term for the amount by which a debt instrument’s price is lower than its face value at issuance. For T-bills, the entire interest is OID. OID rules in the tax code tell us how to recognize this discount as interest income. For long-term bonds, OID is accrued over time. For short-term (like T-bills), it’s generally taken at maturity or sale (unless you elect otherwise). The OID is the reason a sold-before-maturity T-bill can have its gain treated as interest.

• Interest Income (Ordinary Income): Money received as interest (including T-bill OID interest) is taxed as ordinary income by the IRS. It’s included in your taxable income and taxed at your marginal rate. There’s no special rate for interest (unlike capital gains or qualified dividends). It’s also included in calculations for things like NIIT, phaseouts of deductions/credits, etc. Ordinary income means it’s part of your regular tax base.

• Form 1099-INT / 1099-OID: These are IRS information forms provided to investors who receive interest. Form 1099-INT reports interest income, including Treasury interest (often noted as such). Form 1099-OID reports accrued original issue discount on certain bonds. For short-term Treasuries, brokers usually use 1099-INT, but if you had a weird situation like selling one, you might see something on 1099-OID. Always cross-check your 1099s to make sure Treasury interest is correctly identified, so you can claim your state tax exclusion.

• TreasuryDirect: An online platform from the U.S. Treasury where individuals can buy Treasuries directly. If you use TreasuryDirect to buy 3-month bills, you’ll still get taxed the same way. TreasuryDirect will provide an annual statement of interest (you can retrieve a 1099-INT from them online). Taxes are not automatically withheld or anything on TreasuryDirect either. So, TreasuryDirect or brokerage – doesn’t change tax rules, just possibly how you get the tax info.

• Tax-Exempt Interest: Interest that is exempt from federal income tax (like muni bond interest). T-bill interest is not federal tax-exempt, but it is state tax-exempt. We sometimes call it “double exempt” if something is free from both, but T-bills are only single-exempt (state/local). When doing taxes, don’t confuse Treasury interest with “tax-exempt interest” – the latter term usually refers to muni bond interest, which you still have to report (for informational purposes) on your 1040 but not pay federal tax on. Treasury interest you do pay federal tax on.

• Taxable Equivalent Yield: A concept to compare a tax-free yield to a taxable yield. For instance, to Dave in Example 4, a 5% tax-free yield was worth ~5.77% taxable. Formula: Tax-free yield / (1 – tax rate) = taxable equivalent. In context of Treasuries, you often compute the state-taxable-equivalent yield for comparison to bank CDs or corporate bonds. If your state tax is s%, and a Treasury yields t%, the equivalent taxable yield = t% / (1 – s%). If you have local tax, include that too. For fully taxable vs state-free, this helps evaluate choices.

• Net Investment Income Tax (NIIT): A 3.8% federal surtax on investment income (including interest, dividends, capital gains, etc.) for high-income individuals (above $200k single or $250k married filing jointly). T-bill interest does count as net investment income. That means if your income is high enough to trigger NIIT, you’ll pay an extra 3.8% on that interest. (This is in addition to regular income tax, effectively making top rate 40.8% as noted.) There’s no special carve-out for Treasury interest here.

• Estimated Taxes: Quarterly tax payments some taxpayers make to cover income that has no withholding (like interest, self-employment income, etc.). If you have a substantial amount of T-bill interest, you might need to adjust your estimated tax payments to avoid underpayment penalties. For example, if you invest in T-bills heavily and earn $10,000 of interest in a year, that’s $10k with no withholding – you might owe a few thousand in tax on it. Pay as you go, or safe harbor, to avoid a penalty surprise.

• Intergovernmental Immunity: A constitutional principle that the federal and state governments can’t tax each other’s essential functions. In tax terms, it historically meant federal bond interest was immune from state tax, and state bond interest could be immune from federal tax (if Congress allowed it, which they do via IRC §103 for munis). It’s why we have this split where Treasuries are state-tax-free and munis are federal-tax-free. Court cases like McCulloch and South Carolina v. Baker have defined the boundaries. But for our purposes: Intergovernmental immunity = no state tax on U.S. obligations.

Understanding these terms will help you navigate not only 3-month T-bill taxation but also other financial instruments’ tax treatments as you diversify your portfolio.

Common Mistakes to Avoid with T-Bill Taxes

Even savvy investors can slip up when it comes to taxes. Here are some things to avoid when dealing with 3-month T-bills and taxes:

• Assuming T-Bill Interest is Tax-Free Everywhere: A frequent misconception is “Treasury = tax-free.” We must clarify: Treasury interest is not tax-free at the federal level. Don’t mistakenly omit T-bill interest from your federal taxable income – that’s an error and could invite IRS correspondence. The tax-free part only applies to state/local. Conversely, some folks mistakenly pay state tax on it; be sure to exclude it there.

• Forgetting to Exclude Treasury Interest on State Return: As discussed, you generally need to subtract U.S. obligation interest on your state tax form. If you forget, you’ll overpay state tax. This is easy to miss if you’re not aware – tax software usually handles it if you input 1099-INT details correctly. Double-check the state calculation: ensure that $X of Treasury interest isn’t being taxed by your state. The difference can be substantial in high-tax states. 💸

• Misreporting Sale vs. Interest: If you sell a T-bill before maturity, don’t just accept the 1099-B showing a “short-term gain” as pure capital gain. Remember that part (or all) of that gain is actually interest in the eyes of the IRS. The safe approach if uncertain: report the entire gain as interest income. Or dig into the accrued OID rules if you want to split it. But a mistake would be to report the gain only as a capital gain and not report any interest – that could underreport your ordinary income. While the tax rate might end up the same, the character matters for things like NIIT calculations and state tax (though state won’t tax either in this case, it might need the identification for exclusion). When in doubt, consult a tax advisor or IRS Pub 550 examples for sold T-bills.

• Neglecting Estimated Taxes: T-bill interest comes in lumps at maturity. If you have a large amount invested, say millions in T-bills, the interest could be tens of thousands. With no withholding on that interest, you may need to make quarterly estimated tax payments. A mistake is to wait until April and then owe a big amount with potential underpayment penalties. Avoid that by planning your estimated payments in line with your T-bill interest schedule or relying on safe harbor (paying at least last year’s total tax in estimates if that covers it). Essentially, treat T-bill interest like any other untaxed income for planning.

• Mixing Up Tax Treatments of Different Bonds: Don’t confuse Treasuries with municipals or corporate bonds. For example, some people buy a mutual fund and see “tax-exempt interest dividends” and get confused with their Treasury fund dividends. Remember: Treasury interest = federally taxable, muni interest = federally tax-free (usually). Also, U.S. Agency bonds (from Fannie Mae, Freddie Mac, etc.) often are subject to state tax (they are not Treasuries), so don’t lump those in. The mistake would be to assume all “government” bonds have the same tax treatment. They don’t – it’s specific to U.S. Treasury obligations for state exemption. So be careful in categorizing your 1099-INT entries.

• Over-concentration in Taxable Treasuries without considering tax-deferred options: If you have room in an IRA or 401k, it might be wiser to hold interest-producing assets there to defer/avoid taxes. It’s not a mistake per se to hold T-bills in taxable accounts (especially since they do have the state tax break), but if you’re seeking to optimize taxes, consider asset location. A common oversight is keeping a lot of cash in taxable T-bills while your IRA holds stocks – depending on your strategy, flipping that (bonds in IRA, stocks in taxable if you can get qualified dividends/long-term gains) can yield tax benefits. So, plan holistically.

• Ignoring Form 1099-OID or Statements: If you buy Treasuries via TreasuryDirect or some brokers, they might issue a statement for interest. Don’t ignore any tax document from the Treasury or broker. Sometimes a TreasuryDirect statement might not look like a 1099-INT, but it provides the interest info. Ensure you include all interest earned, even if under $10 (technically even $1 interest is taxable, though payers only required to 1099-int for $10+). Not reporting interest just because you didn’t get a form could be a mistake – the IRS receives copies of these forms too and matches them.

Avoiding these pitfalls will ensure you reap the intended benefits of 3-month T-bills (simplicity, safety, state-tax-free income) without running into avoidable tax issues. When in doubt, consult a tax professional especially if you have large holdings or unusual transactions with your T-bills.

Pros and Cons of Investing in 3-Month T-Bills (Tax Perspective)

Investing in 3-month Treasury bills comes with unique advantages and some drawbacks, especially when viewed through a tax lens. Here’s a summary of the pros and cons from a tax standpoint:

In summary, 3-month T-bills shine for investors in high-tax states due to the state tax exemption, and they offer simplicity and predictability in taxation. On the flip side, the federal tax bite is inevitable and at ordinary rates, which can be a downside compared to some other investment types. The frequent maturity can be both a pro (you can always adjust and you’re never locking in a tax liability too far ahead) and a con (constant small taxable events).

From a purely tax perspective, one might say: if your goal was to minimize taxes, 3-month T-bills are not as effective as tax-free bonds for federal purposes, but they are more attractive than fully taxable short-term investments. And unlike stocks, you won’t get preferential capital gain treatment, but you also won’t have the uncertainty of whether you’ll have a gain or loss (which has its own tax planning challenges).

Many investors accept the federal tax on T-bills as a reasonable trade-off for the safety and liquidity these instruments provide – especially considering no state tax sweetens the deal.

FAQs: Treasury Bills & Taxes

Below we answer some frequently asked questions about the tax treatment of 3-month Treasury bills (and T-bills in general). Each answer is brief, with a Yes or No where applicable:

Q: Are 3-month Treasury bills taxable at the federal level?
Yes. Interest earned on 3-month T-bills is fully taxable by the IRS as ordinary income. You must report it on your federal tax return for the year in which the T-bill matures or is sold.

Q: Do I have to pay state income tax on 3-month T-bill interest?
No. Interest from U.S. Treasury bills is exempt from state and local income taxes. You report it for federal purposes, but you will exclude it from taxable income on your state return.

Q: Are Treasury bills tax-free?
No (not fully). Treasury bills are not tax-free at the federal level – you owe federal tax on the interest. They are only tax-free at the state and local level, which reduces your overall tax burden slightly.

Q: How is interest from a 3-month T-bill reported to me?
Yes – via 1099-INT. You will typically receive a Form 1099-INT from your broker or TreasuryDirect reporting the interest income from T-bills if it’s $10 or more. Include that on your tax return.

Q: Do 3-month T-bills issue a 1099-INT or 1099-OID?
1099-INT mostly. In most cases, interest from short-term T-bills is reported on 1099-INT. A 1099-OID might be used in certain situations (like if a bill straddles year-end or was sold before maturity), but generally 1099-INT.

Q: Are 6-month and 1-year T-bills taxed differently than 3-month T-bills?
No. All Treasury bills, regardless of maturity, have the same tax treatment: taxable at federal level as interest, exempt from state and local tax. The only difference is timing (when the interest is received).

Q: If I reinvest the maturity proceeds into a new T-bill, can I defer the tax?
No. Reinvesting doesn’t defer taxation. When a T-bill matures, the interest earned is taxable in that year even if you immediately use those funds to buy another T-bill. Each T-bill’s interest is taxed upon maturity.

Q: Do I pay taxes on Treasury bills in an IRA or 401(k)?
No (not immediately). If T-bills are held in a tax-advantaged account like an IRA or 401(k), you don’t pay taxes on the interest at the time. The interest accumulates tax-deferred (or tax-free in a Roth), and taxes apply under the account’s rules (e.g., upon withdrawal from a traditional IRA).

Q: I’m a foreign investor – is my T-bill interest taxed by the US?
No (for most). Generally, U.S. Treasury interest paid to foreign investors qualifies as portfolio interest and is not subject to U.S. withholding tax. Nonresident investors typically can receive T-bill interest free of U.S. tax (though their home country might tax it).

Q: Does Treasury bill interest count towards the 3.8% Net Investment Income Tax (NIIT)?
Yes. Interest from T-bills is investment income. If your modified AGI is above the NIIT threshold, your T-bill interest will be included in the calculation and could incur the additional 3.8% tax.

Q: Where do I put Treasury bill interest on my 1040?
Interest income. Include it with your other taxable interest on Form 1040 (line for “Interest Income”). If your total interest (plus dividends) is over $1,500, you’ll also attach Schedule B, where you list sources (you can aggregate U.S. Treasury interest together).

Q: Are Treasury bills better than bank CDs from a tax perspective?
Yes (if you have state tax). Federally, both are taxed the same. But T-bill interest is state-tax-free, whereas bank CD interest is not. In a state with income tax, Treasuries provide a higher after-state-tax return compared to an equivalent-yield CD.

Q: Can I deduct any expenses or losses against T-bill interest?
No (not directly). There’s no special deduction related to T-bill interest. If you incur a loss selling a T-bill, that’s a capital loss that can offset other capital gains. But you cannot net that against interest income directly on the 1040 (interest is ordinary income, separate bucket from capital gains/losses).

Q: Do any states tax U.S. Treasury interest?
No. By federal law, no state can tax interest from U.S. Treasury bills, notes, or bonds. All 50 states and D.C. exempt Treasury interest from their income taxes (if they have an income tax at all).

Q: Will holding 3-month T-bills affect my tax bracket significantly?
It depends on amount. The interest will add to your taxable income. Small amounts likely won’t move you to a higher bracket. Large amounts could, since it’s ordinary income. Plan accordingly if investing a substantial sum, as it could push you into a higher marginal federal bracket or phaseouts.