How are Treasury bills taxed?

A T-bill pays no coupon. You buy below face value and receive the full face value at maturity, and the difference is your return.

Despite looking like a price gain, that difference is treated as interest income, not as a capital gain. It therefore gets no preferential rate and is taxed as ordinary income federally.

It is taxed in the year the bill matures. A bill bought in November maturing in February is taxed in the second year, not the first, which is a simple and legitimate way to shift income across a year end.

Interest on all Treasury securities is exempt from state and local income tax. That is a statutory feature of federal obligations, not a choice your state makes.

In a state with no income tax the exemption is worth nothing. In a high-tax state it is worth a meaningful slice of yield, and it can flip which instrument is genuinely better.

A T-bill and a bank CD paying identical headline rates are not equivalent for someone paying state income tax, and the CD is the worse of the two.

The comparison that works is after-tax yield. Take the T-bill yield and compare it to the CD yield reduced by your state tax rate.

A T-bill at 4.20% and a CD at 4.35% look close, but for someone paying 6% state tax the CD is worth about 4.09% after state tax, so the T-bill wins.

This arithmetic is why Treasury money market funds are frequently a better home for cash than a savings account paying a similar headline rate.

Hold to maturity and the whole return is interest. Sell earlier and the treatment splits.

The portion of the discount accrued while you held it is interest. Anything above that, arising because rates moved in your favour, is a capital gain, short-term if you held a year or less, which is the usual case for bills.

Selling below your accrued value produces a capital loss, which offsets gains normally.

Treasury notes and bonds pay a coupon twice a year, taxable federally as interest in the year received and exempt from state tax in the same way.

TIPS add a wrinkle: the inflation adjustment to principal is taxable each year even though you receive no cash for it until maturity. That phantom income is why TIPS are often held inside retirement accounts.

Series I savings bonds share the state exemption and additionally allow federal tax to be deferred until redemption.

A money market fund holding Treasury securities passes the state exemption through on the portion of income derived from them, and publishes that percentage each year.

The percentage matters. A fund holding a mix of Treasuries and repurchase agreements may pass through far less than its name suggests, and some states impose a minimum threshold before allowing any exemption at all.

Fund providers publish the figure in January, usually as a supplementary tax document rather than on the 1099 itself.

Because the interest is ordinary income federally, T-bills held in a taxable account give up part of their yield to federal tax each year.

But their state exemption only works in a taxable account, and it is worthless inside an IRA where no state tax would apply anyway.

So for someone in a high-tax state, T-bills are one of the few fixed income holdings with a genuine argument for sitting in the taxable account rather than the sheltered one.

Capital gain and loss treatment is in IRS Publication 550. Treasury security tax treatment is described by TreasuryDirect. Walnut is informational and is not an investment adviser. This guide is educational and not personalized tax or investment advice; anything with a tax consequence is worth confirming with a tax professional.