Taxation of Treasury Bills: What You Need to Know
By Personal Finance DeskUpdated Nov 10, 2026
Key takeaways
- T-bill interest is federally taxable as ordinary income, at your marginal rate.
- It is exempt from state and local income tax.
- Interest is usually reported on Form 1099-INT and belongs on your federal return even if no form arrives.
- For most individuals, the interest is taxable in the year the bill matures or is sold, not the year you buy it.
- Funds, retirement accounts and foreign ownership change how the rules apply.
Treasury bills are not fully tax free. The interest you earn on a T-bill is subject to federal income tax at your ordinary rate, but it is exempt from state and local income tax. The exemption comes from federal law (31 U.S.C. § 3124), which bars states and localities from taxing interest on U.S. government obligations. That split is the main tax benefit of T-bills: they cost you nothing at the state level, which matters most when your state income tax rate is high.
How T-bill interest is taxed
T-bills are short-term debt of the U.S. government, sold in denominations from $100 up to $10 million, with maturities of one year or less (4, 6, 8, 13, 17, 26 and 52 weeks). They do not pay coupons. You buy a bill at a discount and receive the full face value at maturity. The difference is your interest.
Federal tax. The discount is taxed as interest income, not as a capital gain, so the lower long-term capital gains rates never apply. It is added to your other income and taxed at your marginal bracket. Higher earners may also owe the 3.8% net investment income tax, which covers interest.
State and local tax. You leave T-bill interest out of state taxable income. Many state returns have a specific subtraction line for U.S. government interest, so the interest included in federal income has to be backed out on the state form rather than simply omitted.
Timing. Individuals using the cash method, which covers nearly everyone, report the discount when the bill matures. A 26-week bill bought in October and redeemed the following April produces income in the later tax year. Rolling bills over does not defer the tax indefinitely: each maturity is a taxable event, even when the proceeds immediately buy a new bill.
Selling before maturity. If you sell a bill early, the share of your gain that reflects the discount earned while you held it is treated as ordinary interest income. Any gain or loss beyond that is a capital item, and because no bill is held longer than a year, it is short term. The short-term vs. long-term capital gains rules explain why that difference matters for other assets but rarely helps here.
Reporting and withholding
In January, the Treasury sends owners of bills held through TreasuryDirect a Form 1099-INT showing the prior year’s interest, and the same information goes to the IRS. Bills held at a brokerage are reported by the broker, usually on its consolidated 1099. Interest on Treasury obligations appears in Box 3 of Form 1099-INT, the box state tax software uses to apply the exemption.
You report the interest on Form 1040. If a 1099-INT is missing or late, the income is still taxable and still has to be reported.
To avoid a large bill at filing time, TreasuryDirect lets you elect federal withholding on your interest, up to 50%. The Treasury sends the withheld amount to the IRS and shows it on your 1099-INT. Otherwise, you can cover the tax through estimated payments or by adjusting your paycheck withholding on Form W-4.
Example: comparing a T-bill with a CD
Certificates of deposit, savings accounts and corporate bonds are taxed at both the federal and state levels. To compare them fairly with a T-bill, compare after-tax yields.
Hypothetical assumptions: a T-bill yielding 4.00%, a 24% federal marginal rate and a 9% state rate. For simplicity, state tax is not deducted against federal income.
| T-bill | CD | |
|---|---|---|
| Federal tax | 24% | 24% |
| State tax | 0% | 9% |
| Share of yield kept | 76% | 67% |
| After-tax yield | 3.04% | Depends on CD rate |
The T-bill keeps 4.00% × 0.76 = 3.04%. For the CD to match that, its yield must satisfy CD yield × 0.67 = 3.04%, so the break-even CD rate is 3.04% ÷ 0.67 ≈ 4.54%. In this example, a CD paying less than about 4.54% leaves you with less after tax than the 4.00% T-bill, even though its headline rate is higher.
The general formula is:
Break-even taxable yield = T-bill yield × (1 − federal rate) ÷ (1 − federal rate − state rate)
The advantage scales with your state rate. In states with high income taxes, such as California, New York, Oregon and Hawaii, the gap is large. In states with no income tax, such as Texas or Florida, the T-bill exemption is worth nothing, and you can compare headline yields directly.
Exceptions that change the answer
T-bill funds and ETFs
Owning bills through a mutual fund, money market fund or ETF turns the interest into fund dividends. Federally, these are taxed as ordinary dividends, not qualified dividends. At the state level, the exemption usually passes through only for the share of income that came from direct U.S. government obligations, and funds publish that percentage each year for tax filing. Some states, including California, Connecticut and New York, allow the exclusion only if the fund held at least 50% of its assets in U.S. obligations at the required times. Income from repurchase agreements backed by Treasuries generally does not qualify. Check a fund’s annual state tax information before assuming its yield is state exempt.
Retirement accounts
Inside a traditional IRA or 401(k), T-bill interest is not taxed when it is earned. Instead, withdrawals are taxed as ordinary income, including at the state level, so the state exemption is effectively lost. In a Roth account, qualified withdrawals are tax free altogether. For how withdrawals are taxed, see taxes on an IRA withdrawal.
Foreign investors
Nonresident aliens usually file Form W-8BEN with their broker. Original issue discount on obligations maturing in 183 days or less is generally exempt from U.S. withholding tax. Their home country may still tax the income.
Businesses
The exemption covers state and local income taxes on individuals. Some state franchise taxes on corporations measure tax by income in a way that can include federal interest, so businesses should confirm their state’s treatment.
FAQs
Is there a way to make T-bill interest completely tax free?
Only by holding the bills in a Roth account and meeting the rules for qualified withdrawals. In a taxable account, federal tax always applies. The education exclusion sometimes mentioned for Treasury securities applies to Series EE and I savings bonds, not to T-bills.
Do I owe state tax on T-bill interest if my broker's 1099 lumps it with other interest?
No. The exemption depends on what the income is, not on how it is presented. Brokers typically show Treasury interest separately or in Box 3, and you subtract it on your state return.
The Bottom Line
Investors in high income tax states such as California, New York, Oregon and Hawaii gain the most from T-bills, because the interest escapes state tax while staying federally taxable as ordinary income. Compare a T-bill with a CD on after-tax yield using the break-even formula, and check how a fund, retirement account or business ownership changes the state exemption before relying on it.
