What follows is a true story. A story with a sad ending. But one that has a lesson for everyone. Stick with the story, as there's a high degree of certainty you probably know someone in this exact situation.
The tax ticker is set
Joe purchased Series E saving bonds each year in the 1970s. With half down and promise of double value upon maturity, Joe amassed a nice $140,000 retirement fund. After 20 years the bonds matured. Joe did not yet need the money, so he converted them to Series H savings bonds. This effectively deferred the interest income on the Series E bonds since the bonds were not cashed.
With the new Series H savings bonds, Joe paid federal income tax each year on the interest earned. Meanwhile the taxable interest from the series E bonds continued to be deferred.
The result? Joe thought he was paying tax on the interest each year…BUT there was a sleeping tax bill on interest income of $70,000 just waiting until Joe cashed in his series H bonds!
The tax bill explodes
Joe received word that his series H bonds would no longer pay interest. So he tells his grandson to go to a bank and cash in the bonds. Why have bonds that no longer pay interest? And…it’s no big tax deal because he has been paying tax on his Series H bond interest income each year. The grandson has financial power of attorney so he does as his grandfather asks.
Surprise! Joe receives a notice from the IRS saying he owes them $24,000, including penalties and interest!
Lessons for all of us
Never disregard 1099s or printed details. When the grandson cashed in the Series H bonds, if he looked closely on the face of the bonds, he may have noticed the deferred interest. But it would contradict what grandpa had told him. Further, his grandpa probably received a Form 1099 that was disregarded because he believed he was already reporting the interest as taxable income.
Old savings bonds can be confusing. There are many different issues and flavors of savings bonds. When you see any uncashed bonds, conduct the necessary research to understand your potential obligations. This is especially true for bonds past their maturity date.
Ask before you sell. Always understand the tax consequences BEFORE you selling any property, or executing any transaction for that matter. Even the most innocent of transactions can have their own tax time bomb. So call an expert before you buy or sell.
Tax planning matters. While Joe would always owe federal income tax when he cashed the bonds, he could have reduced his effective tax rate by cashing them in over time instead of all in one year. In this case, it exposed a lot of income to a much higher tax rate. He could have saved over $10,000 in taxes with a little planning!
Because neither the bank nor federal taxing authorities believe it their duty to help you make knowledgeable tax decisions, you are on your own. This one-way street of knowledge makes having an expert on your side more important than ever!