Tax-Deferred, Inflation-Resistant

Tax Tip Tuesday

Public opinion polls indicate that consumers view inflation as the top problem facing the United States and that the general public is inflation averse. 

But what if inflation had an attractive money-making and tax-saving component to it? 

But they say, “the difference between a problem and an opportunity is what you make of it”.  With that being the case, let’s consider a tax-deferred and inflation-resistant investment strategy – Series I Bonds.

I bonds are a type of investment issued by the U.S. Treasury to protect your money from losing value due to inflation. With inflation at four-decade highs, investors are ever more interested in higher-yielding, lower-risk investments, and I bonds fit the bill. 

The initial interest rate on new Series I savings bonds is 9.62 percent. You can buy I bonds at that rate through October 2022.  Interest rates on I bonds are adjusted regularly to keep pace with rising prices.

You must own the bond for at least five years to receive all the interest that is due. You cannot cash out an I bond before holding it for a year; if you do so after that point (but before five years), you forfeit three months of interest.

There are several tax benefits of owning Series I savings bonds, which makes them an even better low-risk investment for investors who live in high-tax states and cities, such as:

•  The interest is tax-deferred until the bond is redeemed or the bond stops earning interest after 30 years (whichever is later),

• An election to claim the interest accrued each year is available, which may be ideal for children or lower-income taxpayers,

• The interest is exempt from state income tax, and

• An individual can exclude the interest income from tax if the bond proceeds are used for qualified higher education expenses under §135.

In periods of high inflation, the Series I bond is a significant potential investment to preserve capital. Of course, because of the possible high interest rates, the federal government restricts how many I bonds U.S. citizens and residents can purchase each year.

An individual can only buy up to $15,000 in I bonds directly in one year:

• $10,000 electronically via TreasuryDirect, and

• $5,000 paper via a federal tax refund.

There are two ways to buy I bonds beyond the $15,000 amount: use of business entities and use of trusts.

For business entities, they can buy up to $10,000 in I bonds per calendar year. If an individual owns multiple business entities, each separate business entity can buy up to $10,000 per calendar year in its different account.

A business entity can be a corporation, partnership, LLC, PLLC, or sole proprietor. That means that even if you’re self-employed and file taxes on an IRS Schedule C as a small business, you can purchase up to $10,000 I bonds annually for that business.

This purchasing power also applies to living trusts, through which people can purchase an additional $10,000 in I bonds per year. The trickiest part is the name of the trust account. If your revocable living trust is created by a trust agreement, they want the registration to include both the trustee(s) and the grantor(s). If it’s created by a declaration of trust, they want only the trustees.

So, a married couple, each of whom own a business and have living trusts, could buy up to $60,000 in I bonds annually

Investors can purchase federal government securities directly from the U.S. Treasury via TreasuryDirect, an online platform.  New issues of U.S. Treasury bills, notes, bonds, savings bonds, and TIPS are all available from TreasuryDirect.

Generally, I bonds make sense as part of one’s emergency fund which should be fully liquid, in cash, ready to deploy. But, if you have additional funds beyond what you need in cash, it makes sense to put some of that money in I bonds to outrun inflation with low risk.

If you like the idea of making money and deferring taxes, contact us at www.saunderstax.com or at 301-714-2071.  Our passion is helping you experience a Less Taxing Life and More Prosperous Solutions. 

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