A Treasury bill, or T-bill, is a short-term debt obligation of the United States government that pays no coupon and is sold instead at a discount to the face value it repays at maturity. Treasury bills, notes, and bonds are direct debts (obligations) of the U.S. government (IRS, Publication 550).
The difference between the discounted price paid for a bill and the face value received at maturity is interest income (IRS, Publication 550). That single classification decides most of what a preparer or a bookkeeper has to do with one, because it puts the whole return on the interest line rather than on Schedule D.
What the Treasury Actually Sells
The bill is defined by its term, not by its yield. Treasury sells bills for terms ranging from four weeks to 52 weeks, and the terms now offered are 4, 6, 8, 13, 17, 26, and 52 weeks (TreasuryDirect, Treasury Bills).
Bills are sold at a discount or at par, which is face value, and at maturity the holder is paid face value. A bill can be held to maturity or sold before it matures. The rate is fixed at auction, and for bills “interest” is the difference between what was paid and the face value received when the bill matures (TreasuryDirect, Treasury Bills).
The purchase mechanics are narrow and worth knowing before a client’s cash schedule is built around them. The minimum purchase is $100, in increments of $100. The maximum is $10 million on a noncompetitive bid, and 35% of the offering amount on a competitive bid. Bills are issued in electronic form only, and interest is paid when the bill matures (TreasuryDirect, Treasury Bills).
Auction frequency differs by term. The 52-week bill is auctioned every four weeks, and the 4, 6, 8, 13, 17, and 26-week bills are auctioned weekly (TreasuryDirect, Treasury Bills).
One instrument sits alongside bills without being one of the scheduled offerings. Treasury also sells Cash Management Bills at various times and for variable terms, they run on no regular auction schedule, and they are only available through a bank, broker, or dealer rather than through TreasuryDirect (TreasuryDirect, Treasury Bills).
The Return Is Interest, Not Gain
This is the point most often got wrong on a return, and it is stated plainly by the IRS rather than inferred.
Interest income from Treasury bills, notes, and bonds is subject to federal income tax. The holder should receive Form 1099-INT showing the interest, in box 3, paid for the year (IRS, Publication 550). Box 3 is the reporting home for the whole family, so a bill’s discount lands beside savings bond interest rather than beside sale proceeds. The broader mechanics of the line item are in interest income.
Timing follows the instrument’s own life. Generally, the interest income is reported when the bill is paid at maturity (IRS, Publication 550). Two qualifications sit on that word “generally”, and both matter in practice.
The first is the premium case. If a premium was paid for a bill, meaning more than face value, the premium is generally reported as a section 171 deduction when the bill is paid at maturity (IRS, Publication 550).
The second is rolling the position. If a Treasury bill is reinvested at maturity in a new Treasury bill, note, or bond, the holder receives payment for the difference between the proceeds of the maturing bill, meaning par amount less any tax withheld, and the purchase price of the new Treasury security. The full amount of the interest income on each bill must still be reported by the time that bill reaches maturity (IRS, Publication 550). A rollover moves the cash, it does not move the income.
When the Discount Has to Accrue Before Maturity
The report-at-maturity default is a default. For a short-term obligation, meaning one with a fixed maturity date of one year or less from the date of issue, other than a tax-exempt obligation, a holder generally can choose to include any discount and interest payable on the obligation in income currently (IRS, Publication 550). For some holders that choice is not available at all.
Discount or interest must be included in current income as it accrues for any short-term obligation, other than a tax-exempt obligation, that is held by an accrual-basis taxpayer, held primarily for sale to customers in the ordinary course of a trade or business, held by a bank, regulated investment company, or common trust fund, held by certain pass-through entities, identified as part of a hedging transaction, or a stripped bond or stripped coupon held by the person who stripped it, or by any other person whose basis is determined by reference to the basis in the hands of the person who stripped it (IRS, Publication 550).
That is a list, not a single test, and any one entry on it is enough. A firm carrying bills for a business client on the accrual basis is on the first line of it before any election is considered.
For an obligation in that list that is a short-term government obligation, the amount included in income for the current year is the accrued acquisition discount, if any, plus any other accrued interest payable on the obligation. The acquisition discount is the stated redemption price at maturity minus the holder’s basis (IRS, Publication 550). Basis is then increased by the amount of discount included in income currently (IRS, Publication 550).
The accrual itself uses either the ratable accrual method or the constant yield method (IRS, Publication 550). Where the constant yield method is chosen to figure accrued acquisition discount, the cost of acquiring the obligation is treated as the issue price, and that choice cannot be changed once made (IRS, Publication 550).
The State and Local Exemption Is Statutory
Interest income from Treasury bills, notes, and bonds is exempt from all state and local income taxes (IRS, Publication 550), and TreasuryDirect states the same result for bills as no state or local taxes (TreasuryDirect, Treasury Bills).
The rule behind that sentence is broader than income tax and it carries two exceptions. Stocks and obligations of the United States Government are exempt from taxation by a State or political subdivision of a State, and the exemption applies to each form of taxation that would require the obligation, the interest on the obligation, or both, to be considered in computing a tax, except a nondiscriminatory franchise tax or another nonproperty tax instead of a franchise tax, imposed on a corporation, and an estate or inheritance tax (31 U.S.C. 3124(a)).
Both exceptions have to travel with the rule. A corporate franchise tax computed on a base that includes federal obligations is not blocked by the exemption, and neither is a state estate or inheritance tax reaching a decedent’s bills.
The federal side of the answer is not decided by that subsection at all. For obligations issued by the Government or an agency, the tax status of the interest, and the tax treatment of gain and loss from the disposition of those obligations, is decided under the Internal Revenue Code of 1986 (31 U.S.C. 3124(b)).
Where a Bill Sits in the Financial Statements
Two separate classifications reach a T-bill, and they answer different questions.
The first is marketability, which is a transfer question. Marketable means the security can be transferred to someone else and can be sold before it matures, meaning before it reaches the end of its term, and Treasury offers five types of marketable security, Treasury Bills, Treasury Notes, Treasury Bonds, Treasury Inflation-Protected Securities and Floating Rate Notes (TreasuryDirect, About Treasury Marketable Securities). The accounting side of that label is worked through in marketable security.
The second is the cash equivalent test, which is a maturity question. For purposes of FASB Statement 95, cash equivalents are short-term, highly liquid investments that are both readily convertible to known amounts of cash and so near their maturity that they present insignificant risk of changes in value because of changes in interest rates, and generally only investments with original maturities of three months or less qualify under that definition (FAS 95, paragraph 8). Examples of items commonly considered to be cash equivalents are Treasury bills, commercial paper, money market funds, and federal funds sold, for an enterprise with banking operations (FAS 95, paragraph 9).
The two labels do not decide each other, and a 52-week bill shows why: it is marketable from the day it is issued, and its original maturity is well past three months. The wider classification is set out in cash equivalents, and the case of an instrument that never trades and still qualifies is in certificate of deposit accounting.
Common Questions
Not the discount. The difference between the discounted price paid and the face value received at maturity is interest income, and it is reported in box 3 of Form 1099-INT (IRS, Publication 550).
Selling before maturity does not convert it either, at least not up to a point. Where the holder did not choose to include the discount and interest in income currently, any gain on a sale, exchange, or redemption of the obligation must be treated as ordinary income, up to the amount of the ratable share of the discount (IRS, Publication 550).
Between four weeks and 52 weeks. The terms currently offered are 4, 6, 8, 13, 17, 26, and 52 weeks, and Cash Management Bills run for variable terms outside that schedule (TreasuryDirect, Treasury Bills).
No. Interest is paid when the bill matures, and the rate is fixed at auction (TreasuryDirect, Treasury Bills). There is no periodic coupon to accrue between payment dates, which is why the bookkeeping question is the discount rather than the accrued interest that a coupon instrument raises.
Yes for the interest. Interest income from Treasury bills is exempt from all state and local income taxes (IRS, Publication 550). The underlying exemption is wider than income tax and carries its own two exceptions, a nondiscriminatory franchise tax or another nonproperty tax instead of a franchise tax imposed on a corporation, and an estate or inheritance tax (31 U.S.C. 3124(a)).
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