Interest payments and increases in the principal of Treasury Inflation-Protected Securities (TIPS) are subject to federal taxation, but are exempt from state and local income taxes.
- The sum of the semiannual interest payments paid in a given year is shown on Form 1099-INT.
- The amount by which the principal of your TIPS rose or decreased due to inflation or deflation is shown on Form 1099-OID. Even if your TIPS hasn’t matured and you haven’t received a payment of principle, increases in principal are taxable in the year they occur.
Is it wise to invest in inflation-protected securities?
I Bonds are financial instruments that have very specific regulations, attributes, and predicted yields and returns. Understanding these should assist investors in making better investing decisions, so I though a quick, more mathematical explanation might be helpful.
Current inflation rates, which are equivalent to 7.12 percent, forecast inflation rates, and the length of the holding term can all be used to estimate expected returns on I Bonds. Let’s begin with a simple example.
I Bonds are presently yielding 7.12%. Because interest is paid semi-annually, if you buy an I Bond today, you will receive 3.56 percent interest in six months. The following is the scenario:
If inflation stays at 7.12% throughout the year, these bonds should keep their 7.12% yield and you should get another 3.56 percent interest rate payment in the second half of the year. When you add the two interest rate payments together, you receive 7.12 percent for the entire year, which is exactly what you’d expect. The following is the scenario:
If you cash out the bond after three months, you will be charged a 1.78 percent interest rate penalty. When I subtract the penalty from the above-mentioned interest, I get a year-end estimated return of 5.34 percent.
The inflation rate for the second half of the year is the sole real variable in the above equation. For the first half, inflation and interest rates have already been set at 7.12 percent and 3.56 percent, respectively. The penalty is determined by the interest rate paid in the second half of the year, which is, in turn, determined by inflation. As a result, we can condense all of the preceding tables and calculations into the following simple table.
The technique can likewise be extended to various forward inflation rates. The following are the details.
Returns are higher when inflation is higher, as can be seen in the graph above. If inflation is low, returns are still reasonable because investors can lock in a 3.56 percent interest rate payment if they buy now, regardless of how inflation evolves. Investors would receive 4.06 percent in interest payments in 2022 if inflation falls to 2.0 percent, which is the Federal Reserve’s long-term goal.
If forecast inflation rates remain constant throughout time, the table above can be extended to span different holding periods. Although this is not a realistic assumption given the volatility of inflation rates, I believe the study will be useful to readers. The following are the more detailed results.
When inflation is low, the best gains come from buying bonds, receiving the guaranteed 3.56 percent interest rate, and selling them quickly. If inflation falls, there’s no benefit in owning an inflation-protected bond.
When inflation is high, the best profits come from keeping bonds for a long time, allowing you to receive as many (high) interest rate payments as possible while minimizing or eliminating the penalty for holding for a short time. When inflation is strong, there’s little value in selling an inflation-protected bond.
Importantly, investors have the option of deciding how long they want to hold these bonds, thus the most rational course of action is obvious: hold the bonds until inflation falls, then sell. This, of course, is quite reasonable. When inflation is high, inflation-protected securities are profitable; when inflation is low, they are not. As a result, when inflation is high, as it is now, it makes sense to acquire inflation-protected securities and then sell when inflation falls. It’s a common-sense approach, and the math adds up.
How do inflation-protected Treasury bonds work?
TIPS (Treasury Inflation-Protected Securities) give inflation protection. As assessed by the Consumer Price Index, the principal of a TIPS increases with inflation and falls with deflation. When a TIPS matures, the adjusted principal or the original principal, whichever is greater, is paid to you.
TIPS pay a fixed rate of interest twice a year. Because the rate is applied to the adjusted principal, interest payments grow with inflation and fall with deflation, just like the principal.
TreasuryDirect is where you may get TIPS from us. TIPS can also be purchased through a bank or broker. (In Legacy TreasuryDirect, which is being phased out, we no longer sell TIPS.)
How can I avoid tip taxes?
Service charges should not be included in your daily tip record.
- The remuneration should neither be a bargaining chip or determined by company policy; and,
Why are tips subject to taxation?
If you’ve recently started working in the food service industry, you may be wondering if tips are taxable. The short answer is that the IRS considers tips to be taxable income. If you receive tips, you must pay income, Social Security, and Medicare taxes on the money you receive.
How are tips taxed?
Your employer is required by the IRS to deduct enough money from your wages to meet income, Social Security, and Medicare taxes on both your hourly salary and tips. However, you are accountable for informing your employer about your tips.
Even if you receive tips directly from customers in cash, the amount withheld from your paycheck is based on the whole of your earnings plus the tip revenue you report. It’s critical that you keep a daily record of the tips you earn so that you can report the total to your boss every month.
Why are tips taxable and what is a taxable tip?
Because tips are considered income, they are taxed. Some tips are liable to payroll taxes and Social Security, while others are not. The following are examples of tips that must be recorded and taxed:
- You receive tips from other employees through tip pools, tip splits, or other tip-sharing arrangements.
Tips that don’t need to be reported
You are not required to report tips to your employer if you do not get at least $20 in tips during the month. However, while preparing your income tax return, you must include these tips in taxable income. Apply the $20 limit to each employment if you have more than one.
Non-cash tips, such as tickets or other valued things, are also exempt from reporting requirements.
Pooled or shared tips you pay to others
If you share some of your reportable tips with other employees, you can lessen the number of tips you have to report. If you get a $125 tip and pay the busser and bartender each $35, you just have to disclose $90 in tips.
Do I need to report “auto-gratuities” or surcharges?
Service costs or large party charges may be added to a customer’s bill by some employers. Because the consumer did not choose who to pay or how much to pay, the IRS does not consider these to be tips. As a result, you are not required to submit these expenditures to your employer as tips. Because the amounts you earn from those charges will be included in your paycheck, you will already be paying income, Social Security, and Medicare taxes on that income.
What work-related expenses can food service workers deduct from their taxes?
Unreimbursed employee costs are no longer eligible for a tax deduction on your federal tax return starting in 2018, unless you itemize. However, if you qualify, several jurisdictions continue to offer a deduction on your state tax return.
If you itemize your deductions rather than taking the standard deduction, you may be able to deduct unreimbursed expenses that exceed 2% of your adjusted gross income. In order to deduct these expenses, you must have receipts:
- Work uniforms, if they’re required for your job and you can’t wear them on a regular basis
Employees, not independent contractors, make up the majority of food service workers. In general, if the payer directs what work is done and how it is done, the worker is considered an employee rather than an independent contractor.
How do I report tips to the IRS?
By the 10th of the next month, the IRS requires you to submit your total monthly tips to your employer. If your employer does not have a system in place for reporting tip revenue, any employee who has received tips can use Form 4070 to do so. However, if your report includes all of the following, you don’t need to utilize that form:
Your company will report your information to the IRS and deduct money from your paycheck to cover tip withholding.
What if I have unreported tip income?
When it comes to paying your taxes, you may have undeclared tip money in some circumstances. For example, if you got noncash tips from customers or had months when your tips were less than $20. You’ll need to fill out Form 4137 to report these amounts. On the form, you’ll find instructions for calculating the Social Security and Medicare taxes you’ll owe on unreported tip money.
What are the potential penalties for failing to report tips accurately?
If you don’t declare your tips to your employer, the IRS can charge you a penalty equivalent to half of the Social Security and Medicare taxes you didn’t pay. Your W-2 will also reflect how much tax you owe if you didn’t earn enough in earnings and tips that your employer pays to you directly to satisfy your tax withholding. You must pay anticipated tax penalties after you file your tax return if the amount you underpay is considerable.
Do you have any experience with municipal bonds?
Residents of the issuing state are generally excluded from federal and state taxes on income earned from municipal bonds. While interest income is tax-free, any capital gains delivered to the investor are taxable.
Is Treasury bill interest taxable?
Interest earned on Treasury bills, notes, and bonds is taxed at the federal level, but is free from all state and local income taxes.
Are municipal bonds exempt from taxes?
Municipal bonds (sometimes referred to as “munis”) are fixed-income investments that offer better after-tax returns than comparable taxable corporate or government issues. Interest paid on municipal bonds is generally excluded from federal taxes and, in some cases, state and local taxes as well.
Is it a good time to buy Ibonds right now?
- If you bought bonds in 2021 and wanted to buy more but hit the annual limit, now is a good time to acquire I bonds.
- If you want to “get the greatest deal,” you should keep an eye on the CPI-U inflation indicator.
- The difference between the March figure (released in April) and the September number of 274.310 determines the following I bond rate. The February number is 283.716 as of March 10, 2022. If there is no further inflation, the rate will be 6.86 percent from May to November 2022.
- You may wish to buy your next I bonds in April or wait until May, depending on the CPI number announced in April.
- However, there’s a strong chance you’d rather buy I bonds by April 28, 2022 or earlier to take advantage of the 7.12 percent rate on new purchases through April 2022.
An I bond is a U.S. Government Savings Bond with a fixed interest rate plus an inflation adjuster, resulting in a real rate of return that is inflation-adjusted. The I bond is an excellent place to seek for savers in a world where inflation is a concern and there are few inflation-adjusted assets.
- If you cash out between the end of year one and the end of year five, you will be penalized by losing the previous three months’ interest.
- You can only purchase $10,000 per year per individual, and you must do it through TreasuryDirect.gov.
Read on for additional information on I Bonds and why April might be a good time to buy them.
Many of the investors we speak with had never heard of US Series I Savings Bonds (I Bonds), but were recently made aware of them due to the eye-popping yields they began giving in 2021.
When the 6-month ‘inflation rate’ of 1.77 percent was published in May 2021 (which is 3.54 percent annually! ), coverage began in earnest.
I Bonds: The Safe High Return Trade Hiding in Plain Sight & Investors Flock to ‘I Savings Bonds’ for Inflation Protection WSJ: I Bonds the Safe High Return Trade Hiding in Plain Sight & Investors Flock to ‘I Savings Bonds’ for Inflation Protection
You’ll be earning twice as much for half of the year when the US government reveals the 6-month inflation rate. The I bonds are priced in semi-annual 6-month terms, although most interest rates are quoted in annual terms. Simply double the 6-month inflation rate to determine the annualized rate and compare it to other rates.
Your $100 investment in April 2021 I bonds will be worth $103.56 in about 6 months. This equates to a 7.12% annualized rate.
You’ll get a new six-month rate after six months, and your money will increase at that pace.
You must hold I bonds for a period of 12 months, and you have no idea what the next 6 months will bring in terms of interest, but what could go wrong?
In the worst-case scenario, you earn 7.12 percent interest for the first six months after purchasing your I bond, then 0 percent thereafter. 6 months later, your $100 would be worth $103.56, and 12 months later, it would still be worth $103.56. If the rate in a year’s time isn’t what you want, you can cash out your I bond in a year’s time, forfeit the three months’ interest (which would be 0% or more), and still have $103.56. (or more).
Since the inception of I bonds in September 1998, there have been 48 declared inflation rate changes, with only two being negative!
Even if inflation is negative, the interest rate on I bonds will never go below 0.0 percent!
Consider how much you can commit to a 12-month interest rate that pays more than 3.5 percent when you open your bank statement and require a microscope to discover the pennies of interest you’re getting. I bonds are dubbed “America’s Best Kept Investing Secret” by Zvi Bodie. Let’s battle the current low interest rates by purchasing some I Bonds and informing everyone we know about this fantastic offer. Go to TreasuryDirect.gov to purchase your I Bonds.
- Jeremy Keil writes, “October 2021 Will Probably Be the Best Month Ever in History to Buy I Bonds.”