What is deferred interest on Series H Savings Bond?

I inherited two Series H Bonds back in 1995; one for $5,000 and one for $10,000. I am considering cashing in the $10,000 H bond. I am currently getting an interest payment twice a year. What is this 'interest deferred' on the front of the bond? What does it mean? I guess my real question is - since I inherited this, I don't know if taxes have been paid on it or not. If I cash this, will that basically be adding $10,000 to my W-2 income earned, or is it only on the interest earned? I've been getting the 1099 tax form and been reporting the interest received for some time now, but I guess I'm unclear what ramifications will ensue if I cash this now.

Tom's Response

If you cash the $10,000 H bond, you'll receive $10,000 in cash and a 1099-INT for the amount of deferred interest shown on the front of the bond.

Here's the background - the person you inherited the H bond from once had Series E or EE Savings Bonds. The interest earned on these was added to the value of the bond and the income tax on the interest was deferred. At some point the Series E/EE bond was converted to a Series H bond.

This conversion allowed the tax deferrment on the interest earned up to that point to continue, but from then on the interest was paid in cash semiannually. When you inherited the bond, you not only got the value of the bond, you also got the obligation to pay the income tax on the embedded interest that had never been paid.

This page on federal income tax brackets will help you decide how much to hold back for taxes if you decide to cash the bond.