Savings bonds are great way to save on taxes, as long as you follow all the rules

If you own U.S. Savings Bonds, you might stick the certificates aside and not think about them at tax season, but you better pull them out and check if you need to report any income.

One of the biggest advantages about the interest earned by a savings bond is that it is not subject to any state or local tax. A second advantage is that a person can choose to defer reporting the interest earned for federal taxes until the bonds are redeemed. This is the most common way savings bond investors deal with the interest earned and that's fine, until you get to the bond's final maturity (the date that the bond stops earning interest).

Unfortunately, there is a rule that most savings bond investors don't know about: Once a savings bond reaches its final maturity, the interest accumulated over the entire life of the bond MUST be reported on that year's tax return. This rule, stated in IRS Publication 550, applies whether savings bond owners decide to cash-in or hold their bonds after final maturity.

If you didn't know this rule, you're not alone. Most investors are unaware of this rule and are unintentionally violating IRS statutes by not reporting the interest at the proper time. This violation is considered the same as under-reporting earned income on your federal income tax return and could become quite a problem if its not properly reported. It is estimated that there are millions of savings bond owners who are not aware of this rule and could be placing themselves in line for a red flag if the problem is caught by an IRS auditor.

How can you prevent yourself from being audited for not having properly reported your savings bond interest? Follow these steps: