Are Treasury Bonds Taxable in California? Exemption Rules and Exceptions

Are Treasury bonds taxable in California? No — the interest is exempt from California state income tax. That exemption covers T-Bills, T-Notes, T-Bonds, TIPS, and U.S. savings bonds. What California can tax is a capital gain if you sell a Treasury before maturity for more than you paid, and that gain is taxed at ordinary income rates reaching 13.3% for top earners.

Where the Exemption Comes From

Federal law, not state policy, controls this. Under 31 U.S.C. § 3124, stocks and obligations of the United States are exempt from taxation by any state or political subdivision.¹ California’s own regulations confirm that interest on bonds and other obligations of the United States is exempt from state taxation.² No state can override that.

Interest Is Exempt, Capital Gains Are Not

Hold a Treasury to maturity and everything you earn is interest. California takes none of it. Sell it early at a profit and that profit is a capital gain, which California taxes as ordinary income with no preferential rate.³ The federal statute itself sends the tax treatment of gains and losses on these obligations back to the Internal Revenue Code.¹

For a high-bracket California resident, the gap matters. A capital gain from an early sale is hit with the full state rate, which climbs to 13.3% including the 1% mental health services surcharge on taxable income above $1 million. Holding the same security to maturity would have produced entirely state-tax-free income.

T-Bills and Original Issue Discount

T-Bills do not pay coupons. You buy at a discount and receive face value at maturity. That built-in discount is original issue discount, which the IRS reports as interest income on Form 1099-INT.⁴ California’s regulations treat that original discount as interest when the bond is redeemed at face value.² Buy a $10,000 T-Bill for $9,800, hold to maturity, and the $200 is exempt. Sell that same bill on the secondary market above your cost and the profit is a taxable capital gain.

TIPS and Savings Bonds

Treasury Inflation-Protected Securities adjust their principal with inflation. Both the semiannual coupons and the inflation adjustments to principal count as interest on a U.S. government obligation, so both are exempt from California income tax.⁵ Federal tax applies to the inflation adjustment each year even before you receive the cash, but California does not add to that burden.

Series EE and Series I savings bond interest is also exempt from California tax.

Treasury Mutual Funds and ETFs

Owning Treasuries through a fund does not automatically make the income state-exempt. California requires the fund to hold at least 50% of its assets in U.S. government obligations or California state and municipal obligations before any portion of its dividends can pass through to you tax-free at the state level.⁶

If the fund clears the 50% threshold, only the portion of dividends attributable to U.S. government obligations is exempt. Each year the fund company issues a tax supplement showing that percentage, which you multiply by your total ordinary dividends from the fund to get the exempt amount. The percentage changes year to year, so check the current statement rather than reusing last year’s number.

If the fund falls below 50%, none of its dividends qualify for the California subtraction, even the share genuinely tied to Treasury interest. A broad bond fund that mixes Treasuries with corporate or mortgage-backed bonds can easily land on the wrong side of that line. A dedicated Treasury fund almost always clears it.

How to Claim the Exemption on Your California Return

Your broker reports Treasury interest in Box 3 of Form 1099-INT, separate from other interest in Box 1.⁷ That Box 3 amount gets rolled into total taxable interest on federal Form 1040, line 2b. To remove it from your California income, enter it on Schedule CA (540), Part I, Section A, Line 2, Column B (Subtractions).⁸

Column B on Line 2 is where interest from U.S. savings bonds, Treasury bills, notes, bonds, and other direct obligations of the United States belongs.⁸ The subtraction reduces your California adjusted gross income. Capital gains from selling Treasuries early are reported separately and get no subtraction.

Miss the subtraction and California keeps the overpayment. The FTB will not flag the error and refund you. To recover, you’d file an amended return, and California generally allows refund claims within four years of the original filing deadline.

Not Every Government Bond Qualifies

Readers sometimes assume anything with a federal label is state-tax-free. It isn’t.

California municipal bonds work in reverse of Treasuries: interest from bonds issued by the State of California or its local governments is generally exempt from California tax but federally taxable. Bonds from other states and their municipalities are fully taxable by California.⁶

Federal agency bonds are the real trap. California does not treat Fannie Mae, Freddie Mac, or Ginnie Mae as U.S. obligations, so interest from their bonds is fully taxable by the state.⁶ Other agencies, including Federal Home Loan Banks and Federal Farm Credit Banks, carry a state tax exemption under their own enabling statutes. If you’re buying agency debt for tax efficiency, verify the specific issuer rather than assuming agency bonds behave uniformly.

1
Office of the Law Revision Counsel. 31 USC 3124 Exemption From Taxation
2
Legal Information Institute. California Code of Regulations Title 18 Section 24271(e) – Interest
3
Franchise Tax Board. Capital Gains and Losses
4
Internal Revenue Service. Publication 1212, Guide to Original Issue Discount (OID)
5
Internal Revenue Service. Topic No. 403, Interest Received
6
Franchise Tax Board. 2024 Supplemental Guidelines to California Adjustments
7
Internal Revenue Service. Form 1099-INT
8
Franchise Tax Board. 2025 Instructions for Schedule CA (540) California Adjustments