The tax is on the interest, not on what your parents paid for the bond. You can check with any bank about what it costs to buy a $5000 bond; you know what you got, the difference is interest. I think the cost is $2500 but you can check that. In January you will get a statement, a 1099, showing this interest--that's how the IRS keeps track of these things. The interest goes on schedule B of your tax return, and effectively increases your annual taxable income. Incidentally you don't have to pay state tax on a federal obligation and perhaps that helps a little. Best wishes, Chris
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