I recently inherited a substantial EE bond from my grandmother who passed away in December of 2007. It was purchased in her name in 1996 and I am listed as POD beneficiary. The bond has fully matured and accrued some interest. How are these bonds taxed? Do I file (if so what form) or is it taxed in her estate, or both? Thank you for your answer.

You don't need to file a thing, until you cash in the bonds, at which point you will have to report the sale on your income tax. Until then they grow tax free. The executor of the estate takes care of all filings regarding estate taxes. However, when you do cash the bonds and report the interest n your income taxes there are two different ways that the tax basis for the bonds can be determined, depending on how the executor treats them in valuing your grandmother's estate. If your grandmother's estate is small enough to not owe any estate taxes (i.e. less than $2M total value), it would make sense for the executor to include the full value of the bonds including accrued interest through the date of death in the estate assets. That way the bonds pass to you at a basis equal to their accrued value, and going forward when you cash the bonds you will owe income tax only on the additional accrued interest after the date of death. The executor should provide you with a list showing how much each bond was valued in the estate so that ou know what the difference is.

However, if your grandmother's estate is large enough to owe estate taxes, then you are better off if the executor includes only the original purchase value of the bonds in the estate valuation, without any accrued interest. Under this arrangement the basis for the bonds is the original cash basis as paid by your grandmother - i.e. half the face value. This is pemissible because the bonds have grown with accrued interest tax-deferred, so they are treated differently than stocks or other bonds. In the future when you cash the bonds you would report as interest income the full difference between the original purchase price (paid by your grandmother) and what you get when you sell them. This is results in lower taxes overall because the estate is taxed at a 45% marginal rate, which is certainly higher than your marginal rate on income tax.

The exception to all this is if your grandmother elected to report the accrued interest each year on her income taxes - which is highly unlikely.

Agreed; ebaines explains it very well.