United States Notes (also known as Legal Tender Notes because of their payment obligation stating "This Note is a Legal Tender") are characterized by a red seal and serial number. They were among the first national currency of the United States, authorized by the Legal Tender Act of 1862 and began circulating during the American Civil War. They immediately followed the Demand Notes of 1861, and also the Interest Bearing Notes at the time, which were an offshoot of government bonds that were allowed to circulate. They preceded the National Bank Notes and Gold Certificates of 1865.
United States Notes were printed in the following denominations: $1.00, $2.00, $5.00, $10.00, $20.00, $50.00, $100.00, $500.00, $1000.00, $5000.00 and $10,000.00.
The Treasury Department issued these Legal Tender Notes directly into circulation, and they are obligations of the United States Government. The issuance of United States Notes is subject to limitations established by Congress. In order to stimulate the economy, the Acts of July 10th, 1862 and March 3rd, 1863 (among other things) established a statutory limitation of $300 million on the amount of United States Notes authorized to be outstanding and in circulation. This currency was not backed by any deposit in any bank or government reserve, in contrast to the gold certificates at the time. They also did not bear interest, unlike the appropriately titled Interest Bearing Notes of 1861 to 1865. While $300 million was a significant figure in Civil War days, it is now a very small fraction of the total currency in circulation in the United States.
Both United States Notes and Federal Reserve notes are parts of the national currency of the United States and both are legal tender. They circulate as money in the same way. However, the issuing authority for them comes from different statutes. United States Notes were fiat currency, in that they were never redeemable explicitly for any precious metal. However, while the United States was on the gold standard, it was possible to redeem them for gold by first exchanging them for a currency of a different obligation, for example a gold certificate. Whoever accepted the exchange was left with the less-trusted fiat currency. While nowadays we tend to accept currency on faith without question, at the time it was a serious issue, as the government sought to strike a balance between coin shortages and fiat currency.
After the abandonment of the gold standard in 1933, all types of issued currency (silver certificates, federal reserve notes, and United States notes) were redeemable only for silver. This ceased to be the case in 1963, when all U.S. currency became fiat currency. At this point, the United States notes became obsolete, and no more were issued after around 1966. In order to meet the requirement of $300 million in "circulation", a series of $100 bills was printed in 1966, and comically moved from one Federal Reserve Bank to another every few weeks. These $100 notes command a healthy premium in new condition.
The act was repealed in 1970, and none have been placed in to circulation since January 21, 1971. As is the case with all issue of the U.S. from 1861 onward, any United States note still in circulation is legal tender at its face value, and may have a premium to collectors.
The Federal Reserve Act of 1913 authorized the production and circulation of Federal Reserve notes. Although the Bureau of Engraving and Printing (BEP) prints these notes, they move into circulation through the Federal Reserve System. They are obligations of both the Federal Reserve System and the United States Government. On Federal Reserve notes, the seals and serial numbers appear in green.
Source: U.S. Treasury Dept. (http://www.ustreas.gov/education/faq/currency/legal-tender.html#q3)