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Savings Bond Interest Earnings

I understand that there are now tax incentives associated with Savings Bonds that are used to pay for some costs of a college education. What can you tell me about this?

Under some circumstances, the interest on savings bonds purchased after December 31, 1989, may be completely or partially excluded for tax purposes if the bonds are cashed during a year when tuition and fees at a qualified post-secondary educational institution are paid for the bond owner, the owner's spouse, or a dependent. For full details on this offering, you should review a copy of IRS Publication 550, Investment Income and Expenses, and IRS Form 8815, Exclusion of Interest from Series EE U.S. Savings Bonds issued after 1989.

In order to be eligible for the income tax exclusion, bonds must be registered in the name of a person who is 24 years of age or older on the first day of the month in which the bonds are issued. Any other individual can be listed on the bonds as a beneficiary, but only a spouse can be a co-owner if the bonds are to qualify for the exclusion. The bonds must be redeemed in the same calendar year that tuition and fees are paid. The tax exclusion can be claimed for the interest on bonds whose redemption value equals or exceeds the total cost of tuition and fees. If the value of the bonds redeemed exceeds the amount spent, only a proportional amount of the interest income may be excluded from Federal income tax.

In the year of redemption, a bond owner's modified adjusted gross income must meet certain income limits. You should verify the current income limits in the IRS Publications for the current tax year. Married couples must file jointly. Modified adjusted gross income includes the accumulated interest on bonds redeemed during the year before the exclusion.

What are the other ways to receive tax advantages while saving for a child?

Individuals with modified adjusted gross incomes that are likely to exceed the limits of the interest exclusion program can still receive tax advantages when saving for a child's future education. It also offers all individuals a way to save for any future need a child might have. To secure this tax advantage:

  • Buy bonds in the child's name alone, or with a parent, relative or any other person as beneficiary (not co-owner).
  • After the first year in which bond purchases have been made (or later), parents may choose to file a Federal income tax return in the child's name (the child will need to have a Social Security number) reporting the entire accumulated accrued interest on all bonds registered to the child. Show on the return that it is being filed with the intent of reporting savings bonds interest annually. Save a copy of the return. In some cases, tax deferral may be more advantageous than this annual reporting method. If bonds are cashed after a child reaches 14 years of age, all deferred interest income will be taxable to the child.
  • Under the annual reporting method, no tax will be due until the child has unearned income (interest and dividends) of $600 or more in a single year, and no further returns need to be filed until that annual level has been reached.
  • Under the annual reporting method, you will need to file an income tax return for any year in which the child's unearned income exceeds $600. For children under the age of 14, taxes will be paid at the parent's rate if the unearned income exceeds $1,200. Once a child has reached 14 years of age, all taxes will be paid at the child's rate.
  • When the bonds are redeemed, only the most recent year's accrual will have to be reported for tax purposes if the annual reporting method was used. In most cases, little or no tax will have been due over the life of the bonds. It is essential to keep good records.
Last Updated: 12/5/2010 9:37 AM