U.S. savings bonds are a good and investment vehicle and they also have a tax advantage because the interest they earn is free from state and local taxation. There is also an interest exclusion for savings bonds proceeds used for college tuition. U.S. savings bonds are excellent investment choices to take advantage of tax-free interest where the bonds are used to pay for college tuition.
Savings Bonds for Higher Education
In order to take advantage of the savings bond for higher education, the bond must be issued to an individual at least 24 years old. This usually means that the bond will be issued to you, rather than to your child who will be attending college. It is allowable to own the bond jointly with your spouse, but not with another person (such as your child).
Furthermore, only Series EE and Series I U.S. savings bonds qualify because these are the bonds bought at a discount that accrue earnings over time.
Savings Bonds Interest Excluded from Taxes for Education Expenses
For the interest to be excludable from income taxes, the proceeds from the bond must be used for “qualified higher education costs” for any individual who is your dependent (or for you or your spouse). Costs which qualify are for tuition or fees at a college or graduate school. (Nursing schools and some vocational schools may also qualify.) Room and board costs do not qualify. See the IRS publication for details on the exact requirements for which expenses the excludable savings bond interest income may be used on.
The IRS also says that it’s OK to use savings bond money (and preserve the tax-free interest status) to contribute to a child’s Coverdell education savings account, formerly called an education IRA, or to a qualified state tuition program.
However, ff the bond proceeds exceed the qualified educational expenses, only a proportionate share of the bond interest will be excluded from a taxpayers income.For example, if a qualifying bond is redeemed and $10,000 in proceeds are received: $2,000 of interest and $8,000 of principal. Of the $10,000 in proceeds, $9,000 (that is, 9/10) are spent on qualified higher education costs. In this situation, 9/10 of the interest, or $1,800, is the excludable amount. The rest of the interest ($200) is taxable as income.
Interest Exclusion Phase Out
Another important rule is that the benefit of the interest exclusion is “phased out,” i.e., taken away, if your adjusted gross income (AGI) in the year the bonds are redeemed is above a set amount. To compute your AGI for this purpose, you must include the interest.
If a married couple filing jointly has AGI of more than $113,950 for 2014, a portion of the exclusion benefit is lost. If their AGI is $143,950 or more, the exclusion is not available and all of the interest is taxable. These amounts are adjusted yearly to reflect current inflation. For unmarried taxpayers, the phase-out of benefits starts at $76,000 of AGI for 2014 and continues until there are no benefits for AGI of $91,000.
IRS Form to Exclude Bond Income
This break is not available to taxpayers who use Form 1040EZ. You must file Form 1040A or Form 1040 and, if married, file a joint return. In addition, 1040A filers will have to complete Schedule 1; 1040 taxpayers must file Schedule B. In either case, you’ll also have to fill out Form 8815 and attach it to your return.