Educational Savings Bonds

Do you own a Series EE U.S. Savings Bond that was purchased after 1989 and you were at least 24 years old when you purchased it?  If so, the interest increment of the Bond that would normally be taxable at the Bond's maturity may be excluded from your Gross Income (it is never taxed) if the Bond proceeds (both principal and interest) are used to pay tuition expenses.  Tuition expense means essentially the same here as it did under the Educational Credit analysis:  tuition and fees paid to an accredited educational institution for the taxpayer, the taxpayer's spouse, and/or dependents.  As we saw with the Educational Credits, to prevent you from doubling up on tax benefits, you can't count as qualified tuition those expenses funded through the tax-free sources noted on page 99.  If the total amount of the Bond proceeds exceeds the qualified tuition expense not all of the interest increment will be excluded.

Example:  Mark cashes in a qualified savings bond to fund his son, Bryan's, tuition expenses.  The redemption proceeds were $6,000 (a tax-free return of principal (original cost) of $4,000 and interest of $2,000).  Bryan's qualifying tuition expenses were $5,000.  Since the total redemption proceeds exceed the qualified tuition expenses, only $1,667 of the interest increment is excludable from Mark's Gross Income ($5,000 divided by $6,000 times $2,000).

If all of the Bond proceeds are expended for tuition and fees, the entire interest increment that would normally be taxable is excluded from income.  The exclusion is computed on Form 8815 (available on my Web site under the Tax Planning section).

Your ability to take advantage of this income exclusion is phased out as your Adjusted Gross Income (see pages 9-10) goes up.  For married taxpayers filing jointly in 2004, the exclusion begins being phased out once AGI hits about $89,750 and is entirely phased out by the time AGI reaches about $119,750 (the phase-out range for single taxpayers is approximately $59,850 to $74,850 of AGI).  These phase out ranges are indexed for inflation, so they go up a little every year.  Again, remember that to the extent the Savings Bond interest is excludable from your income, you cannot use that tax-excluded income to pay tuition expense that you are also counting toward an Educational Credit (see page 98).

For more information on Educational Savings Bonds, go to my Web site, click on Educational Savings and then Educational Savings Bonds.