1) ABOUT THE EDUCATION TAX EXCLUSION

2) WHO'S ELIGIBLE?

3) DOLLAR LIMITS

4) BUYING BONDS FOR THE EDUCATION TAX EXCLUSION

5) CLAIMING THE EDUCATION TAX EXCLUSION

Return to Top

2.1) Can anyone purchase these bonds and take advantage of the tax exclusion?

No, to exclude interest earnings on Series EE and I Bonds issued after 1989, a taxpayer must be at least 24 years old before the bonds' issue date. Since a bond's issue date is the first day of the month in which the taxpayer purchases the bond, the taxpayer must be 24 years old before the first day of the month in which the bond is purchased. Also, if the taxpayer is married, the taxpayer must file a joint return in order to exclude the bond interest from income.

2.2) Can anyone take advantage of the interest exclusion by purchasing bonds as gifts?

No, the purpose of this program is to benefit the taxpayer(s) paying for qualified educational expenses of the taxpayer, taxpayer's spouse, or taxpayer's dependent within the meaning of section 151 of the Internal Revenue Code. To exclude the bond interest from gross income, the bond must be in the name of the taxpayer, or in the name of the taxpayer and the taxpayer's spouse, and not in the name of the dependent. The designation of the dependent as beneficiary is permitted.

2.3) What about registering the bond in the parent and child's name as co-owners?

For purposes of eligibility for the tax exclusion only, the designation of a child as co-owner with his or her parent isn't permitted. Bonds must be in the name of the taxpayer, with or without a beneficiary, or in the name of the taxpayer and the taxpayer's spouse as co-owners to exclude the bond interest from the taxpayer's gross income.

2.4) Can a child be named as beneficiary on a bond for which the interest exclusion will be taken?

Yes. Any person may be named as beneficiary without affecting the eligibility of the bond for tax exclusion. A child may not be a co-owner of such a bond.

2.5) Does the education tax exclusion affect savings bonds that have been or are being purchased by a parent registered in the name of a child alone, or the child's name with the parent as beneficiary?

No, the Federal income tax rule that applies to such bonds remains the same. For a child under 14, only the interest and dividend income in excess of $1,500 is taxed at the parent's rate in 1999. (This figure is indexed for inflation annually.) If the child is 14 or older, all income is taxed at the child's rate. You may choose between annual or deferred reporting, taking into account your child's age and expected future earnings. However, interest earnings on such bonds don't qualify for the education savings bond tax exclusion.

2.6) I may not qualify for the education tax exclusion. Are there any other options?

Yes, there is another way to use savings bonds to pay for your children's education expenses. Interest income on bonds purchased in a child's name alone or with a parent as beneficiary (not co-owner), can be included in the child's income each year as it accrues or deferred until the bonds are redeemed. In either case, the child will be subject to any Federal income tax on the interest.

The parent may file a Federal income tax return in the child's name (the child will need to have a Social Security Number) reporting the total accrued interest on all bonds registered to the child. The intention to report savings bond interest annually, i.e., on an accrual basis, must be noted on the return. The decision to report accrued interest income annually currently applies to all future years, and can be changed only by filing IRS Form 3115 with the IRS and fulfilling other requirements outlined in IRS Publication 550, "Investment Income and Expenses."

No tax will be due unless the child has total income in a single year equal to the threshold amount that requires a return to be filed, and no further returns need to be filed until that annual income level has been reached. For children under the age of 14, unearned income (including dividends and interest), over a specified threshold amount for that age group will be taxed at the parent's rate. If the child is age 14 or older, income will be taxed at the child's rate.

With this approach, the tax liability on the bond interest is determined on an annual basis so that when the bonds are redeemed, only the current year's accrual will be subject to Federal income tax. Make sure you keep complete records when using this system.

For more information on this approach, see IRS Publication 929, "Tax Rules for Children and Dependents."

3.1) Do both the principal and interest from bonds redeemed during the year have to be used for qualified educational expenses to exclude the bond interest from gross income?

Yes, only if the taxpayer pays qualified education expenses equal to or greater than all proceeds (i.e., interest and principal) from bonds redeemed during the year can all interest accrued on such bonds be excludable from his or her gross income.

3.2) What if the amount of the bond redemption proceeds exceeds the amount of the qualified educational expenses?

If the amount of the redemption proceeds from all eligible bonds redeemed during the year exceeds the amount of the qualified educational expenses paid during such year, the amount of excludable interest will be reduced pro rata. For example, if the bond proceeds amounted to $10,000 ($5,000 principal and $5,000 interest) and the qualified educational expenses are $8,000, the taxpayer would only be able to get an exclusion for 80 percent ($8,000/$10,000) of the interest earned, or $4,000.

3.3) Are there income limitations?

Yes, in 2003, the full interest exclusion is available for married couples filing joint returns with modified adjusted gross incomes of up to and including $87,750 and for single filers with modified adjusted gross incomes of up to and including $58,500. These are the limits currently in effect for 2003.

In 2004, the full interest exclusion is available for married couples filing joint returns with modified adjusted gross incomes of up to and including $89,750 and for single filers with modified adjusted gross incomes of up to and including $59,850.

3.4) What is modified adjusted gross income?

For purposes of this program, modified adjusted gross income (AGI) means the sum of the taxpayer's adjusted gross income for the taxable year, including interest on U.S. Savings Bonds before exclusion, but taking into account the partial exclusion of social security and tier 1 railroad retirement benefits, adjustments for contributions of retirement savings, and adjustments for limitations on passive activity losses and credits. It also includes the gross income earned by citizens or residents of the U.S. living abroad and income from sources within Guam, American Samoa, the Northern Mariana Islands, and Puerto Rico.

3.5) What benefits, if any, are there for taxpayers who file jointly with modified adjusted gross incomes above $87,750 (or $58,500 for single filers) in 2003 and $89,750 (or $59,850 for single filers)in 2004?

For 2004, the interest exclusion benefits will phase out for joint filers with an AGI of between $89,750 and $119,750 ($59,850 and $74,850 for single filers) by a decreasing percentage above the threshold income level. For example, a taxpayer filing jointly with an AGI of $104,750 would only be able to take advantage of one-half of the exclusion, while a taxpayer filing jointly with a modified AGI of $113,750 would only be allowed an exclusion of 20 percent of the eligible interest income. A similar phase-out applies to single filers. Note: Married individuals filing separately will not be able to take advantage of the program regardless of their incomes.

For 2003, the interest exclusion benefits will phase out for joint filers with an AGI of between $87,750 and $117,750 ($58,500 and $73,500 for single filers) by a decreasing percentage above the threshold income level. For example, a taxpayer filing jointly with an AGI of $102,750 would only be able to take advantage of one-half of the exclusion, while a taxpayer filing jointly with a modified AGI of $111,750 would only be allowed an exclusion of 20 percent of the eligible interest income. A similar phase-out applies to single filers. Note: Married individuals filing separately will not be able to take advantage of the program regardless of their incomes.

3.6) Are these income limits adjusted for inflation?

Yes, these income limits are indexed for inflation and then rounded to the nearest multiple of $50.

Return to Top

4.1) How do I buy a savings bond to take advantage of the education tax exclusion?

Since the program utilizes Series EE and I Bonds, there are no differences in purchase procedures except (1) Series EE bonds must have been purchased after December 31, 1989, (2) they must be registered in the taxpayer's name alone, with or without a beneficiary, or in the name of the taxpayer and spouse (not a dependent child) as co-owners, and (3) the taxpayer must be at least 24 years old before the issue date of the bond. Otherwise, the bonds may be purchased like other Series EE or I Bonds.

4.2) Where can I buy Series EE and I Bonds?

Savings bonds can be purchased through more than 40,000 financial institutions nationwide or through employers offering the Payroll Savings Plan. Participants enrolled in Payroll Savings Plans who intend to use the redemption proceeds of Series EE or I Bonds issued after December 31, 1989, for eligible educational expenses should review the form of registration being used to ensure it meets the requirements of the law.

4.3) Are there limitations on the denomination of the bonds used?

No, any Series EE or I Bond denomination, from $50 to $10,000, is eligible for the education tax exclusion as long as other criteria for the program are met.

4.4) Is there a limitation on the number or amount of Series EE and/or I Bonds one can buy?

Yes, the standard annual purchase limit of $30,000 face value ($60,000 for a husband and wife holding bonds as co-owners) in Series EE bonds and $30,000 face value in Series I bonds applies to the education tax exclusion. There's no limit to the amount of bonds that can be accumulated for educational expenses over time-- as long as the amount of bonds purchased and held during a single year doesn’t exceed the limitations discussed above and all other requirements of the program are met.

4.5) I just realized that the bonds for our children's education are in the wrong names--theirs, not ours. As I understand it, this would not qualify for the tax exemption. Can I change the names?

Yes, as long as the funds used to buy the bonds didn’t belong to your children and the bonds are dated January 1990 or later. If I Bonds or Series EE bonds purchased January 1990 or later were bought to qualify for the education tax exclusion, but were improperly registered when they were issued, the bonds may be reissued to qualify for the program. The purchaser would need to complete a form get the bonds reissued. Form PD F 4000 is used to request reissue of Series EE bonds. Form PD F 5387 is used to request reissue of Series I bonds.

The purchaser needs to complete and sign the appropriate form. The signature on the form needs to be guaranteed or certified by an authorized certifying officer (available at a bank, trust company, or credit union). The completed form, along with the bonds, should be mailed to the Federal Reserve Bank that handles savings bond transactions for your region.

Return to Top

5.1) What are the redemption procedures for holders of qualified bonds?

There are no changes in the redemption procedures for paying agents. It's the bond owner's responsibility to maintain a record of bond redemption transactions to support claims for exclusion from gross income in the year that qualified bonds are redeemed and qualifying educational expenses are incurred.

However, if an owner redeeming Series EE and/or I Bonds issued after 1989 states his or her intention to exclude interest from gross income in accordance with the education exclusion, and is at the same time redeeming Series EE bonds issued prior to January 1, 1990, the paying agent should provide separate redemption values and accrued interest subtotals for bonds issued prior to January 1, 1990, and for those issued on or after January 1, 1990. If the bond owner hasn't made a record of the serial numbers, face amounts, and issue dates, the agent should advise the customer to do so before redeeming the bonds. An optional IRS Form 8818 provides instructions and space to record this information.

5.2) How does one exclude the interest income on the tax form?

IRS Form 8815 includes the necessary worksheet and instructions to taxpayers for use in connection with tax returns.

5.3) Will the educational institution be required to verify the educational expenses of the taxpayer, taxpayer's spouse, or the taxpayer's dependent?

Generally no. However, the taxpayer should retain receipts or canceled checks for educational expenses as part of the taxpayer's record to substantiate his or her claim to an exclusion from income of the bonds cashed.

5.4) Can one exchange Series E or EE bonds issued before January 1, 1990, for new Series EE bonds or I Bonds to make them eligible?

No, outstanding savings bonds can't be exchanged for Series EE or I Bonds.

5.5) What happens if bonds dated before January 1, 1990, are redeemed and new bonds are bought with the proceeds?

Accrued interest earnings on the bonds redeemed are taxable to the owner in the year of the redemption regardless of whether the proceeds are used to purchase new Series EE or I Bonds.

For detailed information about the rules as well as information on the income eligibility, check IRS Publication 550, Investment Income and Expenses; Form 8815, Exclusion of Interest From Series EE U.S. Savings Bonds Issued After 1989; and IRS Form 8818, Optional Form to Record Redemption of College Savings Bonds. For current recorded rate information, call 1-800-4US-BOND (1-800-487-2663).