TAX TIP No. 66
'Educated' use of savings bonds earns tax break
U.S. savings bonds
have always been a popular way to stash cash without
a lot of risk. They also have a tax advantage: The interest
they earn is free from state and local taxation.
|In this tax tip:
||Only certain bonds allowed
||Qualified institutions and expense
||Phasing out the tax break
||Paperwork and other filing requirements
Some taxpayers can get that same tax-free interest benefit
on their federal returns. This is the case when the savings bonds are cashed to
pay higher-educational expenses.
There are, of course, rules on what types
of schools and expenditures are acceptable, as well as extra Internal Revenue
Service paperwork to complete. And if you cash in a large amount of bonds or make
a lot of money, you won't get the full benefit of this tax break.
But the effort could help lessen Uncle Sam's tax bite on the savings bond earnings you
put to educational use.
Only certain bonds allowed
First, you must redeem the appropriate savings
bonds to get the break: either Series EE or Series I bonds issued after Dec. 31,
The bonds must be issued in your name, or, if you are
married, they may be issued in your name and your spouse's name. It does not matter
who bought the bonds.
In either case, the bond owner (or owners)
must have been at least age 24 when the bonds were issued.
A bond bought by a parent, but put in the name of a
child younger than 24, will not qualify for the exclusion.
Also be careful when determining the instrument's
issue date. This is not the date the bond was purchased. A bond could have been
bought after its issue date, which is printed on the front of the document.
Qualified institutions and expenses
You can use the bond money to pay schooling
costs for yourself, your spouse or a dependent. But the expenses and the school
to which they are paid must be "qualified" in the IRS's eyes to maintain
the bond's tax-free interest status.
As with most education-related
tax matters, the IRS accepts authorized payments to a college, university, vocational
school or other post-secondary establishment that meets student-aid program guidelines
administered by the U.S. Department of Education. This includes public, private
and nonprofit institutions.
Qualified higher-education expenses
paid by bond proceeds generally are limited to tuition and fees that are required
for enrollment or attendance at the school. Room and board are not allowable expenses,
nor are primarily recreational fees. This means you cannot count charges for courses
involving sports, games or hobbies.
The IRS says 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. Check with your state's particular tuition
savings plan for its limits.
Updated: April 8, 2009