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Inheriting EE savings bonds

Dear Tax Talk,
In January 2005, my sister and I inherited roughly $20,000 (face value) in U.S. EE savings bonds from our dad. Most of the bonds were issued around 1990. We cashed the bonds in April 2005, for approximately $21,000, so they earned $11,000 in interest. Is there a step-up in the basis of the bonds to January 2005, or are we liable for all the interest? Thanks. -- Jack

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Dear Jack,
There could be a step-up if you follow my advice carefully. Series EE bonds are bought at a discount and mature at a higher value. This increase in value is considered interest. Most people usually don't pay tax on this interest until they cash in the bonds or the bonds mature.

When you inherit Series EE bonds, the interest is income to the beneficiary, if the person who is responsible for filing the decedent's final return does not elect to report the interest in that filing. If your father died in January 2005, he may not have had enough income to otherwise be required to file a final return.

However, if the election is made, you and your sister may save some taxes on the $11,000. The reason is that your father will still be entitled to claim his personal exemption and standard deduction in 2005, and that will go a long way toward covering the $11,000 in income. If your father was more than 65 at the time of his death, he's entitled to about $9,000 in deductions in 2005, and the remaining $2,000 in income is only subject to 10-percent tax. If you and your sister are in the 25-percent tax bracket, you would end up paying $2,750 in taxes on the $11,000 in interest.

The personal representative is the person responsible for filing your father's final return. If that's you or your sister, then I suggest you make the election on a final return for your father.

Otherwise, talk this matter over with the appointed representative. Publication 559 discusses the responsibilities of filing a final return and also making the election, beginning on page 10. There are also instructions on how to report the interest income on your individual returns if the election is made.

Bankrate.com's corrections policy
-- Posted: Sept. 29, 2005
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