No tax break for savings bond

Dear Dr. Don,
We give our grandchildren Series EE savings bonds and have them issued in their parent’s name with the grandchild as the co-owner. At redemption, is there a tax consequence for the parent if the bonds are not used for education as intended?
— Student Savings

Dear Savings,
Your approach to buying the grandchildren savings bonds doesn’t qualify for the education tax exclusion because the grandchildren are named as co-owners on the savings bonds.

The following comes from the Treasury publication “Questions and Answers about Series EE/I – Education and Savings Bonds“:

What about registering the bond in the parent and child’s name as co-owners?
For purposes of eligibility for the 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.

The children’s parents may be able to reregister the bonds so that the children are no longer the co-owners. From the Q&A publication:

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 Bond Program, 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 PD F 4000 to get the bonds reissued. The purchaser needs to complete and sign the form. The signature on the form needs to be guaranteed or certified by an authorized certifying officer (available at bank, trust company, or credit union). The completed form, along with the bonds, should be mailed to the Treasury Retail Securities Site (TRSS) that handles savings bond transactions for your region.

If the proceeds from the redeemed bonds that qualify for the educational tax exclusion aren’t used for qualified education expenses, the education tax exclusion doesn’t apply. In such cases, the owners will owe federal income taxes on the interest earnings. State and local income taxes don’t apply to the interest earnings on savings bonds. The bond owners also have to satisfy certain income limits specified by law.

Note: Thanks to Joe Hurley, Bankrate’s College Money Guru, for his help in framing this reply.

Bankrate’s content, including the guidance of its advice-and-expert columns and this Web site, is intended only to assist you with financial decisions. The content is broad in scope and does not consider your personal financial situation. Bankrate recommends that you seek the advice of advisers who are fully aware of your individual circumstances before making any final decisions or implementing any financial strategy. Please remember that your use of this Web site is governed by Bankrate’s Terms of Use.

Read more Dr. Don columns for additional personal finance advice. To ask a question of Dr. Don, go to the “Ask the Experts” page, and select one of these topics: “Financing a home,” “Saving & Investing” or “Money.”