dcsimg

PLANNING & GIVING

Education Planning

Education Tax Exclusion

The savings bond education tax exclusion permits qualified taxpayers to exclude from their gross income all or part of the interest paid upon the redemption of eligible Series EE and I Bonds issued after 1989, when the bond owner pays qualified higher education expenses at an eligible institution.

Additional Requirements to Qualify

  • Qualified higher education expenses must be incurred during the same tax year in which the bonds are redeemed.
  • You must be at least 24 years old on the first day of the month in which you bought the bond(s).
  • When using bonds for your child's education, the bonds must be registered in your name and/or your spouse's name. Your child can be listed as a beneficiary on the bond, but not as a co-owner.
  • When using bonds for your own education, the bonds must be registered in your name.
  • If you're married, you must file a joint return to qualify for the exclusion.
  • You must meet certain income requirements.
  • Your post-secondary institution must qualify for the program by being a college, university, or vocational school that meets the standards for federal assistance (such as guaranteed student loan programs).

Qualified Expenses

Qualified educational expenses include:

  • Tuition and fees (such as lab fees and other required course expenses).
  • Expenses that benefit you, your spouse, or a dependent for whom you claim an exemption.
  • Expenses paid for any course required as part of a degree or certificate-granting program.
  • Expenses paid for sports, games, or hobbies qualify only if part of a degree or certificate program.

Note: The costs of books or room and board are not qualified expenses.

The amount of qualified expenses is reduced by the amount of any scholarships, fellowships, employer-provided educational assistance, and other forms of tuition reduction.

You must use both the principal and interest from the bonds to pay qualified expenses to exclude the interest from your gross income. If the amount of eligible bonds you've cashed during the year exceeds the amount of qualified educational expenses paid during the year, the amount of excludable interest is reduced pro rata.

Example: Assuming bond proceeds equal $10,000 ($8,000 principal and $2,000 interest) and the qualified educational expenses are $8,000, you could exclude 80 percent of the interest earned, which would equal $1,600. (.8 x 2000 = $1,600)

Income Limitations

The full interest exclusion is only available to married couples filing joint returns and to single filers. Modified adjusted gross income includes the interest earned under a certain limit in each case. These income limits apply in the year you use bonds for educational purposes, not the year you buy the bonds. Exclusion benefits are phased out for joint or single filers with modified adjusted gross income that exceeds the limit. Full instructions and limits are outlined on IRS Form 8815.

Tax Year 2012 Income Limits

For single taxpayers, the tax exclusion begins to be reduced with a $72,850 modified adjusted gross income and is eliminated for adjusted gross incomes of $87,850 and above. For married taxpayers filing jointly, the tax exclusion begins to be reduced with a $109,250 modified adjusted gross income and is eliminated for adjusted gross incomes of $139,250 and above. Married couples must file jointly to be eligible for the exclusion.

Tax Year 2011 Income Limits

For single taxpayers, the tax exclusion begins to be reduced with a $71,100 modified adjusted gross income and is eliminated for adjusted gross incomes of $86,100 and above. For married taxpayers filing jointly, the tax exclusion begins to be reduced with a $106,650 modified adjusted gross income and is eliminated for adjusted gross incomes of $136,650 and above. Married couples must file jointly to be eligible for the exclusion.

Another Education Savings Option

Aside from the Education Tax Exclusion, 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 can be deferred until the bonds are redeemed. In either case, the child will be subject to any federal income tax on the interest.

Parents 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 applies to all future years, and can be changed only by filing IRS Form 3115 with the IRS. Full details of this option and its requirements are 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. Starting with tax year 2006, for children under the age of 18, unearned income over a specified threshold amount for that age group will be taxed at the parent's rate. If the child is age 18 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.

More Information

You can find more information about the education bond program in IRS Publications Online:

  • IRS Publication 17, "Your Federal Income Tax"
  • IRS Publication 550, "Investment Income and Expenses"
  • IRS Publication 970, "Tax Benefits for Education"
  • IRS Publication 929, "Tax Rules for Children and Dependents"