10.   Education Savings Bond Program

Introduction

Generally, you must pay tax on the interest earned on U.S. savings bonds. If you do not include the interest in income in the years it is earned, you must include it in your income in the year in which you cash in the bonds.

However, when you cash in certain savings bonds under an education savings bond program, you may be able to exclude the interest from income.

Who Can Cash In Bonds Tax Free

You may be able to cash in qualified U.S. savings bonds without having to include in your income some or all of the interest earned on the bonds if you meet the following conditions.

  • You pay qualified education expenses for yourself, your spouse, or a dependent for whom you claim an exemption on your return.

  • Your modified adjusted gross income (MAGI) is less than the amount specified for your filing status.

  • Your filing status is not married filing separately.

Qualified U.S. savings bonds.   A qualified U.S. savings bond is a series EE bond issued after 1989 or a series I bond. The bond must be issued either in your name (as the sole owner) or in the name of both you and your spouse (as co-owners).

  The owner must be at least 24 years old before the bond's issue date. The issue date is printed on the front of the savings bond.

  
The issue date is not necessarily the date of purchase—it will be the first day of the month in which the bond is purchased (or posted, if bought electronically).

Qualified education expenses.   These include the following items you pay for either yourself, your spouse, or a dependent for whom you claim an exemption.
  1. Tuition and fees required to enroll at or attend an eligible educational institution. Qualified education expenses do not include expenses for room and board or for courses involving sports, games, or hobbies that are not part of a degree or certificate granting program.

  2. Contributions to a qualified tuition program (QTP) (see How Much Can You Contribute in chapter 8, Qualified Tuition Program).

  3. Contributions to a Coverdell education savings account (ESA) (see Contributions in chapter 7, Coverdell Education Savings Account).

Adjusted qualified education expenses.   You must reduce your qualified education expenses by all of the following tax-free benefits.
  1. Tax-free part of scholarships and fellowships (see Tax-Free Scholarships and Fellowships in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions).

  2. Expenses used to figure the tax-free portion of distributions from a Coverdell ESA (see Qualified Education Expenses in chapter 7, Coverdell Education Savings Account).

  3. Expenses used to figure the tax-free portion of distributions from a QTP (see Qualified education expenses in chapter 8, Qualified Tuition Program).

  4. Any tax-free payments (other than gifts or inheritances) received as educational assistance, such as:

    1. Veterans' educational assistance benefits (see Veterans' Benefits in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions),

    2. Qualified tuition reductions (see Qualified Tuition Reduction in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), or

    3. Employer-provided educational assistance (see chapter 11, Employer-Provided Educational Assistance ).

  5. Any expenses used in figuring the American opportunity and lifetime learning credits. See What Expenses Qualify in chapter 2, American Opportunity Credit, and What Expenses Qualify in chapter 3, Lifetime Learning Credit, for more information.

Eligible educational institution.   An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible educational institution.

  Certain educational institutions located outside the United States also participate in the U.S. Department of Education's Federal Student Aid (FSA) programs.

Dependent for whom you claim an exemption.   You claim an exemption for a person if you list his or her name and other required information on Form 1040 (or Form 1040A), line 6c.

Modified adjusted gross income (MAGI).   For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return without taking into account this interest exclusion. However, as discussed below, there may be other modifications.

MAGI when using Form 1040A.   If you file Form 1040A, your MAGI is the AGI on line 22 of that form figured without taking into account any savings bond interest exclusion and modified by adding back any amount on line 18 (student loan interest deduction) and line 19 (tuition and fees deduction).

MAGI when using Form 1040.   If you file Form 1040, your MAGI is the AGI on line 38 of that form figured without taking into account any savings bond interest exclusion and modified by adding back any:
  1. Foreign earned income exclusion,

  2. Foreign housing exclusion,

  3. Foreign housing deduction,

  4. Exclusion of income by bona fide residents of American Samoa,

  5. Exclusion of income by bona fide residents of Puerto Rico,

  6. Exclusion for adoption benefits received under an employer's adoption assistance program,

  7. Deduction for student loan interest,

  8. Deduction for tuition and fees, and

  9. Deduction for domestic production activities.

   Use the worksheet in the instructions for line 9 of Form 8815 to figure your MAGI. If you claim any of the exclusion or deduction items (1)–(6) listed above, add the amount of the exclusion or deduction to the amount on line 5 of the worksheet. Do not add in the deduction for (7) student loan interest, and (8) tuition and fees, or (9) domestic production activities because line 4 of the worksheet already includes these amounts. Enter the total on Form 8815, line 9, as your modified adjusted gross income (MAGI).

  
Because the deduction for interest expenses attributable to royalties and other investments is limited to your net investment income, you cannot figure the deduction until you have figured this interest exclusion. Therefore, if you had interest expenses attributable to royalties and deductible on Schedule E (Form 1040), Supplemental Income and Loss, you must make a special computation of your deductible interest without regard to this exclusion to figure the net royalty income included in your MAGI. See Royalties included in MAGI under Education Savings Bond Program in Publication 550, chapter 1.

Figuring the Tax-Free Amount

If the total you receive when you cash in the bonds is not more than the adjusted qualified education expenses for the year, all of the interest on the bonds may be tax free. However, if the total you receive when you cash in the bonds is more than the adjusted expenses, only part of the interest may be tax free.

To determine the tax-free amount, multiply the interest part of the proceeds by a fraction. The numerator (top part) of the fraction is the adjusted qualified education expenses (AQEE) you paid during the year. The denominator (bottom part) of the fraction is the total proceeds you received during the year.

Example.

In February 2013, Mark and Joan Washington, a married couple, cashed a qualified series EE U.S. savings bond. They received proceeds of $9,000, representing principal of $6,000 and interest of $3,000. In 2013, they paid $7,650 of their daughter's college tuition. They are not claiming an American opportunity or lifetime learning credit for those expenses, and their daughter does not have any tax-free educational assistance. Their MAGI for 2013 was $80,000.

  $3,000 
interest
× $7,650 AQEE  
$9,000 proceeds
= $2,550 
tax-free 
interest
 

They can exclude $2,550 of interest in 2013. They must pay tax on the remaining $450 ($3,000 − $2,550) interest.

Effect of the Amount of Your Income on the Amount of Your Exclusion

The amount of your interest exclusion is gradually reduced (phased out) based on your MAGI and filing status.

Claiming the Exclusion

Use Form 8815 to figure your education savings bond interest exclusion. Enter your exclusion on line 3 of Schedule B (Form 1040A or 1040), Interest and Ordinary Dividends. Attach Form 8815 to your tax return.


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