33.4 United States Savings Bond Tuition Plans

Consider the use of Series EE bonds (30.14) or I bonds (30.15) to fund part of a college savings program. You can defer the interest income until final maturity (30 years) or report the interest annually. At redemption, the interest is not subject to state or local tax. For bonds purchased in your child’s name, having your child report the interest annually may be advisable where it can be offset by the child’s standard deduction or itemized deductions. To the extent interest is offset each year, it escapes tax (4.29).

Interest exclusion may be available if you redeem EE bonds issued in your own name after 1989 or I bonds.

If you purchased EE bonds (30.14) in your own name or jointly with your spouse after 1989 and have been deferring the reporting of interest income, you may be able to exclude accumulated interest from federal tax in the year you redeem the bonds if in that year you pay tuition and enrollment education fees or you contribute to a Coverdell ESA (33.11) or qualified tuition program (QTP, 33.5). The interest exclusion rule also applies to redemptions of I bonds (30.15). The exclusion, claimed on Form 8815, is subject to several limitations as discussed in the following paragraphs.

Who qualifies for the exclusion.

You must have been age 24 or over before the month in which the bonds were purchased, and the bonds must have been issued solely in your name or in the joint names of you and your spouse. You may not claim the exclusion for bonds bought in your child’s name or owned jointly with your child. In the year the bonds are redeemed you must pay tuition and enrollment fees or contribute to a Coverdell ESA or QTP for yourself, your spouse, or your dependents for whom you claim an exemption on your return. Thus, grandparents may not claim the exclusion if they buy savings bonds to fund the college education of grandchildren unless the children are dependents of the grandparents in the year the bonds are cashed. Married persons filing separately are not eligible for the exclusion.

Excludable amount and phaseout rule.

The tax-free amount of EE or I bond interest is figured on Form 8815. The amount of the exclusion depends on the amount of qualified higher educational expenses you pay in the year of the redemption for yourself, your spouse, or your dependents and your modified adjusted gross income (MAGI) in the year of redemption. However, no exclusion is allowed to a married person who files separately, regardless of income or amount of expenses. Qualified higher education expenses include only (1) tution and fees required for enrollment at a college, university, or vocational school that meets federal financial aid standards, and (2) contributions to a Coverdell. ESA or QTP. Room and board are not eligible expenses.

On Form 8815, qualified expenses must be reduced by the amount of any nontaxable scholarship or fellowship grant, tax-free employer-provided educational assistance, educational expenses taken into account when figuring the American Opportunity credit or Lifetime Learning credit (33.7), and educational expenses taken into account when figuring the tax-free portion of a distribution from a qualified tuition plan (33.6) or a Coverdell ESA (33.11).

If after the required reductions qualified expenses equal or exceed the redemption proceeds, 100% of the interest is potentially excludable, subject to the phaseout based on MAGI. If the redemption amount exceeds the amount of educational expenses (after any required reduction), the excludable amount is based on the ratio of expenses to the redemption amount and the phaseout computation.

A full interest exclusion is allowed only to persons with MAGI below a phaseout threshold. For 2012, the MAGI phaseout ranges are $109,250 to $139,250 for married persons filing jointly and qualifying widow(er)s, and $72,850 to $87,850 for single persons and heads of household. For purposes of applying the phaseout, MAGI is generally your regular adjusted gross income plus the interest on the redeemed EE or I bonds, student loan interest (33.14), or tuition and fees (33.13) that you deduct, and foreign income items and employer-provided adoption assistance that you excluded from income. See the Form 8815 instructions.