When you're planning for your child's education, you don't want to make risky investments. Savings bonds are one of the safest ways that you can invest money for a child's education. Typically, you must pay taxes on the interest your savings bonds earn, but if you're using them for your child's college expenses, you may be able to get the money tax-free. Several factors come into play.
Qualified Educational Expenses
To qualify for tax-free status, your child must be attending school at an accredited college or university. If your child qualifies for federal student aid from the school, then you know it's accredited, but if you're not sure you can check with the U.S. Department of Education's database of accredited postsecondary institutions and programs. Tuition and fees for the school qualify for the exemption, as do any charges from courses or activities that are required for your child to graduate. However, housing, books, school supplies and food do not qualify.
Additionally, you must have been at least 24 years old when you purchased the bonds and meet income requirements. In 2010, for example, the tax exemption benefits start to phase out when you earn $70,100 as a single filer or $105,100 as a married couple filing jointly, and end completely when you earn more than $85,100 as a single person or $135,100 as a married couple. Current limits may vary. If you're married, you can only qualify for the exemption if you file jointly.
Determining the Tax-Free Amount
The amount of tax-free interest depends on how much of the total amount you received for the bond -- including principle and interest -- you use to pay for educational expenses. If you use the full amount, you can receive the full amount of the interest tax free. If, however, the amount of the principle plus interest is greater than the educational expenses, you will have to pay taxes on a portion of the interest. For example, if you received $8,000 in principle and $2,000 in interest ($10,000 total), but paid just $7,000 in qualified educational expenses (70 percent of the total amount you received), you would have to pay taxes on 30 percent of the interest earnings, or $600.
Claiming the Exemption
When you cash in the bonds, the bank will issue you a 1099-INT form and report the earnings to the IRS. You will have to report this as earnings on your tax form, but you can claim the exemption by also filing form 8815 and including the excluded amount on your Schedule B.
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