Redeem Savings Bonds for Education  (continued)

What is modified adjusted gross income (AGI)?

Modified AGI is composed of adjusted gross income (AGI) without taking into account the savings bond interest exclusion. The interest exclusion of the savings bond and phaseout, if any, is computed on IRS Form 8815 – Exclusion of Interest From Series EE US savings bonds and Series I US savings bonds.

Married filing separate taxpayers do not qualify for the interest exclusion of US savings bonds.

The 2005 and 2004 modified adjusted gross income (AGI) thresholds are:

As long as the redemption proceeds (principal and interest) do not exceed the qualified higher education expenses incurred during that year, all of the redeemed interest is tax exempt if otherwise qualifying.

If the redemption amount exceeds expenses paid, a pro rata calculation is performed to determine what portion of the interest will be taxable.

Example:
Assume that Series EE US savings bonds are redeemed for $9,000 ($6,000 principal and $3,000 interest) and the qualified higher education expenses paid are $7,500.

The taxpayer would be eligible to exclude $2,500 of interest ($3,000 x ($7,500 / $9,000)). $500 of the interest is taxable.

The taxpayer is responsible for all interest record keeping and the filing of IRS Form 8815 to calculate the exclusion.