Taxes on US Savings Bonds (I Bonds and EE Bonds), In-Depth - YouTube

This video discusses how United States savings  bonds, both I bonds and EE bonds, are taxed,  

how the taxes are reported and calculated,  and how to minimize or eliminate those taxes. 

Bonds are not subject to  either state or local taxes. 

However, bonds may be subject to  federal taxes, but there are ways to  

minimize or even avoid federal taxes. The owner, who may not be the buyer,  

reports the interest and pays the tax. Taxes can be reported annually or deferred. 

However, the chosen method must  apply to all savings bonds you own,  

including savings bonds you buy later. If you defer the tax, then taxes will  

be due when the bond is redeemed or matures. Co-owners must pay any taxes on bond interest  

that is proportional to the amount of money  they contributed to the purchase price. 

So if a father pays 75% of a savings  bond and his daughter pays 25%,  

then he must pay 75% of the tax and she must pay  25%, even if she receives the entire proceeds. 

This rule allows the choice of reporting the  interest annually or when the bond is redeemed  

or matures. If the tax liability depended  on who received the proceeds of the bond,  

then the choice between annual reporting and  deferred reporting would not be possible. 

Accrual method taxpayers, usually a business or  other entity, must report the interest each year  

as it accrues; there is no other option. Most people choose the deferral method,  

since it eliminates annual reporting and defers  taxes until the bond is redeemed or matures,  

which may be years in the future. However, low-income people, especially children,  

may benefit by reporting the interest annually. Taxes can be saved for children even if  

the proceeds are not used to  pay for educational expenses. 

By putting the bonds in the child’s name only and  filing a tax return for the child and electing to  

report the interest annually, the child’s tax  rate will apply to the child’s income, so if it  

is less than the standard deduction for children  with investment income, then there is no tax. 

However, if the child receives significant  income, then kiddie tax rules may apply. 

In this case, taxes on the interest may be  deferred until the bonds are redeemed, when the  

interest will be taxed at the child’s rate if she  is at least 19 years old, or 24 years old if she  

is a full-time student. Redemptions for younger  children will be subject to the kiddie tax rules. 

Later on, I will be discussing how you  could save on taxes if the bond proceeds  

are used to pay for higher education expenses . However, to take advantage of this program,  

the owner of the bond must be at least 24  years old on the issue date of the bond. 

This means that any bond owned by children will  never qualify for this interest income exclusion. 

To take advantage of this  Education Savings Bonds Program,  

the bond must be owned by a parent or guardian  who is claiming the child as a dependent! 

The choice to report the accrued  interest each year can be made  

either by your child or by you for your child. This choice is made by filing an income tax return  

that shows all interest earned to date on  all US Savings Bonds owned by your child,  

and by stating on the return that your child  chooses to report the interest each year. 

Keep a copy of this return. Unless your child is otherwise  

required to file a tax return for  any year after making this choice,  

your child does not have to file a  return only to report the interest. 

This choice must apply to all savings bonds your  child owns, including all future acquisitions. 

You may change from annual reporting to  deferral by asking the IRS for permission,  

which is granted automatically. Detailed instructions,  

shown here, can be found in IRS Publication  550, under the section for US savings bonds. 

You can also use Form 3115, Application  for Change in Accounting Method,  

to change from annual reporting back to deferral. When the bond is redeemed, matures,  

or is reissued, then a Form 1099-INT  will be issued to the bond owner,  

showing all interest earned by the bond up to that  time, even if the interest was reported annually. 

A Form 1099-INT for bonds held electronically  will be issued by the end of January  

in your TreasuryDirect account. You can find  detailed instructions in TreasuryDirect. 

Form 1099 will report all interest earned  on the bond, so if you previously reported  

some of the interest, then that interest must be  subtracted on Schedule B. If you use tax software,  

as most people do, you must make sure that  the software provides a means of subtracting  

previously reported interest; otherwise, you  will pay additional tax on that interest. 

Federal taxes can be avoided or reduced on  interest used to pay for qualified educational  

expenses or for contributions to Coverdell  Education Savings Account or a Qualified Tuition  

Plan (QTP), also called a 529 plan. To receive this tax-free treatment,  

the following requirements must be satisfied: If a bond is used to pay for your educational  

expenses or to fund your Coverdell ESA or  QTP, then you must be the owner of the bond. 

To pay for expenses or contributions for your  child’s education, then you or your spouse,  

or both, must own the bond and the child must be  your dependent being claimed on your tax return. 

Your child may be a  beneficiary but not a co-owner. 

Qualified expenses must be paid to  an eligible educational institution,  

which is any accredited public, nonprofit, or  private college, university, vocational school,  

or other postsecondary institution. Qualified higher education expenses  

include tuition and fees, but not room and  board, required for enrollment or attendance. 

Qualified expenses also include contributions to a  529 plan or a Coverdell education savings account. 

The expenses must be for you,  your spouse, or your dependent. 

There are also some redemption requirements,  the primary requirement being that the  

educational expenses must be incurred in  the same tax year the bonds are redeemed. 

The tax savings for the educational bond  program is limited by income, specifically  

modified adjusted gross income, or MAGI. MAGI = taxable income + additional income  

that would otherwise be excluded or deducted  when calculating normal tax liability. 

For instance, IRA deductions would have  to be added back to taxable income. 

The income limits phase out  over a range of $15,000,  

or $30,000 for married couples filing jointly. The phaseout limits are adjusted annually for  

inflation and apply when the bonds are  redeemed, not when they are purchased. 

This screen shows the formula and an example  for calculating the tax-free portions of  

bond redemptions if MAGI exceeds the phaseout  threshold but is still below the phaseout limit. 

Simply multiply the redemption amount by the  amount your MAGI exceeds the phaseout threshold  

divided by the phaseout range, then  subtract that from the redemption amount. 

If the bond proceeds exceed  qualified educational expenses,  

then the percentage of interest that  is tax free equals the percentage of  

adjusted qualified educational expenses  over the total bond redemption amount. 

Taxable interest = total interest  minus the tax-free interest. 

Form 8815 must be filed to exclude interest used  to pay for qualified higher education expenses  

or for contributions to a Coverdell  Education Saving Account or a 529 plan. 

You must name each person who is benefiting from  the bond proceeds for their higher education as  

well as the names and addresses of the  eligible institutions. Note that if the  

bond proceeds are contributed to a Coverdell  ESA or a 529 plan, then you must add that to  

the name and address of eligible educational  institutions in Section 1(b) of the form,  

as you can see from the example on the screen.  Use the initials “QTP” to specify a 529 plan. 

Although you do not have to, you can use Form  8818 to keep records of your bond redemptions  

used to pay for higher education. Just specify the serial number,  

issue date, and face value of the bonds. 

Schedule B of Form 1040 is used to  exclude the interest used to pay for  

higher education by subtracting the excluded  interest from the total interest earned. 

You cannot avoid taxes by holding bonds  in an IRA or other retirement account. 

While there is no legal prohibition on holding  US savings bonds in a retirement account,  

there are practical problems. As nonmarketable securities,  

US savings bonds cannot be transferred  from your TreasuryDirect account to an IRA. 

Only cash, not property, can be used for  contributions to retirement accounts. 

Therefore, paper bonds cannot be  transferred to retirement accounts. 

Financial institutions, where most IRAs are held,  also do not offer the option, probably because  

TreasuryDirect offers no option that would  allow financial institutions to automate  

setting up a TreasuryDirect account  for an IRA or other retirement account,  

so it would not be scalable for a large financial  institution to offer this option cheaply. 

What about a self-directed IRA? Trusts can buy savings bonds, and IRAs  

are a special type of trust, but the trustee must  be willing to set up a TreasuryDirect account. 

However, you cannot serve as the trustee  of your IRA, even a self-directed IRA. 

A self-directed IRA may hold US savings bonds  if you can find a trustee who is willing to open  

a TreasuryDirect account and buy them with your  contributions. I could not find any self-directed  

IRAs that offered the option of buying US  savings bonds in their marketing materials. 

Even if it were possible, there are many  disadvantages to self-directed IRAs,  

so, for most people, this  would not be a good option.