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If you redeemed Series I or EE savings bonds to pay higher education expenses you had this year, you may be able to avoid paying tax on the bond interest.
The operative word here is "may." There are many restrictions and requirements on this tax break, and many people find that it doesn't actually help them.
The first requirement is that the bonds must have been issued in 1990 or later, to a person who was at least 24 years old before the bond's issue date.
Also, to qualify for the tax break, your income (not your child's, even if he or she is the one in college) must be below certain limits. For singles or heads of households in 2011, the tax break begins to be phased out at $71,100 of AGI and is completely phased out at $86,100. For marrieds filing jointly, the phaseout begins at $106,650 in 2011 and is complete at $136,650. Marrieds filing separately can't claim the exclusion at all.
If you can meet these requirements, a bond that was issued in your name or your spouse's name qualifies if you paid higher education expenses for yourself, your spouse, or your dependent children. Qualified education expenses include only tuition and fees - not room and board. You also can include any contribution you make to a qualified state prepaid tuition program or to a Coverdell education saving account as an educational expense.
The qualified educational expenses must be reduced by any nontaxable scholarships, veterans' education assistance, benefits under a qualified state tuition program, or nontaxable employer-paid education benefits. Also, you cannot use the same expenses to qualify for the savings bond exclusion and either the American Opportunity credit or the Lifetime Learning credit.
Compare your qualified education expenses with the total amount of proceeds from any savings bonds you redeemed -- "proceeds" includes principal as well as interest. If the total proceeds are less than your total qualified expenses, you can exclude all the interest on the bonds.
If the total proceeds were more than the total expenses, you can only exclude some of the interest. To find out how much, divide your qualified expenses by the total bond proceeds to get a percentage, and multiply that percentage by the interest you received on the bonds. That's the amount of interest you can exclude, unless you're subject to the AGI limits.
If your AGI is within the phaseout range, take your AGI, subtract the bottom rung of the phaseout range (see above), and divide the result by $15,000 if single, or $30,000 if married. The resulting percentage is multiplied by your excludible interest (as calculated in the preceding paragraph), and the result is the amount of the exclusion you lose because your AGI was too high.
The exemption must be computed on IRS Form 8815, Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989, which must be attached to your Form 1040 or 1040A.