How Is the Tax-Free Amount Figured?

If the total you receive when you cash in the bonds is not more than the qualified higher education expenses for the year, all of the interest on the bonds may be tax free. If the total you receive when you cash in the bonds is more than the expenses, part of the interest may be tax free.

To determine the tax-free amount, multiply the interest part of the proceeds by a fraction. The numerator (top part) of the fraction is the qualified higher education expenses you paid during the year. The denominator (bottom part) of the fraction is the total proceeds you received during the year.

Example 1. In February 2001, Mark and Joan, a married couple, cashed a qualified series EE U.S. savings bond they bought in November 1992. They received proceeds of $9,000, representing principal of $6,000 and interest of $3,000. In 2001, they paid $7,500 of their daughter's college tuition. They are not claiming an education credit for that amount, and they do not have a Coverdell ESA (formerly known as an education IRA). Their modified adjusted gross income for 2001 was $80,000.

They can exclude $2,500 ($3,000 × ($7,500 × $9,000)) of interest in 2001. They must pay tax on the remaining $500 ($3,000 - $2,500) interest.

Does the Amount of Your Income Affect the Amount of Your Exclusion?

The amount of your interest exclusion is gradually reduced (phased out) if your modified adjusted gross income is between $55,750 and $70,750 (between $83,650 and $113,650 for joint returns). You cannot exclude any of the interest if your modified adjusted gross income is equal to or more than the upper limit.

The phaseout, if any, is figured for you when you fill out Form 8815.

Illustrated Example. The information is the same as in the previous example except that Mark and Joan have a modified adjusted gross income of $101,650. In this example, they can exclude $1,000 (line 14 of Form 8815 shown on the next page) of interest in 2001.

They must pay tax on the remaining $2,000 interest ($3,000 total interest minus $1,000 excluded interest).

How Is the Exclusion Claimed?

Use Form 8815 to figure your education savings bond interest exclusion. Attach the form to your Form 1040 or 1040A.

Form 8815 for Mark and Joan Washington

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