A tax exclusion is provided for interest earned on U.S. savings bonds used to finance the higher education of the taxpayer, the taxpayer’s spouse, or dependents according to Code section 135.
Timing of Purchase
The bonds must have been purchased after December 31, 1989, and the exclusion is available only to the individual who purchased the bonds. The purchaser of the bonds must have reached the age of 24 and be the sole owner of the bonds. The bonds must be redeemed during the same tax year in which the qualified educational expenses are incurred by the taxpayer, the taxpayer’s spouse, or any dependents.
Qualified Higher Education
Qualified higher education expenses include tuition and fees, net of scholarships and other tuition reduction amounts. Qualified higher education expenses must be further reduced by expenses taken into account for the Hope Scholarship and Lifetime Learning credits. Books, supplies, room and board and expenses incurred for sports, games, or hobbies other than as part of a degree program are not covered.
The key to computing the exclusion is the amount of qualified higher education expenses that the individual incurs in the year the bonds are redeemed. If these expenses exceed the aggregate redemption amount, then all of the interest may be excluded, subject to an income-linked phase-out. If the redemption amount is larger than the qualified educational expenses, however, the exclusion is reduced on a pro rata basis.
It is important to note that married individuals filing separately are not eligible for the exclusion.