Taxes on Bonds Used to Pay College

Dear Dr. Don,My son starts college this fall. We want to use some of his Series EE savings bonds to pay part of his bill, the majority of which is room and board and books, which, as I understand, are not allowable expenses to qualify the bonds as tax exempt. Further, some of the bonds are in his name and some in mine or his father's. Since my son's income will be about $1,000 this year, would he need to pay taxes on the interest from cashing bonds that are in his name? We are considering cashing in about $1,500 (including the money earned on the bond) this year.-- Mardell Matriculate

Dear Mardell,The savings bonds that your son owns in his name don't qualify for the education tax exclusion. Bonds held in your name or his father's name may qualify for the education tax exclusion. The TreasuryDirect Web page "Education Planning" explains the requirements to qualify and defines qualified expenses, but you're right -- room, board and books don't qualify.

The same Web page also discusses how the child paying income tax each year on that year's interest income can minimize the tax impact for savings bonds held in the child's name versus waiting to pay the income tax when the bonds mature or are redeemed. He can make a one-time switch from deferring the income tax to paying annually. But once the change is made, there's no going back to deferring the tax on the interest income, and interest on all of the savings bonds that he owns will have to be reported in the same manner.

The change in reporting interest income may make sense for your son. You can get an estimate of how much interest income that would be by inputting his savings bonds into the Savings Bond Wizard. The Bankrate feature "Kiddie tax rules for child's income," can help you decide how much of the interest earnings would be subject to this tax. Talk to your tax professional if you can't decide if it makes sense to change how he reports interest on his savings bonds.