How these inflation-protected bonds are taxed
Q: When must I pay income tax on the interest I earn on Series I U.S. Savings Bonds? A: You can pay federal income tax each year on the interest earned or defer the tax bill to the end. Most people choose the latter. They report the interest income on their Form 1040 for the year the bonds mature or when they’re cashed in, whichever comes first.
However, deferring tax on the full amount of accrued interest for up to 30 years may sound like a great idea until you get the tax bill for three decades’ worth of interest. Also, taking the tax hit all at once can push you into a higher tax bracket, making the bill even more expensive.
If you cash in I bonds, you must report the interest on line 2b of Form 1040 and pay tax to the extent you didn’t otherwise include the interest income in a prior year. If you received $1,500 or more in interest during the year, you would also have to fill out Schedule B.
Q: Can I avoid paying income tax on the interest income from my I bonds if I redeem them before maturity to pay for college? A: Yes, but there are lots of rules and hurdles to jump over to be able to take advantage of this tax perk. For instance:
You must have purchased the bonds after 1989 when you were at least 24 years old.
The bonds must be in your name only.
The bonds must be redeemed to pay for undergraduate, graduate or vocational school tuition and fees for you, your spouse
or your dependent. Grandparents can’t use this tax break to help pay for their grandchild’s college tuition unless the grandparent can, on his or her 1040, claim the grandkid as a dependent.
Room and board costs aren’t eligible for the exclusion.
You also must meet certain income limits. For 2022, the interest exclusion begins to phase out at modified adjusted gross incomes of more than $128,650 for joint filers and $85,800 for others, and ends at modified AGIs of $158,650 and $100,800, respectively.
If the proceeds from all savings bonds cashed in during the year exceed the qualified education expenses paid that year, the amount of interest you can exclude is reduced proportionally.
Use IRS Schedule B and Form 8815 to report and calculate any excluded I bond interest used for education.
Q: Can I avoid taxes on I bonds if I donate them? A:
Donating an I bond before it matures to charity while you’re alive will also accelerate taxation of the interest income. Giving
away bonds you already own to your alma mater, favorite museum or other charitable organization doesn’t let you avoid the tax on previously untaxed interest. You’re still taxed on all that interest in the year the donation is made.