Interest on EE Savings Bonds

Yes, the owner can switch from what the Treasury calls Method 1 (deferral) to Method 2 (accrual) at any time. The owner would declare as income all accrued interest to date and then would declare the accrued interest each year. See page 8 of IRS Pub 550 for details.

If the above doesn't work for the owner, the owner always has the option of continuing to defer interest and just redeem a certain amount each year to minimze the hit.

My reference to "redeem a certain amount" is to the bonds not the interest.

Considering how hard it is to find low-risk investments that pay 4%, the owner is much better off declaring the interest and holding on to the bonds.

Redeeming only makes sense if he or she doesn't otherwise have enough cash to pay the tax on the interest declared, and then only redeem enough to pay the tax.

R's, John

If the proceeds of redeemed bonds are used to pay qualified eduction expenses, the interest is excluded from taxable income. See pages

61-62 if IRS Publication 970, "Tax Benefits for Education," available in PDF format at

Yes, the owner can switch from what the Treasury calls Method 1 (deferral) to Method 2 (accrual) at any time. The owner would declare as income all accrued interest to date and then would declare the accrued interest each year. See page 8 of IRS Pub 550 for details.

If the above doesn't work for the owner, the owner always has the option of continuing to defer interest and just redeem a certain amount each year to minimze the hit.

====================Careful: I have not reviewed the publication in making my answer, but that sounds a lot like a change in accounting method. The publication will tell you if you need to file a form 3115 for this change.

Don't forget about the non-recognition of interest if the proceeds from the bonds are used for higher education.

That would be a large immediate hit. Could the taxpayer switch methods for only _some_ of the bonds each year, to adjust the taxable amount? (That would make sense to keep more interest in a lower tax bracket, if applicable.)

Seth

One of the changes that does not require IRS permission. See...

No. It's all or nothing. You must change the accounting for all the bonds (EE, E & I) you own.

No. All or nothing, and you can't switch back either.

A side note on this. If you do switch, make sure you keep copies of your returns from the time you switch until you cash the bonds. When you cash them the full interest accrued since the date of sale will be reported on the

1099-INT, and you must make adjustments on Schedule B. All is explained in Pub 550.

Phil Marti VITA/TCE Volunteer Clarksburg, MD

Can a taxpayer gift the bonds to his kids or grandkids? What are the tax consequences? The ideal situation is that the he can give 13k to 52k tax-free, then receiver inherits the cost basis, accrued but undistributed and unreported interest. Then the kid (who may be a parent with kids) can cash the bonds, use it for themselves or their spouse/dependents, etc, and use form 8115 to exclude interest. Of course, American Opporunity and other credits cannot be applied on amounts paid with the interest, but the principal value of the bond can be used to figure these credits.

Am I right in thinking that Series EE bonds can only be used this way to exclude interest for college. But Coverdell can be used for college and K-12 school?

First, to exclude 100% of the interest, 100% of the total proceeds have to be used on qualified education expenditures. If, for example,

60% of the proceeds are spent on qualified education expenditures, then 60% of the interest is excludible. There are other limits. See the IRS Publication 970 I cited earlier.

Yes, the bonds can be gifted away. The only immediate tax consequence is possible gift tax reporting by the donor.

Yes, exclusion of interest from EE bonds is only available for post- secondary education.

But my question is: does the accrued interest (meaning interest that has accrued on the bond, but no tax has been paid on this interest, and it will be taxed once the bonds are redeemed) transfer from the donor to the receiver? The reason for asking is that I think many people who have EE bonds may have no dependents going to secondary school, like grandparents.

Reissuing the bonds in the name of the donee is a reportable taxable event. The donor will receive a 1099 reflecting all accrued interest to date.

Dadgummit! I know that and yet I persist in not remembering.

Thanks, Alan.