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Do we have to pay taxes on savings bond interest?

November 22, 2011: 5:05 AM ET

We understand that there is a provision in the U.S. tax code that allows for the proceeds from the sale of U.S. Savings Bonds to avoid taxation on accrued interest when they're cashed out to pay for college tuition. We'd like to use the money from our savings bonds for our granddaughter's education, and wanted to confirm that this is true. –G. U.

You are correct. You may be able to duck taxes on all or part of the interest on redeemed Series EE and I Bonds issued after 1989, if the principal and interest are used to pay qualified higher education expenses at an eligible university in the same year, according to the U.S. Treasury Department. But there are some catches, including income limits. For married taxpayers filing jointly, the amount of interest you can exclude starts phasing out at a modified adjusted gross income at $106,650 and you can't exclude any interest if your MAGI is $136,650 or more. Also, for education expenses to qualify, you have to use the bonds for your own education, your spouse's, or that of a dependent for whom you can claim an exemption.

If you claim your granddaughter as a dependent, then you're probably all set. (Just check out these other rules.) If not, you'll have to include the interest in your gross income for the year, just like everyone else.

--Kate Ashford

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