Taxpayers may deduct interest earned on series EE or series I U.S. savings bonds issued after
1989. This deduction is not limited to taxpayers who claim itemized
deductions. The bond interest must have been used to pay for the qualified
higher education expenses (tuition and fees required for enrollment, and
contributions to a Coverdell Education Savings Account or Qualified Tuition
the taxpayer, spouse, or dependent; the maximum deduction is limited to total
qualifying expenses. In order for the interest to qualify for the deduction,
the taxpayer must have been age 24 or older when the bonds were issued.
Interest on bonds issued in the name of a child under age 24 does not qualify
for the deduction.
The deduction of interest earned on Education Savings bonds
results in a reduction in federal tax liability. There is no reduction in state
income tax because U.S. bonds are not taxable at the state level. The amount of
the reduction depends on the taxpayer's marginal rate, and if the taxpayer is
eligible for any credits or is subject to the alternative minimum tax (AMT).
A taxpayer claiming a deduction of $5,000 would, due to the income-based
phaseout of the deduction, typically experience the greatest federal and state tax benefits
with income in the 25 percent federal bracket and the 7.05 percent state bracket, resulting in tax benefits of
$1,250 at the federal level and $353 at the state level.
A taxpayer with
a $5,000 deduction who has taxable income only in the bottom federal and state brackets (in tax
year 2016, 10 percent and 5.35 percent), is not eligible for any credits, and is not subject to
the AMT, will experience a tax reduction of $500 at the federal level and $267 at the state level.
Taxpayers with no regular tax liability do not benefit from the deduction.
Interaction with other programs
not deduct interest for qualifying expenses that were paid for with
distributions from a QTP plan or a Coverdell Education Savings
Account. Taxpayers may not claim the American Opportunity credit or the Lifetime
Learning credit for expenses that were paid for with interest earned on
education savings bonds. In determining the student loan interest deduction,
taxpayers must subtract from qualifying higher education expenses any expenses
paid for with interest earned on education savings bonds.
Savings bond interest deduction is subject to an income-based phase-out. In tax
year 2016, the deduction is phased out for married taxpayers with modified adjusted
gross income (AGI) between $116,300 and $146,300, and for single filers and heads
of household with modified AGI between $77,550 and $92,550. The phaseout
ranges are adjusted annually for inflation. Taxpayers with modified adjusted
gross income above the phase-out may not deduct interest earned on Education
Savings bonds. Modified adjusted gross income equals adjusted gross income
before the deduction for student loan interest, plus foreign earned income,
housing costs of individuals living abroad, and income from sources within Puerto
Rico and U.S. territories.