When you cash in your savings bond, you get to reap the benefits of your patience in waiting for the interest to accrue. However, you probably also have some tax obligations to the Internal Revenue Service. How much interest you have to report depends on how you’ve been reporting, or not reporting, the interest in prior years. In addition, you might qualify for to exclude the interest if you use the money for educational costs.
No Prior Reporting
If you cash in your savings bond and haven’t been reporting the interest earned each year, you have to include all of the interest on the bonds as taxable income in that year. For example, if you’ve held a savings bond for 10 years and elected to defer any taxes on the interest until you cashed it in, all 10 years of interest are taxable in the same year. Delaying paying taxes on the interest makes sense to many people, because you can’t take money out of a savings bond to pay the tax. When you cash in the savings bond, you have the extra cash to pay the applicable taxes.
If, on the other hand, you’ve been paying taxes on the interest each year, you only have to report the interest earned in the year that you cash the savings bond. For example, say your savings bond has been earning $100 of interest every year for 10 years and it’s earned $50 in the year you cash it in. Since you’ve included the $100 of interest in your taxable income for each of the last 10 years, you only have to include the last $50 of interest you earned in the year you cashed in the bond.
Exception for Educational Expenses
If you use the savings bond for educational expenses, you may qualify to exempt all of the interest income from federal income taxes. To qualify, the bond must be a series EE or series I bond; it must be in your name, or in your name and your spouse’s name; and you must be at least 24 years old on the date the bond is issued. In addition, your income must fall below certain annual limits, and you cannot file your taxes using the married filing separately status. Qualified educational expenses include tuition and fees, but not room and board.
When you file your taxes, you generally must include the savings bond interest as part of your taxable interest income on line 8a of Form 1040 or Form 1040A. If you have more than $1,500 of taxable interest, you have to also file Schedule B and list each source of interest income. If you’re using the exclusion for educational expenses, you can calculate the exclusion with Form 8815 and then report the exclusion on line 3 of Schedule B so it isn’t included in your taxable income for the year. Include Form 8815 when you file your taxes.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."