When purchasing a paper Series EE bond, you purchase it at a discount and receive the face value of the bond at maturity. For example, you might purchase a $1,000 paper Series EE bond for $500, and when the bond matures, you get the full $1,000. When purchasing a Series I or electronic Series EE bond, you pay the face value of the bond and it accrues interest until the bond matures. For example, you would pay $1,000 for a $1,000 bond, and when the bond matures, you would get the bond amount plus the accrued interest.
The difference between the purchase price and the redemption value is taxable interest income. You can report interest income from Series E, EE, and I bonds in one of 2 ways:
You can report the interest in the year that it is earned.
You can report the entire amount of interest earned when the bond matures or when you redeem it, whichever comes first.
For example, if you purchase a $1,000 Series I bond that earns 4% interest and you keep it for 5 years, you can either report $40 each year in interest, or wait and report $200 in interest when you redeem it. Upon redemption, you’ll receive a Form 1099-INT that reports the full amount of interest the bond earned (in this example, $200). If you report the interest earned every year, you get to reduce your taxable income by the amount of interest you paid tax on in previous years. You can adjust your interest income in the Interest Income section of the Interview.
The advantage of reporting interest annually is that you get to even out your income over the years, which is particularly useful if your savings bond interest is substantial. For example, if you had $1 million in bonds, the interest at maturity could be as much as $200,000.
Important: Once you start reporting bond interest every year, you must continue to report interest earned annually for all Series EE, Series E, and Series I bonds that you own and any you may acquire.
For most investors, though, it probably makes more sense to simply report the interest when you redeem the bond (and receive a Form 1099-INT).
You can help defray the college tuition burden (present or future) by investing in bonds, or by cashing in bonds that you’ve already invested in. If you redeem a Series EE bond purchased after 1989 or a Series I bond and you use the money to pay qualified education expenses, you can exclude the interest from taxable income.
To qualify for this tax break:
The bonds must be in either your name, your spouses name, or in the name of both you and your spouse (as co-owners). The student can't own the bond.
You must be at least 24 years old in the month before the bond was issued.
If the amount you receive when you redeem the bond exceeds the total qualified education expenses, only a portion of the interest can be excluded. Use Form 8815 to calculate the amount of interest income that can be excluded from income.
The interest income exclusion is phased out at higher income levels based on modified adjusted gross income (AGI). Use Form 8815 to calculate your modified AGI.
For 2010, the exclusion begins to phase out at $70,100 for single parents, and is completely phased out at $85,100. For married couples filing jointly or a qualifying widow(er), the exclusion begins to phase out at $105,100, and is completely phased out at $135,100. Married couples who file separate returns aren’t eligible for the exclusion. The Series EE and Series I Savings Bond section of the Interview will help you determine whether or not you qualify for the exclusion.
For more information, see these resources:
Form 8815 Instructions
Form 8818 Instructions
IRS Publication 550: Investment Income and Expenses (Including Capital Gains and Losses)