Question

Starting in 2006, Chuck and Luane have been purchasing Series EE bonds in their name to use for the higher education of their daughter Susie, who currently is age 18. During the year, they cash in $12,000 of the bonds to use for freshman year tuition, fees, and room and board. Of this amount, $5,000 represents interest. Of the $12,000, $8,000 is used for tuition and fees, and $4,000 is used for room and board. Chuck and Luane's AGI, before the educational savings bond exclusion, is $120,000. Review § 135, and answer the following questions.

a)Determine the tax consequences for Chuck and Luane, who will file a joint return, and for Susie.

b) Assume that Chuck and Luane purchased the bonds in Susie's name. Determine the tax consequences for Chuck and Luane and for Susie.

c) How would your answer to part(a) change if Chuck and Luane filed separate returns?

Answer 1

Part A

Paying the tuition and fees ($8,000) for Susie, their dependent, qualifies as higher education expenses. The room and board of $4,000 does not qualify. Since the redemption amount ($12,000) exceeds the $8,000 of qualified higher education expenses, only part of the interest qualifies for exclusion treatment as follows:

$5,000 × ($8,000 ÷ $12,000) = $3,333

Since their modified adjusted gross income (MAGI) of $110,000 exceeds the threshold amount of $94700 for 2006, part of the potential exclusion is phased out.

MAGI $110,000

Less: Threshold amount (94700)

Excess over threshold amount $15300

The amount of the potential exclusion that is phased out is as follows:$3,333 × ($15300 ÷ $30,000) = $1700

Thus, Chuck and Luane can exclude $1633 ($3,333 – $1700) of the savings bond interest received and $3367 ($5,000 – $1633) must be included in their gross income.

Part B

All of the $5,000 of savings bond interest must be included in Susie’s gross income, who is currently 18 years old. The exclusion for educational savings bond under § 135 is applied only if the savings bonds are issued to an individual who is at least age 24 at the time of issuance.

Part C

If Chuck and Luane file separate returns, they do not qualify for exclusion treatment under § 135. Thus, they must include the $5,000 of savings bond interest in their gross income.