Question

Renata redeemed EE bonds which qualify for the educational exclusion. The redemption consisted of $12,000 principal and $4,000 interest. The net qualifying educational expenses are $8,000. Her AGI is below the threshold for phase-out of the exclusion. The taxable interest is

A) $0.

B) $2,000.

C) $2,400.

D) $6,000.

Answer 1

The savings bond education tax exclusion permits qualified taxpayers to exclude from their gross income all or part of the interest paid upon the redemption of eligible series EE and I bonds issued after 1989, when the bond owner pays qualified higher education expenses at an eligible institution.

But the taxpayer must use both the principal and interest from the bonds to pay qualified expenses to exclude the interest from his gross income. If the amount of eligible bonds cashed during the year exceeds the amount of qualified educational expenses paid during the year, the amount of excludable interest is reduced pro rata.

In this question also the amount of eligible bonds cashed of $16,000 ($12,000+$4,000) exceeds the qualified educational expenses of $8,000 paid during the year.

Hence the excludable interest will be 50% of total interest (i.e. $8,000/$16,000 = 50%)

Excludable interest = Interest income*50% = $4,000*50% = $2,000

Taxable Interest = Interest income - Excludable interest

= $4,000 - $2,000 = $2,000

Hence the correct option is B)$2,000.