How to transfer taxable interest to someone with a lower tax rate
Thursday, January 13th, 2005
Categorized as: Savings Bond taxes • Savings Bond college education deduction
My mother purchased series EE bonds for my daughter on her birthdays and Christmas. Her intent was for them to be used for a college education, so she was advised to make them out in my name and social security number with my daughter as beneficiary. My salary is too high to claim the education tax deduction, so I'd like to have my daughter cash and pay taxes on the bonds. My local bank says I must cash the bonds. How can I get the taxes on my daughter's return instead of mine?
Tom's response
The advice your mother received was correct, but lots of people get trapped by the income limitations on the Savings Bond education deduction.
Here's a link to my page on adding a co-owner to a Savings Bond registration. Go there and read up on how to change the registration on these bonds to make your daughter the co-owner rather than the beneficiary. You should leave yourself as owner to avoid creating a taxable event.
When you receive the re-registered bonds with your daughter's name on them as co-owner, she'll be able to cash them herself. The 1099-INT tax form that reports the interest earned by E, EE and I Savings Bonds to the IRS is always issued with the social security number of the person cashing the bonds, so your daughter can report the interest on her return. (For H and HH bonds, the 1099 gets the SSN of the person who has been collecting the bond's interest.)
If you had purchased the bonds yourself, rather than receiving them from your mother, the IRS would expect you to pay the tax, as explained in detail in my post Who pays the taxes. The IRS says, If you used your funds to buy the bond, you must pay the tax on the interest. This is true even if you let the other co-owner redeem the bond and keep all the proceeds.
However, since you didn't use your funds to buy the bonds, and since your mother's gift was always meant for your daughter, this rule doesn't apply. Go forth with a clean conscience and let your daughter pay the tax at her low rate.
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Re: redeeming an HH bond by co-owner:
The Treasury Direct website says: "if another person, such as a joint owner or co-owner, cashes the bond they will receive an IRS Form 1099-INT for the interest received. . ."
You also state: "The 1099-INT tax form. . .is always issued with the social security number of the person cashing the bonds. . ."
But that didn't happen. The co-owner (a friend, not my husband) cashed the bonds, gave his social security number to the bank, the bank forwarded the redemption form to Treasury, Treasury issued and mailed a check directly to the co-owner, and the co-owner cashed the check and kept the proceeds. Yet Treasury issued a 1099-INT only to me and reported to the transaction to the IRS as if I had redeemed the bonds. Treasury insists they did the right thing in accordance with IRS instructions. This extra "income" that I did not actually receive, as things now stand, are likely to cost me (on social security disability) medical benefits and property tax rebates, among other things. Please suggest what I can do about this.
Lois - what I'd do is ask the co-owner to give me the money to cover the losses. As the primary owner of a Savings Bond, you are responsible for the taxes on the interest earned, no matter what SSN is on the 1099. See my post about who is obligated to pay the taxes on Savings Bonds.
Series HH bonds are redeemed by a different group than other Savings Bonds. Apparently they've decided to follow a process that more closely aligns with the IRS rules. Since HH bond interest payments go to the primary owner and since those interest payments require an annual 1099 tax form, they know the primary owner's Social Security Number.
With other Savings Bond series, the redeeming agency doesn't necessarily know the primary owner's SSN (it may or may not be the SSN on the bond) so it has to use the SSN of the person cashing the bonds.
I've edited the above post to make it clear that HH bonds are handled differently with respect to the SSN on 1099s.
So I think I understand that in the example in the original post, the income is not the mother's (even though she paid for the bonds) since Pub. 550 states that if the bond's name is only in the child, it is income to the child.
But in this case, the gift is for the grandchild, does the rule explicitly apply here as well? How about a gift to a spouse, significant other, friend? If I put up the funds and it is only registered in their name, is it income to them?
Mario - If you buy a gift bond for someone else, the receiver of the gift is responsible for the income taxes on the interest, not you, even though you put up the money for the gift.
It doesn't matter what the relationship is between you and the person who receives your gift. The important thing is that it's actually a gift, which means you're not registered as the owner or co-owner of the bond.
Tom, my wife and I purchased a fairly large amount of EE bonds from 1992-1995. We are co-owners of the bonds which are all now registered on Treasury Direct.
When one of us dies, the other will add one or both of our children either as co-owner(s)or beneficiary(s) on the bonds (to the extent they have not then matured). Still no taxable event there, I think, but see subsidiary questions below.
My primary question is can our children as new co-owners redeem the bonds and avail themselves of the educational deduction for the accrued interest if they then meet the income limitations, even though my wife and I never met those limitations.
Two subsidiary questions: 1. Will Treasury Direct accept both children as co-owners or beneficiaries? There seems to be room for only a total of two people on the form and we would then have three.
2. Notice that I said co-owner, not beneficiary. I assume that making them a co-owner would not be a taxable event, and they could redeem the bonds for themselves or for our grandchildren's education at the appropriate time.
However,if my assumption is wrong and naming them as a co-owner upon the death of my wife or me is a taxable event, then would making them a beneficiary(s) work? That might delay their receipt of the money, but still might work depending on the timing of the grandchildrens' college etc.
I have not been able to find answers to these questions anywhere. I fouund your website and it looks like I have struck gold. Obviously,what I am trying to do is skip a generation, avoid or lower the tax and help pay for our grandchildrens' education.
Thanks.
Ted Kensington
Ted - You can only add one person to a Savings Bond registration. You can make that person either the co-owner or beneficiary. This is true for both TreasuryDirect and paper bonds.
It's not a taxable event to add, delete, or change a co-owner or beneficiary in TreasuryDirect. However, a TD co-owner can't cash a Savings Bond unless the co-owner also has a TD account and you give the co-owner transaction rights over the bonds.
And in this case, if the bonds are redeemed by the co-owner, you're still the one whose SSN will be on the 1099-INT tax form reporting the interest to the IRS. The TreasuryDirect reporting process follows IRS rules better than the process for paper bonds.
Moreover, the rules for the Savings Bond education deduction don't allow a grandparent to be the bond's owner.
Now if you and your wife were both to die, your children would become owners of the bonds. If they otherwise qualify they could get a deduction for using the bonds for their kid's education.
But when it comes to a choice between death and taxes, I always advise people to go with the taxes.
You would probably benefit from a weekend with my book. It will give you additional ideas for minimizing your taxes.
Tom,
My grandmother purchased Series E savings bonds for me and they are in my name and my dad's name with his SSN and the word GIFT on them. Several of the bonds have matured and I wish to cash them and pay as little tax as possible. I believe that my family's tax bracket is higher than my father's and have asked him to cash them for me. Is that the correct way to handle this situation?
Kathy - Yes, that will work in this case. The person with the lowest tax rate, you or your father, should cash them and pay the income tax on the accumulated interest.