AKAMAI MONEY

By Deborah Adamson
Advertiser Staff Writer

Q: My daughter is in grad school. The tuition is approximately $28,000 a year. I want you to clarify ... if all of the U.S. savings bond interest will be tax free (if used for education). — Francis Tubania, Wai'anae

A: You may not have to pay federal taxes on all or part of the interest if you cash in a U.S. savings bond for education expenses, as long as the bond is a Series I or Series EE issued after 1989, said Bill Steiner, a spokesman for the Internal Revenue Service. All savings bonds are free of state and local taxes.

The bond must be issued in your name as the sole owner, or you and your spouse as co-owners. The owner must be at least 24 years old before the bond's issue date.

Here are other conditions: the savings bond money must be used for qualified, or IRS-approved, education expenses for yourself, your spouse or a dependent for whom you claimed an exemption on your tax return. The school must be an accredited post-secondary institution.

Approved expenses include tuition and fees but not room and board or non-credit courses. These expenses must be reduced by other tax-free educational benefits.

You also must have a modified adjusted gross income of less than $74,850 if you're single or a head of household; or a modified adjusted gross income of less than $119,750 if you're married filing jointly or a widow or widower with a dependent. If you're married but you and your spouse are filing tax returns separately, you don't get the tax break.

Your modified adjusted gross income is your adjusted gross income (line 37 of form 1040) with certain tax deductions or exclusions added back. To calculate that, go to www.irs gov /publications/p970/ch10.html or call (800) 829-3676 and ask for Publication 970.

How much interest is tax free? When you cash your bond, if the total is less than your approved educational expenses, including any adjustments, then all of the interest may be tax free. If your bond amount is greater than expenses, only part of the interest may be tax free.

To calculate how much interest is tax free, multiply the interest by the ratio of qualified educational expenses to the total bond amount.

For example, let's say you and your spouse cashed in a savings bond for $9,000, with $6,000 as principal and $3,000 as interest. And in 2004, let's say you paid $7,650 of your daughter's college tuition.

To get your ratio, divide $7,650 of expenses by the total bond amount of $9,000 for a 0.85 ratio. Multiply 0.85 by $3,000 of interest to get $2,550. Therefore, $2,550 of the $3,000 in interest is tax free. You have to pay taxes on the remaining $450.

Another wrinkle: If you make between $59,850 and $74,850 as a single or head of household filer, the amount of interest you can shelter from taxes phases out. For those who are married filing jointly or qualifying widows or widowers, it's between $89,750 and $119,750. Married filing separately doesn't qualify.

If you fall within the phase out range, fill out IRS form 8815 to calculate how much of the interest is free of taxes. Download a form at www.irs.gov. To get a copy by mail, call 800-829-3676.

Got a personal finance or consumer question? Contact Deborah Adamson at dadamson@honoluluadvertiser.com or 525-8088.