If you buy a paper Series EE U.S. Savings Bond, you buy it at a discount and receive the face value of the bond at maturity. Ex: You might purchase a $1,000 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. It accrues interest until the bond matures. Ex: You pay $1,000 for a $1,000 bond, and when the bond matures, you 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 1 of these ways:

• Report the interest in the year you earn it.
• Report the entire amount of interest earned when the bond matures or when you redeem it, whichever comes first.

Ex: 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 to 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. If you report the interest earned every year, you get to subtract the interest you paid tax on in prior years from your taxable income.

By reporting interest annually, you can even out your income over the years. This is useful if your U.S. Savings Bond interest is substantial. Ex: If you had $1 million in bonds, the interest at maturity could be as much as $200,000.

If you start reporting bond interest every year, you must continue to report interest earned every year. This:

• Includes the interest for bonds you own and any you later acquire
• Applies to all Series EE, Series E, and Series I bonds

For most investors, it probably works out better to report the interest when you redeem the bond.

Interest Income Exclusion for Education

You can help defray college expenses by investing in bonds or by cashing in bonds you've already invested in. You can exclude the bond interest from taxable income if both of these apply:

• You redeem Series EE bonds purchased after 1989 or Series I bonds.
• You use the money to pay qualified education expenses.

To qualify for this tax break:

• The bonds must Series EE bonds purchased after 1989 or Series I bonds.
• The student can’t own the bonds. The bonds must be in 1 of these names:
  • Your name
  • Your spouse’s name
  • Both you and your spouse’s names as co-owners
• You must be at least age 24 in the month before the bond was issued.

If the amount when you redeem the bond is more than the total qualified education expenses, you can only exclude a portion of the interest. Use Form 8815 to figure the interest income you can exclude from income.

The interest income exclusion is phased out at higher income levels based on modified adjusted gross income (AGI). Use Form 8815 to figure your modified AGI.

For 2012, the exclusion begins to phase out at $72,850 for single filers, and is completely phased out at $87,850 . If you’re married filing jointly or a qualifying widow(er), the exclusion begins to phase out at $109,250 , and is completely phased out at $139,250 .

Married couples who file separate returns aren't eligible for the exclusion.

To learn more, see:

• IRS Form 8815 instructions
• IRS Form 8818 instructions
• IRS Publication 550: Investment Income and Expenses (Including Capital Gains and Losses)
• IRS Publication 970: Tax Benefits for Education