How to Get a Break on Child’s Education

QUESTION: I know that I can buy U.S. savings bonds now and pay no taxes on their accumulated interest when I cash them in, if I use the proceeds for my child’s education. I also know that this tax break is available only if you meet certain income requirements. But I don’t know when the income limits are applied: when the bonds are purchased, or when they are sold?--E.C.

ANSWER: Recognizing the difficulty that many middle-income families have preparing for college educations, Congress established a special savings bond program last year. Basically the law says that interest earned on Series EE bonds purchased after Dec. 31, 1989, are free from federal taxation if they are redeemed to pay for college or vocational school.

However, Congress imposed several restrictions on the program, including a limit on the income of families allowed to take advantage of it. For couples filing a joint tax return, the bond proceeds are completely tax free if their total adjusted gross annual income is less than $60,000. Families between $60,000 and $90,000 are entitled to partial benefits that gradually diminish as their income increases. There are no advantages available to families with adjusted gross incomes of more than $90,000.

For individual filers, full benefits are available to taxpayers with adjusted gross incomes of less than $40,000, with diminishing benefits up to a limit of $55,000.

Our tax experts tell us that these income limits are applied when the bonds are cashed in, not when they are purchased. Of course, you don’t know absolutely what your adjusted gross income will be when it’s time to cash them in, but perhaps you can make a reasonable guess based on your current income and the rate at which it has been growing over the last several years. If you’re not sure, or if it looks as though it will be a close call as to whether you will qualify for any benefits, you may want to consider that Congress may still decide to adjust the limits to account for inflation. This, however, is not a certainty.

A financial adviser can tell you if it’s worth your while to gamble on your being eligible to take advantage of the tax breaks. It may well be that you can do as well, or better, by making an alternative investment for your child’s college education.

By the way, other restrictions on the program require that bond buyers must be at least 24 years old. Further, the tax break will apply only to bond proceeds used for tuition and required school fees--not books and room and board. In addition, it will apply only to degree programs at colleges, universities and certain vocational schools.

Finally, and grandparents especially please note: These breaks are available only for bonds purchased by the parents of the children attending college, not any other family members or interested outsiders unless they claim the children as dependents. So if you want to help your grandchildren--and you don’t claim them as dependents--your best bet is to make a gift of money to your children and have them purchase the bonds for your grandchildren. You may not make a direct purchase of bonds that qualify for these tax breaks.

Social Security Tax Deduction Starts in ’91

Q: Several months ago you wrote that self-employed workers may deduct half of their Social Security taxes as a business expense when computing their income tax obligation. You said the deduction would begin this year. But I don’t see any place for it on the tax form I was just sent. What’s happening?--

A.R.

A: The deduction becomes effective for income earned in 1990, not 1989. So beginning with the tax form you file next year for income and expenses incurred this year, self-employed taxpayers may deduct the employer’s half of their Social Security contributions as a business expense on their tax filings. The deduction should be reported on Schedule C of the tax forms. For more information, see Section 1449.725 of the Internal Revenue Code.

As we noted previously, this provision is designed to more equitably treat the self-employed worker, who is actually half employee and half employer.

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053