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Report EE Bond interest annually to avoid big tax hit

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in Small Business Tax

If you receive gifts of Series EE Savings Bonds in a child’s name, stash them away for a rainy day.

There’s no tax to pay on the accrued interest in the bonds until your child cashes them in or they mature ... unless you choose otherwise.

Strategy: Elect to report the EE Bond interest annually. In other words, plan on reporting the interest that accrues in 2009 on the 2009 tax return you will file for the child.

Why would you volunteer to report the interest sooner rather than later? In the child’s tax bracket, there’s no tax to pay for years to come, assuming his or her unearned income remains below the annual standard deduction amount ($950 for 2009). And the tax bill, if any, should be relatively small when your child finally redeems the bonds.

In contrast, if you don’t report the interest annually, your child could be hit with a hefty tax bill in the year of redemption. This is especially true if you have your child cash in all the bonds the same year (e.g., the child’s freshman year at college).

Note that this election isn’t restricted to newborns. It is available to anyone, regardless of age, who owns Series EE Bonds (or older Series E Bonds, for that matter). You must pay tax on all the accrued interest in the year of the election and then include any subsequent interest in taxable income the year it accrues.

For instance, if your 7-year-old owns EE Bonds, you might make the election for 2009 to avoid a big hit for the child later on.

Tip: You only have to make the special election once on behalf of the child. But then it applies to all future years and future EE Bonds received by the child.

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