Page 668 - TaxAdviser_2022

Because inflationary adjustments to indexed bonds are taxed
currently rather than when the cash is received at maturity, the tax
ramifications of TIPS cancel out some of the inflationary protection
they are designed to provide.

exchange) (Regs. Sec. 1.454-1(a)(1); is not made, all income on the bond is subsequent earnings on the bonds are
IRS Letter Ruling 8217231)). taxable at maturity, thus affecting the taxed to the donee.
The election to convert to the accru- taxation of Social Security benefits only A Series EE (and, presumably, a
al method for U.S. savings bond interest in the year of the bond’s maturity. If the Series I) bond can be transferred to a
should be considered for a taxpayer election is made, the income may affect revocable (living) trust without trig-
when any of the following occurs: the taxability of Social Security benefits gering the deferred income (Rev. Rul.
■ Additional current income may go in multiple years. However, spreading 58-2; IRS Letter Ruling 9009053). A
untaxed (e.g., the taxpayer’s income the income may create less of an impact Series HH bond can also be transferred
is below the filing limit) — this than including all of the accrued inter- to a revocable trust without triggering
includes bonds owned by children est in the year the bond matures. the deferred Series E and EE inter-
who are not subject to the kiddie The election to accrue interest on est income.
tax; U.S. savings bonds is made by attaching U.S. savings bonds are subject to state
■ Additional current income would an election statement to the taxpayer’s inheritance, gift, and excise taxes. They
be taxed at a lower rate than income return for the year it is effective (Regs. are not, however, subject to the income
in the year of the bond’s maturity Sec. 1.454-1(a)). It can be revoked only taxes of states, U.S. possessions, or local
(after considering the time value of with IRS consent, but the IRS provides taxing authorities. Taxpayers living in
money); taxpayers with an expeditious method high-tax states may achieve tax savings
■ The tax rate is relatively low for the of revoking the election, thereby allow- by investing in U.S. bonds, since the
final return of a deceased taxpayer in ing them to return to the cash-basis interest is not taxable by states. However,
relation to the tax rate of the estate method for reporting the interest such taxpayers must own the bonds
or beneficiaries; income. Revoking the election may be directly, not through a qualified plan or
■ A carryforward item (deduction or appropriate when income recognized individual retirement account (IRA), to
credit) is expiring or otherwise could under the accrual method is subject to achieve state income tax savings. Most
be used to offset the additional tax or taxed at an increased rate. states tax IRA and qualified plan distri-
income; If a U.S. savings bond is transferred butions (to some extent) regardless of
■ Itemized deductions are of little or during the owner’s lifetime, the trans- the nature of the assets held in the plan
no benefit because of a low level feror generally must recognize any in- or IRA.
of taxable income or the standard come that has been accrued but not yet Planning tip: Tax savings can also be
deduction exceeds the itemized reported. Nevertheless, gifting a bond realized by using Series EE U.S. savings
deductions; or may be beneficial if substantial income bonds to pay for a child’s education
■ The accelerated income may be is yet to be earned on the bond and the expenses. All or a portion of interest
offset by a deduction for investment donee is in a lower tax bracket than the on Series EE U.S. savings bonds issued
interest that would otherwise be donor. The donor could structure the after Dec. 31, 1989, may be excluded
deferred under Sec. 163(d). transfers as annual gifts qualifying for from income if bond proceeds are used
This election represents one of the the annual gift tax exclusion under Sec. to pay qualified higher education ex-
few opportunities to manipulate taxable 2503(b). The value of the gift would penses at eligible educational institutions
income as late as when the tax return is be the sum of the bonds’ redemp- (Sec. 135). However, from an investment
being prepared. tion values (according to government strategy standpoint, the returns from
Caution: The taxpayer should tables), which include accrued interest. other investments may exceed the rela-
consider the impact of the accrued and The donor must include in income tively low yields on savings bonds, mak-
recognized income on the taxability of the increment in value (accrued inter- ing other investments preferable despite
Social Security benefits. If the election est) as of the date of the transfers. Any the exclusion of savings bond interest.

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