Families who bought Series EE or I savings bonds years ago and are now redeeming them to cover college tuition face a federal tax bill on the accumulated interest, unless they qualify for a little-used statutory exclusion that can zero out that liability entirely. Under 26 U.S. Code Section 135, bond interest that would otherwise count as gross income can be excluded when the proceeds pay qualified higher education expenses in the same tax year. The exclusion hinges on income limits, paperwork, and timing, and the gap between who could benefit and who actually claims the break remains wide.
Why the Section 135 Bond Exclusion Demands Attention in 2026
Savings bond interest is taxable at the federal level as a default rule, according to the IRS savings bond guidance. That same page confirms an explicit exception: some or all of the interest may be excludable if qualified higher education expenses are paid during the year of redemption. The distinction matters because many bondholders cash out without realizing they could have matched the redemption to a tuition payment and avoided the tax hit altogether.
The statute itself, codified in Section 135, sets out the conditions: the bonds must be Series EE or I, issued after 1989, and the owner must have been at least 24 years old at the time of purchase. Qualified expenses include tuition and fees at eligible institutions, and the exclusion phases out as modified adjusted gross income rises above thresholds published annually by the IRS. If a taxpayer’s income exceeds the upper limit, the exclusion disappears entirely, even if every other requirement is met.
A testable question sits at the center of how this benefit actually reaches households. Because paper bond sales at tax time have largely ended and purchases now flow through TreasuryDirect, adoption of the education exclusion may shift measurably toward digitally active filers. Correlating TreasuryDirect redemption volumes with MAGI ranges in IRS enforcement files could reveal whether the transition away from paper bonds expanded or narrowed the pool of families who claim the break. No public dataset currently answers that question, a gap that limits any confident assessment of the program’s reach.
IRS Verification, Forms, and the Income Ceiling
The IRS does not simply take a filer’s word for it. IRS Publication 550 for 2025 states that the agency verifies the Section 135 exclusion using bond redemption information supplied by the Department of the Treasury. That cross-check means filers who claim the exclusion without actually redeeming qualifying bonds risk automated correction notices and potential penalties if the misstatement is significant.
Recordkeeping starts before the tax return. The IRS recommends using Form 8818 to log redemptions of post-1989 EE and I bonds, and the data recorded on that optional form feeds directly into Form 8815, which calculates the excludable interest. Skipping Form 8818 does not disqualify a filer, but losing track of serial numbers, face values, and redemption dates can make completing Form 8815 difficult and increase the risk of mismatches with Treasury data.
The income ceiling is the second major filter. The exclusion is reduced as modified adjusted gross income enters a phaseout band and is eliminated once income exceeds the top of that range. Because the thresholds adjust annually, families planning around multi-year tuition bills need to watch not just when bonds will be redeemed, but also how scholarships, withdrawals from other accounts, and capital gains might push them over the limit in a given year.
Coordinating with Other Education Benefits
Section 135 does not operate in isolation. The same dollar of tuition cannot be used both to justify tax-free bond interest and to support a claim for education credits such as the American Opportunity Tax Credit or the Lifetime Learning Credit. Households that layer multiple benefits must allocate expenses carefully, assigning some costs to the credits and others to the bond exclusion to avoid double counting.
Coordination issues are especially acute when 529 plan distributions enter the picture. Qualified 529 withdrawals are already tax-free if used for education costs, so pairing them with the bond exclusion on the same expenses can trigger adjustments from the IRS. Tax preparers often recommend mapping out which dollars will be covered by which benefit before the semester begins, then timing bond redemptions to fill remaining uncovered expenses.
Planning Around Redemption and Ownership
Ownership structure can make or break eligibility. The exclusion belongs to the bond owner, not necessarily the student whose education is being funded. If grandparents own the bonds and redeem them to pay a grandchild’s tuition, they must meet the age, issuance, and income tests, and the expenses must be incurred by the owner, spouse, or dependent as defined for tax purposes. Families that discover this too late may find that bonds held in the “wrong” name generate fully taxable interest.
Timing also matters. The law requires that qualified expenses be paid in the same tax year the bonds are redeemed. Paying spring tuition in December and waiting until January to cash in the bonds can sever the link needed for the exclusion. Conversely, redeeming bonds in December to cover a bill that is not paid until January can create a similar mismatch. Aligning bursar payments and redemption dates on a calendar-year basis helps preserve eligibility.
A Narrow but Valuable Tool
For households that thread all of these needles, the payoff can be substantial. Decades of accrued interest on Series EE and I savings bonds can be sheltered from federal income tax when used for qualifying education costs, effectively boosting the after-tax return on what is already a low-risk investment. Treasury’s own savings bond tax page underscores that the exclusion is limited but potentially powerful, and that careful documentation is essential.
As college costs continue to rise and older bond issues reach maturity, awareness of the Section 135 exclusion may determine whether families surrender a portion of their savings to taxes unnecessarily. The rules are technical, but they are also stable enough to plan around, making this niche benefit worth a closer look before the next tuition bill comes due.
Warren Cohen is a finance writer based in Phoenix, Arizona, covering personal finance topics including credit, banking, and beginner investing. He earned his degree in business administration from Arizona State University and began his career working in consumer finance, where he gained direct experience with lending and credit systems. He now writes for personal finance websites and fintech platforms, focusing on clear, practical content that helps readers make informed financial decisions.
