BUREAU OF THE PUBLIC DEBT Legal Aspects of United States Savings Bonds Preface As of September 1, 1998 This pamphlet is designed to highlight various "legal aspects" of United States Savings Bonds, with emphasis on tax liability and reissues. While intended primarily for lawyers, trust officers, accountants, and legal representatives of estates, it may also serve as a guide for anyone who has decisions to make concerning the disposition of outstanding savings bonds or the form of registration for new bonds. Subjects are discussed here only in summary form. The pamphlet is not intended as a substitute for complete and qualified legal advice. For further details, see the regulations contained in current editions of official Treasury Circulars listed below and referred to in the text. Series E and Series H and Savings Notes (Freedom Shares): Circular No. 530—Governs United States Savings Bonds of all series except EE, HH, and I (Title 31, Code of Federal Regulations, Part 315). Circular No. 653—Offering Circular for Series E Bonds, issued from May 1941 through June 1980 (Title 31, Code of Federal Regulations, Part 316). Circular No. 905—Offering Circular for Series H Bonds, issued from June 1952 through December 1979 (Title 31, Code of Federal Regulations, Part 332). Circular No. 1036—Exchange offering of Series H Bonds (Title 31, Code of Federal Regulations, Part 339). Public Debt Series No. 3-67—Offering Circular for U.S. Savings Notes, issued from May 1967 through October 1970 (Title 31, Code of Federal Regulations, Part 342). Series EE and Series HH: Public Debt Series No. 1-80—Offering Circular for Series EE Bonds, issued January 1980 and thereafter (Title 31, Code of Federal Regulations, Part 351). Public Debt Series No. 2-80—Offering Circular for Series HH Bonds (including exchange offering), issued January 1980 and thereafter (Title 31, Code of Federal Regulations, Part 352). Public Debt Series No. 3-80—Governs United States Savings Bonds of Series EE and HH (Title 31, Code of Federal Regulations, Part 353). Series I: Public Debt Series No. 1-98—Offering Circular for Series I Bonds issued September 1998 and thereafter in denominations of $50, $75, $100, $500, $1,000, and $5,000 and for Series I Bonds issued May 1999 and thereafter in denominations of $200 and $10,000 (Title 31, Code of Federal Regulations, Part 359). Public Debt Series No. 2-98—Governs United States Savings Bonds of Series I (Title 31, Code of Federal Regulations, Part 360). References to Department of the Treasury circulars hereafter will be to the current edition and will be abbreviated, such as DC 530 and DCPD 3-80. References to the Code of Federal Regulations will be by title number and section number, for example, 31 CFR 315.25. Wherever in the text references to bonds indicate that the securities being referred to are of the accrual type, the term "bonds" includes United States Savings Notes. References to Internal Revenue Service Rulings will be to the Cumulative Bulletin for the year in which the ruling was issued. For example, Revenue Ruling 143 for 1954, appearing in Volume 2 of the Cumulative Bulletin for 1954 at page 12, would be cited as Rev. Rul. 54-143, 1954-2 C.B. 12. Copies of current Treasury circulars may be obtained from any of the five Federal Reserve Banks or Branches listed below, or from the Savings Bond Operations Office, Parkersburg, WV 26106-1328. Internal Revenue materials should be obtained from the Office of the District Director, Internal Revenue Service. Federal Reserve Offices That Provide Savings Bond Services Servicing Office Reserve Districts Served Geographic Area Served Buffalo Branch Federal Reserve Bank P.O. Box 961 Buffalo, NY 14240-0961 716/849-5165 New York and Boston CT, MA, ME, NH, NJ (northern half), NY, RI, VT, Puerto Rico, and Virgin Islands. Pittsburgh Branch Federal Reserve Bank P.O. Box 299 Pittsburgh, PA 15230-0299 412/261-7800 Cleveland and Philadelphia DE, KY (eastern half), NJ (southern half), OH, PA, and WV (northern panhandle). Federal Reserve Bank of Richmond Savings Bond Operations P.O. Box 85053 Richmond, VA 23285-5053 804/697-8370 Richmond and Atlanta AL, DC, FL, GA, LA (southern half), MD, MS (southern half), NC, SC, TN (eastern half), VA, and WV (except northern panhandle). Federal Reserve Bank of Minneapolis P.O. Box 214 Minneapolis, MN 55480-0214 612/204-5000 (ask for "Savings Bond area") Minneapolis and Chicago IA, IL (northern half), IN (northern half), MI, MN, MT, ND, SD, and WI. Federal Reserve Bank of Kansas City P.O. Box 419440 Kansas City, MO 64141-6440 816/881-2919 Dallas, San Francisco, Kansas City, and St. Louis AK, AR, AZ, CA, CO, HI, ID, IL (southern half), IN (southern half), KS, KY (western half), LA (northern half), MO, MS (northern half), NE, NM, NV, OK, OR, TN (western half), TX, UT, WA, WY, and Guam. Contents Income Tax Status 1 The Education Tax Exclusion 2 Shifting of Income Tax Liability 3 Handling of Bonds Upon Death of Owner/Coowner/Beneficiary 5 Federal Estate Tax 12 Federal Gift Tax 16 State Gift Tax 18 State Inheritance Tax 18 Verifying Holdings 18 Payment to Other Than Registered Owner 19 Payments to Minor 20 Series HH Bond Exchange Privilege 20 Partial Redemption 21 Lost, Stolen, Destroyed, or Mutilated Bonds 21 Limitation on Transfer or Pledge 22 Limitation on Judicial Proceedings 22 Chain Letter Schemes 23 Miscellaneous Provisions 23 1 Income Tax Status The interest on all United States securities issued since March 1, 1941, is subject to Federal income tax. However, the interest is exempt from any taxation of income by a state, municipal, or local taxing authority. Regulations under the Interest and Dividend Tax Compliance Act of 1983 require that the taxpayer identifying number of the person presenting a savings bond/note for payment be furnished at the time of redemption. For individuals, this is their social security number. Savings bonds will not be redeemed if the payee's taxpayer identifying number is not furnished. In addition, Series HH bonds will not be issued unless the owner provides the certification of taxpayer identifying number required by IRS regulations. (See IRS Form W-9.) Under certain conditions, interest paid on savings bonds may be subject to backup withholding under the Act. Series E, EE, and I Bonds, and Savings Notes (Freedom Shares) The difference between the purchase price of a Series E/EE/I bond or savings note and its redemption value is considered interest under the Internal Revenue Code. If a taxpayer is on the accrual basis for income tax purposes, the interest on Series E/EE/I bonds and savings notes must be reported as income each year. If a taxpayer is on a cash basis, however, one of two methods may be chosen in accounting for the interest on the securities. They are: . defer reporting of interest until the year in which the Series E/EE/I bonds or savings notes are cashed, disposed of, or reach final maturity, whichever occurs first, or . report interest each year as it accrues. If a taxpayer elects to report the interest as it accrues, all interest accrued and not previously reported on all appreciation-type securities owned must be included as income for the tax year in which the election is made. Once the election to report interest as it accrues has been made, a taxpayer cannot switch to deferring reporting the interest without prior notification to the Internal Revenue Service. This change is exempt from the fee for filing IRS Form 3115 (See 26 CFR 1.454-1, Rev. Proc. 89-46). Series H and HH Bonds Interest on Series H and Series HH bonds is paid semiannually by check or by direct deposit, and must be reported annually for Federal income tax purposes. Direct deposit is mandatory for bonds issued since October 1, 1989. 2 Income Tax Liability on Bonds/Notes Registered in Coownership Form The accompanying table indicates the Federal income tax liability on savings bonds/notes registered in coownership form and cashed during the lifetimes of both coowners - regardless of which coowner cashes Series E/EE/I bonds or savings notes, or receives the interest on Series H or Series HH bonds. How Purchased "A" buys bond in name of "A" and "B" coowners "A" and "B" buy bonds in coownership each contributing part of the purchase price "A" and "B" receive bonds in coownership as a gift from "C" Who is Liable for TAX* Interest is income to "A" as the person who contributed the purchase price Interest is income to both "A" and "B" in proportion to their contributions to the purchase price Interest is income to both "A" and "B" - 50 percent to each owner * Also applies to tax-deferred Series E/EE bond and note interest, as noted on Series H/HH bonds received in exchange. The Education Tax Exclusion The Technical Corrections and Miscellaneous Revenue Act of 1988 amended the Internal Revenue Code of 1986 to provide a new section 135 (26 USC 135) which authorizes a special tax exclusion of the interest income from savings bonds issued after December 31, 1989 (Series EE and I bonds) and redeemed in a year in which qualified owners pay offsetting post-secondary educational expenses. The general provisions of section 135, including restrictions, are outlined below. To qualify for the interest exclusion, the bonds must be of Series EE issued after December 31, 1989, or Series I bonds. The bonds must be issued to individuals who are at least 24 years old on the first day of the month in which the bonds are issued and redeemed in the year in which the owner pays qualified post-secondary educational expenses of the owner, the owner's spouse, or the owner's dependent. If the bonds are intended to help pay for the educational expenses of dependent children, the parent will be able to benefit from the tax exclusion only if the bonds are issued in either one parent's name or both parents' names. To be eligible for the exclusion, bonds cannot be issued in the name of a child, although the child may be the registered beneficiary. Qualified educational expenses include tuition and fees to an eligible educational institution. Room, board, and books are not qualified educational expenses. Eligible educational institutions include colleges, universities, technical institutes, and vocational schools within the United States. For tax years starting after December 31, 1997, “The Taxpayer Relief Act of 1997” enacted August 5, 1997, added contributions to qualified State tuition programs to the definition of qualified higher education expenses. This means that if a taxpayer redeems his or her savings bonds and pays the proceeds into a qualified State tuition program, all or part of the interest earned on the bonds redeemed may be eligible for exclusion from the taxpayer’s modified adjust gross income (MAGI) 3 for that year as long as all applicable requirements of the tax regulations are met. In other words, contributing eligible savings bond proceeds to a qualified State tuition program is treated in the same manner as payment of those proceeds to a qualified higher education institution. Subject to other limitations outlined in this section, particularly the income limits referred to below, the interest on qualifying bonds will be fully exempt from Federal income tax only if the qualifying tuition and fees paid during the year are equal to or more than the redemption proceeds (principal and interest) of qualified bonds, regardless of how the qualifying bond proceeds are actually used. If tuition and fees are less than the value of the bonds cashed, the exemption is proportional to the percentage of the value that was used for tuition and fees. For example, if $10,000 worth of bonds are redeemed during the year, but tuition and fees total only $8,000, 80 percent of interest income is exempt from Federal income tax. Income limits apply to the taxpayer's modified adjusted gross income in the year bonds are redeemed and tuition is paid. These income limits are adjusted annually for inflation and can be found in the instructions on the IRS Form 8815 for the tax year involved. Modified adjusted gross income includes the bonds' accumulated interest before exclusion. Married taxpayers must file a joint return to be eligible for the exclusion. The Internal Revenue Service has issued Form 8818 to assist taxpayers in keeping records of bonds that may qualify for the interest exclusion. IRS Form 8815 should be filed in the year the exclusion is being claimed. To obtain copies of the forms and to get additional information on the exclusion, taxpayers should call or write their district IRS office. Shifting of Income Tax Liability A change in the registration of a savings bond that does not change its ownership will not result in a shifting of income tax liability. This means that if the original sole owner of a bond has it reissued to add the name of another person as coowner or beneficiary, the transaction is not considered a disposition that requires the owner to include in his or her gross income the accrued interest on the bond. (Rev. Rul. 64-302, 1964-2 C.B. 170; Rev. Rul. 58-2, 1958-1 C.B. 236.) Note, however, that regulations governing Series I bonds do not permit reissue to eliminate the name of a living owner or coowner from an I bond’s registration unless the owner or at least one of the coowners is obtaining a divorce from his or her spouse or the marriage of the owner or at least one of the coowners is being annulled. (See Sections 360.22 and 360.47 in DCPD 2-98.) Similarly, if a Series EE savings bond is registered in the name of the person who furnished the funds for its purchase and in the name of another person as coowners and the bond is reissued to eliminate the name of that other person (the one who did not provide the money to buy the bond) no disposition or taxable event has occurred. (Rev. Rul. 68-61, 1968-1 C.B. 346.) If the name of a living person liable for income tax on an eligible Series E/EE/I bond or savings note is removed, the change in registration is considered a disposition of the bond. (See "Income Tax Liability on Bonds/Notes Registered in Coownership Form," page 2.) For the tax year of the disposition, the accrued interest must be reported as part of the gross income of the person whose name is removed. See Rev. Rul. 55-278, 1955-1 C.B. 471, which discusses the tax aspects of 4 making a gift of Series E bonds. When a taxable disposition occurs in a reissue transaction, the reporting and backup withholding provisions of the Internal Revenue Code apply even though no interest payment is received by the former owner. Here are some examples: . Exchange of Series EE for Series HH The sole owner of Series EE bonds exchanges them for Series HH bonds. The Series HH bonds are issued in the owner's name and that of another individual as coowner. The change in registration is not a disposition that requires the original owner of the EE bonds to include in his or her gross income the accrued interest on those bonds. The owner has the privilege of continuing to defer reporting the accumulated interest on the Series EE bonds until the tax year in which the Series HH bonds are redeemed, are disposed of, or have reached final maturity, whichever is earlier. (Section 1037(a), Internal Revenue Code of 1986 as amended; 31 CFR 352.7(g).) The original owner of the Series EE bonds must be the owner or the first-named coowner of the Series HH bonds, and he or she is required to include in his or her gross income all of the Series HH bond interest paid semiannually. (Note: No exchange of I bonds for other series of savings bonds is permitted under the governing regulations.) . Transfer of Bond through Death of Owner An individual buys a savings bond with a nephew named as coowner (or beneficiary). The purchaser dies after several years; the nephew becomes sole and absolute owner of the bond. The death of the original owner does not result in a taxable event for Federal income tax purposes. The income tax liability for the accumulated interest would pass along with the bond to the nephew and would remain his along with liability for additional accruals. (See Rev. Rul. 64-104, 1964-1 C.B. 223.) However, if the person filing the final income tax return of the decedent elects to include all interest earned on all bonds owned by the decedent to the date of the decedent's death, the nephew's tax liability would extend only to the interest accruing from that date. (See Rev. Rul. 68-145, 1968-1 C.B. 203.) The tax liability would be the same if the purchaser in this example had bought the bond in his or her name alone, and the nephew had received the bond as a specific legacy and had it reissued in his name. However, if the bond were received not as a specific legacy, but as a settlement of a specific dollar legacy, then the legal representative of the estate for Federal income tax purposes would report the accrued interest up to the time of distribution. The nephew would assume income tax liability for the interest accruing after reissuance. In most cases where the bonds are part of a distributive share, the tax liability for the accrued interest simply passes on to the heirs or legatees. . Reissues from Parent to Child A parent who has bought and held a Series E or Series EE bond for several years decides to make a gift of it to his or her child. The bond is reissued in the child's name alone, or with the parent or 5 someone else as beneficiary. Such a reissue is a taxable event. Any accrued interest would have to be included in the gross income of the parent for the taxable year in which the reissue took place. The interest accruing thereafter would be the liability of the child for income tax purposes. (See Rev. Rul. 54-327, 1954-2 C.B.50.) (Regulations do not permit this reissue for I bonds. See Section 360.47 of DCPD 2-98.) . Transfer of a Bond to a Trust Upon the reissuance of bonds to a trust, the owner must include in gross income the accumulated interest on the bonds, including any tax-deferred increment noted on the Series H/HH bonds, unless, under the grantor trust provisions of the Internal Revenue Code, the owner of the bonds is treated as the owner of the portion of the trust represented by the tax-deferred accumulated interest on the reissued bonds. If the bondowner is treated as the owner of that portion, the accumulated interest continues to be income of the bondowner rather than of the trust and, therefore, the bondowner can continue to defer reporting the interest earned each year. The bondowner must include the total accumulated interest in gross income for the tax year in which the bonds are redeemed, otherwise disposed of, or reach final maturity, whichever is earlier. These rules apply when bonds being reissued are Series E/EE/I bonds or savings notes or when bonds being reissued are Series HH bonds received in exchange for Series E/EE bonds or savings notes. NOTE: In the foregoing examples, it is assumed that all persons are on the cash reporting basis and have not elected to report their bond interest annually as it accrues. Most taxpayers use the cash method of accounting. Additional information, and letter rulings, may be obtained by writing to: Internal Revenue Service, Associate Chief Counsel (Domestic), Attention CC:CORP:T, P. O. Box 7604, Ben Franklin Station, Washington, DC 20044. Contact that office for instructions on the information to be submitted in connection with a letter ruling request. Handling of Bonds Upon Death of Owner/Coowner/Beneficiary Savings bonds owned by natural persons may be registered in one of three forms - one person as sole owner, two persons as owner and beneficiary, or two persons as coowners. Procedures to follow in the event of death of the owner, coowner, or beneficiary are described here for each type of registration. In all cases, appropriate evidence may include: certified copies of death certificates; certified copies of letters of appointment; and/or, certified copies of final accounts and court decrees and orders. One Person as Sole Owner: A bond registered in the name of one individual only (or to which the decedent was the sole person entitled at the time of death) becomes a part of the estate on the death of the owner. (See Section 315.70(a) of DC 530, Section 353.70(a) of DCPD 3-80, and Section 360.70(a) of DCPD 2-98.) In such cases, the bond will be paid or reissued upon the request of the legal representative of the decedent's estate, in accordance with Treasury regulations. The procedure to be followed will depend on whether the estate is administered and whether the bonds are of Series I or of another series, such as, E, EE, H, or HH. 6 . In the course of administration If the estate is being administered, the bond may be paid to the representative or reissued in the name of a distributee. (See Section 315.71(a) of DC 530, Section 353.71(a) of DCPD 3-80, and Section 360.71(a) of DCPD 2-98.) For Series I bonds, the representative should use Public Debt Form 5394 to request redemption or reissue of bonds of that series. He or she should follow instructions on the form and provide any supporting evidence and forms indicated in those instructions. For savings bonds of other series and savings notes, the representative’s requests for payment should be supported by evidence of the representative's authority and can be submitted to any financial institution qualified as a savings bonds paying agent. On the back of each bond in the estate, the representative’s signature in each request for redemption should include a reference to the fiduciary capacity and should be certified or guaranteed if the agent opts not to redeem the bonds and instead elects to forward the bonds unpaid to a servicing Federal Reserve Office for redemption. Representatives requesting reissue should file Public Debt Form 1455 along with evidence of the representative's authority. If the new owner desires to name a coowner or beneficiary, an additional request on Public Debt Form 4000 should be executed. (This can be a simultaneous transaction if both forms are submitted with the bond to a servicing Federal Reserve Bank or Branch.) The representative’s evidence of authority should be certified to be true and correct under seal of the court clerk and should be dated within 6 months of the transaction if more than a year has passed since the representative’s appointment. . After administration is closed If the decedent’s estate has been settled in court, the bond will be paid to, or reissued in the name of, the appropriate heir or legatee as determined by court records. (See Section 315.71(b) of DC 530, Section 353.71(b) of DCPD 3-80, and Section 360.71(b) of DCPD 2-98.) Persons entitled to Series I bonds should use Public Debt Form 5394 and follow procedures in instructions on that form. For savings bonds of other series and savings notes, the persons entitled to the decedent’s estate may execute the requests for payment on the backs of the bonds or use a detached request for payment (Public Debt Form 1522). If reissue is desired, the heirs should execute Public Debt Form 4000. Requests for either payment or reissue should be supported by evidence of the court's determination, e.g., a certified copy of the court-approved final account for the estate, the court’s decree of distribution, or other pertinent court records. . Without administration For Series I bonds, if no legal representative of the decedent's estate has been or will be appointed, persons entitled should use Public Debt Form 5394 and follow procedures in instructions on that form. (See Section 360.72 of DCPD 2-98.) For savings bonds of other series and savings notes, the bonds may be paid or reissued pursuant to an agreement signed by all persons entitled to share in the estate (Public Debt Form 5336 for all series of savings bonds, except Series I bonds.). Such persons are determined in accordance with state law. Payment of outstanding debts can also be accomplished in this manner, but bonds may not be reissued in the name of a creditor. (See Section 315.72 of DC 530 and Section 353.72 of DCPD 3-80.) [...]... For savings bonds of other series and savings notes: certified copy of letters testamentary or of administration or, Public Debt Form 2488-1 if face amount of bonds totals $1,000 or less For savings bonds of other series and savings notes: certified copy of death certificate Series EE and HH bonds - no evidence necessary if decedent is beneficiary For savings bonds of other series and savings notes, Public. .. or of administration on estate of person last deceased, or Public Debt Form 2488-1 if face amount of bonds totals $1,000 or less, For Series I bonds, see Public Debt Form 5394 For savings bonds of other series and savings notes: certified copy of decree of distribution or final account or, Public Debt Form 2458 if face amount of bonds totals $1,000 or less For savings bonds of other series and savings. .. death of "B", if "A" is still living If "A" and "B" are spouses, half the value of the bonds is included in the gross estate of the first to die However, if "A" dies first and "B" is not a United States citizen, the total value of the bonds is included in "A's" estate If "B" dies first and "A" is not a United States citizen, no part of the value of the bonds is included in "B's" estate 15 Source of Funds... Source of Funds Form of Registration Gift Tax Estate Tax "A" and "B" "A" or "B" Neither "A" nor "B" has gift tax liability in the year of purchase Should either permit the other, during the lifetime of both, to obtain and retain the redemption value of the bond, the other would have a gift tax liability in the year of redemption for that portion of the redemption value that represents the proportion of the. .. absolute owner of the bond If the decedent bought the bond, the Federal income tax liability on the interest earned to date of death ordinarily shifts to the survivor The bond may: 1 be redeemed 2 be reissued Proof of death of the other coowner and a request on an appropriate form— Public Debt Form 5387 for Series I bonds, and Public Debt Form 4000 for savings bonds of other series and savings notes—... are spouses, half the redemption value of the bonds is included in the gross estate of the first to die regardless of the relative contributions of "A" and "B" However, if the survivor of "A" and "B" is not a United States citizen, that portion of the redemption value on the date of death proportionate to the survivor's contribution to the purchase price would be excludable from the decedent's gross... name of the donee as owner or by way of authorized reissue, like similar transfers of other property, is subject to Federal gift tax (See Instructions for IRS Form 709.) In the case of reissue of savings bonds, the redemption value at the time that the gift is made is used in determining the amount of the gift Who is Liable The tax is imposed on the donor However, should the donor fail to pay the tax... provide proof of death of the owner in order to cash the bond or have it reissued (See Section 315.70(c) of DC 530, Section 353.70(c) of DCPD 3-80, and Section 360.70(c) of DCPD 2-98.) For Series E and Series H bonds and notes, if the beneficiary dies first, the owner may, upon submitting proof of the beneficiary's death, have the bond reissued to name another beneficiary or coowner Proof of the beneficiary’... extent of the value, at the time of the decedent's death, of the savings bonds and other property received (See Instructions for IRS Form 706.) Determining Bond Values When savings bonds form a part of the estate for tax purposes, the redemption value on the date of the owner's death (or alternate valuation date, if elected) is the amount used in computing the gross estate Tables of redemption values... of coowner bonds, many states follow the rule applied under the Federal estate tax provisions by measuring each coowner's taxable interest in the bonds by the amount contributed to the purchase price Other states treat the bonds as held in equal shares by each coowner and require that one-half of their value be reported as part of the gross estate of the coowner first to die, regardless of whose funds . BUREAU OF THE PUBLIC DEBT Legal Aspects of United States Savings Bonds Preface As of September 1, 1998 This pamphlet is designed to highlight various " ;legal aspects& quot; of United. reissued. Proof of death of the other coowner and a request on an appropriate form Public Debt Form 5387 for Series I bonds, and Public Debt Form 4000 for savings bonds of other series and savings. the name of one individual only (or to which the decedent was the sole person entitled at the time of death) becomes a part of the estate on the death of the owner. (See Section 315.70(a) of