Are taxes due on old savings bonds?

Lynn Brenner | Family Finance

12:25 PM EST, March 7, 2008

Recently my 89-year-old uncle told me his late wife had left some E Series savings bonds. I found there are approximately 99 bonds, with a face value of $7,000. Most of them are more than 30 years old.

The bank estimates they're worth $20,000 to $25,000 with the interest they've earned. My uncle's yearly income is approximately $15,316. He wants to cash them in and transfer the money to a checking and/or savings account. His tax accountant said, "considering his income and expenses," he can "safely" transfer only up to $5,000 of the interest without being heavily penalized. Is there any solution?

R.W., via e-mail

It's unclear what "penalty" the tax accountant is referring to, other than income tax due on the accrued bond interest. Are you concerned that the interest would increase his income enough to make his Social Security taxable? His Social Security benefit won't be subject to taxes unless his "provisional" income exceeds $25,000, says Barry C. Picker, a Brooklyn tax accountant -- and it doesn't sound as if this will be a problem. Your uncle's "provisional" income includes only half of his Social Security benefit. You say his annual income is $15,316. Let's assume $15,000 is from Social Security, and $316 is investment income. That makes his "provisional" income $7,816 -- half his Social Security benefit ($7,500) plus $316 of investment income. It would take $17,185 of bond interest to push his "provisional" income over $25,000.

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Of course, he will owe taxes on the interest when he cashes in the bonds. He'll get a Form 1099, stating the amount of taxable interest he has received.

The tax on accrued interest was due when the bonds reached maturity. The person responsible for paying it was your uncle's late wife. Technically, your uncle can't be taxed in 2008 on income that should have been taxed before 2005, because, three years after a tax return is filed, it's closed. And the government can't come back and demand taxes. (There are important exceptions: The statute of limitations is six years if you failed to report more than 25 percent of your income. And if you committed fraud, there is no statute of limitations.)

But in real life, your uncle won't want to argue these technicalities with the IRS, Picker says. He should cash in the bonds and pay the taxes. When bonds reach the maturity date, they stop accruing interest.

In your Feb. 3 column, you said that when you calculate the taxable profit on the sale of your house, you add the cost of home improvements to the original price. What if you don't have all the receipts, or you did the work on your own?

M.G., via e-mail

Estimate the fair market cost of the work to the best of your ability. The IRS knows that many people don't save all their receipts or canceled checks, and it won't reject a reasonable estimate.

You don't have to list the capital improvements on your tax return, or attach receipts or itemize capital improvements. You just have to be prepared to back up the amount if you're audited.

A capital improvement materially adds value to the house, like finishing a basement, replacing a roof, adding a bathroom or putting in new wiring. The key word is "materially." (You can't include the cost of replacing wallpaper, for example.)

Send questions to Family Finance, Business Desk, Newsday, 235 Pinelawn Rd, N.Y. 11747-4250, or e-mail to Bfamfin@aol.com. Include your age, income, and a list of major assets. Sorry, letters and e-mails can't be answered personally. Questions are addressed only in the column.