26 U.S.C. § 135 — Income from United States savings bonds used to pay higher education tuition and fees

(a) General rule. If someone redeems a "qualified United States savings bond" during the tax year and uses the money to pay "qualified higher education expenses" that same year, the redemption money is not included in their taxable income. (b) Limitations. (1) Limit when bond proceeds exceed expenses: if the total bond proceeds someone redeems during the year are more than the qualified education expenses they paid that year, the tax-free amount is capped. It can only be as large as a fraction of what would otherwise be excludable — a fraction where the top number is the education expenses paid, and the bottom number is the total bond proceeds redeemed. (2) Limit based on income: if the taxpayer's modified adjusted gross income is over $40,000 ($60,000 for a joint return), the tax-free amount shrinks. Start with the amount that would otherwise be excludable. Figure the taxpayer's income above the $40,000 or $60,000 threshold. Reduce the excludable amount by the same fraction that this excess income bears to $15,000 ($30,000 for a joint return) — so the exclusion is fully phased out once income is $15,000 (or $30,000) over the threshold. Starting with tax years after 1990, the $40,000 and $60,000 thresholds increase each year using a cost-of-living formula tied to a separate part of the tax code. If the adjusted number is not a multiple of $50, round it to the nearest $50 — round up to the next $50 if it lands exactly on a multiple of $25. (c) Definitions. (1) A "qualified United States savings bond" is a savings bond issued after December 31, 1989, to someone who was at least 24 years old when it was issued, sold at a discount under the relevant Treasury law. (2) "Qualified higher education expenses" means tuition and fees required for the taxpayer, the taxpayer's spouse, or a dependent the taxpayer claims, to enroll in or attend an eligible school. This does not include expenses for sports, games, or hobby courses, unless they are part of a degree program. It does include contributions made to a 529 qualified tuition program, or to a Coverdell education savings account, on behalf of someone described above — though the tax-free part of such a contribution does not increase that person's "investment in the contract" for other tax purposes. (3) "Eligible educational institution" has the same meaning given in section 529(e)(5). (4) "Modified adjusted gross income" means the taxpayer's regular adjusted gross income, calculated while ignoring this section and several other specific sections — including ones covering foreign income exclusions and student loan interest — and after applying a few other specific sections, including the ones covering Social Security income and passive activity losses. (d) Special rules. (1) Before applying the (b) limits, qualified education expenses must first be reduced by any amount the individual received for that education as: a tax-free scholarship; a VA educational assistance allowance; a tax-exempt payment for education expenses, other than a gift, bequest, devise, or inheritance; or a payment, waiver, or reimbursement under a 529 tuition program. (2) Expenses must also be reduced, before the (b) limits, by whatever amount was used to figure the education tax credit under section 25A, and by amounts used to figure the tax-free treatment under the 529 and Coverdell account rules. (3) Married taxpayers who file separate returns cannot use this exclusion at all — it applies only if a married taxpayer and their spouse file a joint return for the year. (4) The Treasury Secretary may write regulations needed to carry out this section, including rules on recordkeeping and information reporting.