Holding Series E bonds could cost ovener's heirs more

Continuing to hang onto Series E Savings Bonds could cost your heirs more than they might cost you. This reader's situation could be similar to yours. "I have about $90,000 in E-bonds purchased between 1941 and 1967. I have begun to redeem those purchased in 1941 and plan to retain the rest until they no longer draw interest.

"My survivors will inherit them but must pay tremendous inheritance and other taxes. I am single and have plenty to live on without depending on E-bond interest. Am I foolish in continuing to treat these E-bonds this way?"

E-bonds are unique; they don't conform to certain rules applicable to other, similar investments. While their semiannual increases in redemption value represent interest accumulations, the higher values are not taxed as long-term gains. Instead, all of the difference between the original purchase price and redemption value is taxed as ordinary income.

When E-bonds are included among the assets of a decedent for figuring federal estate taxes, their redemption value is taken as of the date of death. Under certain conditions the beneficiary of E-bonds can take a deduction on his or her federal income tax for an estate tax paid that is attributable to interest on the E-bonds included in a decedent's estate. If there was no tax paid, then the beneficiaries are liable for tax on the accumulated interest at the time they redeem the E-bonds. Interest on E-bonds is not subject to state income taxes, but the E-bonds' full value will be used in figuring inheritance taxes.

Because of these tax liabilities, you may be doing your heirs a favor if you redeem the E-bonds, pay income taxes due on the accumulated interest and give the remaining cash up to $3,000 a year for each donne. There are several potential advantages to such a program:

1. Your income tax bracket may be less than your heirs'. you would need to figure the marginal tax rate payable on accumulated interest and compare. If your heirs were minors with few if any tax liabilities, they could receive your E-bonds, declare the interest, and still pay little or no taxes because their total income would be under the limit. However, if your heirs are working adults, their marginal income tax rates are likely to be higher than yours. Thus, you could pass along tax-free cash to them as a gift without incurring a gift-tax liability as long as annual gifts did not exceed $3,000 per person.

2. Without knowing the value of your total estate, you could reduce estate taxes by redeeming the E-bonds and giving the cash prior to death. As long as the redemptions do not exceed $3,000 for each donee, you incur no gift tax liabilities. You cannot give E-bonds without redeeming them unless the donee is listed as co-owner. Then income tax liability is the co-owner's.

3. Your heirs would pay no inheritance taxes on the after-tax value of your E- bonds. This way, you pay only the income tax due; they pay nothing additional as long as annual gifts do not exceed $3,000 per person.

4. Since you state that you have plenty to live on without depending on E-bond interest, you are not reducing your living income. Actually, until you redeem an E- bond, you cannot spend the interest. Some retirees cash in long-held E-bonds on a regular schedule to increase their spendable income. If you do not use or need this income, giving some of the E-bonds while you are liv ing could reduce overall taxes.