What are the tax implications of buying municipal bonds in another state?
If an investor buys the muni bonds of another state, their home state may tax interest income from the bond. It is beneficial to check the tax implications of each specific municipal bond before adding one to your portfolio, as you might be unpleasantly surprised by unexpected tax bills on any capital gains.
What are the characteristics of a municipal bond?
II) A municipal bond is a debt obligation issued by the federal government. III) The interest income from a municipal bond is exempt from federal income taxation. IV) The interest income from a municipal bond is exempt from state and local taxation in the issuing state.
What is the level of risk in municipal bonds?
All the bonds have the same maturity date and all have approximately the same level of risk. The general level of interest rates is declining. Martin is in the 33 percent federal income tax bracket and the 8 percent state income tax bracket. The municipal bonds are from his home state.
Are zero-coupon municipal bonds taxable?
Zero-coupon municipal bonds, which are bought at a discount because they do not make any interest or coupon payments, don’t have to be taxed. In fact, most aren't. As long as you’re investing in a local municipal bond, taxes won’t be a concern. This provides a big advantage over taxable bonds, even with lower interest.
Why are municipal bonds important?
Municipal bonds are debt securities issued by state, city, and county governments to help cover spending needs. From an investor's perspective, munis are interesting because they are not taxable on the federal level and often not taxable at the state level. Munis are often favored by investors in high-income tax brackets because ...
What is the tax rule for muni bonds?
This nugget of tax law states that if you purchase a bond at a discount and the discount is equal to or greater than a quarter-point per year until maturity, then the gain you realize at the redemption of the bond (par value minus purchase price) will be taxed as ordinary income, not as capital gains. This could mean the difference between paying 15% and 37% on the gain 2 for those in the top tax bracket.
What happens if you sell a zero coupon bond?
If you sell for less than the adjusted issue price, you suffer a capital loss, which can be utilized to reduce your overall tax bill. The biggest and most obvious benefit of zero-coupon bonds is that you’re buying the bond at a big discount to its face value. This is also known as the original issue discount or OID.
What is a muni bond?
A bond is a debt security issued by a company or government to raise money and cover spending needs. A municipal bond, also known as a muni, is debt security used to fund capital expenditures for a county, municipality, or state. Municipal bonds are commonly tax-free at the federal level ...
Is a muni bond federally taxed?
Although it is relatively uncommon, some muni bonds are federally taxed if the holder is subject to alternative minimum tax (AMT). If you are unsure whether a specific muni is subject to AMT, consult the broker before purchase.
Is a muni bond tax exempt?
However, some activities do not fall under this tax exemption. For instance, coupon payments for muni bonds sold to fund those activities are federally taxed, with one common example is a bond issued to fund a state's pension plan obligation. When this type of bond is for sale, brokers selling the bond should readily know whether it is taxable.
Do municipal bonds have federal or state taxes?
Municipal bonds are free from federal taxes and are often free from state taxes. If the bond purchased is from a state other than the purchaser's state of residence, the home state may levy a tax on the bond's interest income.
Answer
b. A municipal bond is a debt obligation issued by the federal government.
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Overview of Municipal Bonds
Municipal Bonds and Capital Gains
Municipal Bonds and "De Minimis"
Municipal Bonds and Federal Taxes
The Alternative Minimum Tax
Zero-Coupon Municipal Bonds
Muni Bond Taxes FAQs
- What Is the Distinguishing Feature of How Municipal Bonds Are Taxed?
Municipal bonds are free from federal taxes and are often free from state taxes. If the bond purchased is from a state other than the purchaser's state of residence, the home state may levy a tax on the bond's interest income. Alternatively, if the bondholder sells the bond and there is a g… - What Happens to Muni Prices When Taxes Increase?
Because municipal bonds are generally free from taxes, they become an attractive investment when taxes increase.6 Demand for munis increases, and, as a result, so do their prices.
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