Under present federal income tax law, the interest income you receive from investing in municipal bonds is not subject to federal income taxes.* In most states, interest income received from securities issued by governmental units within that state is also exempt from state and local taxes. In addition, interest income from bonds issued by U.S. territories and possessions is exempt from federal, state and local income taxes in all 50 states.
One of the best ways to appreciate the tax-exempt advantage of a municipal bond is to compare it to a taxable investment. For example, assume you are in the 33% federal tax bracket, file a joint return and with your spouse, claim $210,000 in taxable income.
Now assume you have $30,000 to invest and you are considering two alternative investments: a taxexempt municipal bond yielding 5.0%, and a taxable corporate bond yielding 7.0%. Which investment will prove most advantageous in terms of after-tax income?
If you invest your money in the municipal bond, you would earn $1,500 in interest (a 5.0% yield) and not pay any federal income taxes. The taxable bond investment, however, would provide you only $1,407 in income after federal income taxes had been deducted (a 4.7% yield).
As you can see, the municipal bond would provide the better yield after taxes are taken into account. The tax-exempt bond yield advantage would be an even better investment if you accounted for state and local income taxes when calculating returns on the taxable bond investment.
To determine the yield you would need to earn from a taxable investment to equal the yield on a taxexempt security, refer to the chart on pages 12 and 13, or visit investinginbonds.com to use our Tax-Free vs. Taxable Yield Comparison Calculator online.