A person in the 35% tax bracket receives more benefit from the tax savings than does a person in the 25% tax bracket.

Most municipal bond interest is also free of AMT or the alternative minimum tax.Īs a result, the higher the investor’s tax bracket, the benefit of the tax-free income becomes greater. Other tax exemptions can include being free of city income taxes as well in cities like New York City when qualifying municipal bonds are purchased. (We will cover state taxation rules in a later chapter.) However, if the same LA resident purchased a Texas municipal bond, the income would still be tax-free on a federal level, but the California resident would owe California state income taxes since it is a bond issued out-of-state. For instance, a resident of Los Angeles can buy any municipal bond issued by a municipality in California and will not have to pay California state income taxes on the interest income. In most states, the interest income from municipal bonds issued by an issuer in the state is free from state income taxes in that state.

EXAMPLE: If you buy $10,000 worth of municipal bonds with a 4% coupon, the $400 you receive every year is tax-free.Īdditionally, municipal bonds can be free of state income taxes as well.

Not even US Treasuries offer income that is free from federal income taxes. This is the most significant benefit of municipal bonds and it is a characteristic unique to municipal bonds. The interest income earned from most municipal bonds is exempt from all federal income taxes regardless of your tax bracket. Federal tax-exemption of municipal bonds.

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